The economic motivation to work arises from the fact that people need income to buy the goods and services they desire. As a consequence, people are willing to work—to supply labor.
There is an opportunity cost involved in working—namely, the amount of leisure time one sacrifices. People willingly give up additional leisure only if offered higher wages. Hence the labor supply curve is upward sloping.
A firm's demand for labor reflects labor's marginal revenue product. A profit-maximizing employer will not pay a worker more than the value of what the worker produces.
The marginal revenue product of labor tends to diminish as additional workers are employed on a particular job (the law of diminishing returns). This decline occurs because additional workers have to share existing land and capital, leaving each worker with less land and capital to work with. The decline in MRP gives labor-demand curves their downward slope.
The equilibrium wage is determined by the intersection of labor supply and demand curves. Attempts to set above-equilibrium wages cause labor surpluses by reducing the jobs available and increasing the number of job seekers.
Labor unions attain above-equilibrium wages by excluding some workers from a particular industry or craft. The excluded workers increase the labor supply in the nonunion market, depressing wages there.
Differences in marginal revenue product are an important explanation of wage inequalities. But the difficulty of measuring MRP in many instances leaves many wage rates to be determined by custom, power, discrimination, or opportunity wages.
