Chapter 8 The Labor Market

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Chapter 8The Labor Market
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The Labor Supply Decision (a)

• Do workers decide on how much to work?
• Many do not
• However, some workers do
• Part-time workers
• Workers who work overtime
• Workers who moonlight
• Salaried workers

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The Labor Supply Decision (b)

• The method workers use to decide on the goods
  they buy is the same as the method they use to
  allocate their scarce time to leisure or labor
• Buying more of good X means a consumer can afford
  less of good Y.
• There is also a trade-off between work and
  leisure.
• More work means less leisure but more consumption.

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Trade-offs for the Labor Supply Decision

• More money or more time off
• A job now but give up college or go to school and
  be poorer for a while but earn more money later.

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The Choice between Leisure and Consumption

• The opportunity cost of one hour of leisure is
  the wage a worker gives up and the consumption
  goods that wage could buy.
• This trade-off is the slope of the budget
  constraint.

160
16hrs
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The Choice between Leisure and Consumption (cont.)

• Suppose the wage is 10 per hour and the worker
  has 16 hours per day to supply to the labor
  market.
• If the worker supplies all 16 hours of labor,
  then he can consume 160 of consumption goods.
  This is the vertical intercept of the budget
  constraint.
• If the worker supplies 15 hours of labor, he can
  consume 150 goods, and so on.
• If he works zero hours, he can consume 16 hours
  of leisure but zero consumption goods. This is
  the horizontal intercept of the budget
  constraint.
• The worker-consumer chooses a point on his budget
  constraint that is best for him, and this gives
  his labor supply at the prevailing wage rate.

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Steves Budget Constraint Between Leisure and
Income
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The Real Wage (a)

• Workers are interested in the real wage.
• The real wage is the nominal wage adjusted for
  inflation.
• W nominal wage p price of consumption.
• Real wage w W/p.

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The Real Wage (b)

• When the real wage increases, the budget
  constraint gets steeper.
• When the real wage changes, a worker may change
  the amount she works.
• There are two effects at work the substitution
  effect and the income effect.

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Substitution and Income Effects (a)

• When the real wage rises,
• Leisure is more expensive (opportunity cost of
  leisure rises).
• The worker is richer.
• The substitution effect of a rise in the real
  wage
• Leisure more expensive, so the worker buys less
  leisure and works more.
• The labor supply increases.
• The income effect of a rise in the real wage
• The worker is richer and buys more normal goods
  CDs, restaurant meals, and leisure.
• Workers work less and the labor supply falls.

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Substitution and Income Effects (b)

• If the labor supply curve is upward sloping, then
  the substitution effect dominates the income
  effect.
• An increase in the real wage increases the labor
  supply.
• If the labor supply curve is backward bending,
  then the income effect dominates the substitution
  effect.
• An increase in the real wage reduces the labor
  supply (so leisure rises), e.g., doctors and
  dentists.

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Labor Participation (a)

• The reservation wage Wr is the minimum wage at
  which an individual supplies labor.

R
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Labor Participation (b)

• For most men, the decision is not whether to work
  but how much.
• Formerly it was presumed that women would drop
  out of the labor force to have children and that
  they would not reenter the labor force after the
  children were grown.
• Today women's labor force participation rate is
  over 50.

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Womens Labor Force Participation

• Womens labor force participation rate has risen
  dramatically over the last 40 years.
• In addition there has been an increase in the
  demand for women's labor as discrimination has
  been barred by federal law and attitudes have
  changed.
• Women's employment and wage situation can be
  explained partly by a shift of the labor supply
  curve and partly by a movement along the labor
  supply curve.

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Womens Labor Force Participation
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Labor Demand

• The demand for labor is a derived demand
• It depends on the demand for output workers
  produce
• Firms hire workers only if they are profitable.
• The last worker hired makes just enough output so
  that when it is sold, it equals his or her wage.

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The Marginal Product of Labor (a)

• Marginal product of labor (MPL)
• The output one additional worker produces
  (holding all other inputs, such as capital,
  constant)
• The law of diminishing marginal returns
• The MPL is a decreasing function
• As more labor is hired, successive units are less
  productive because they use less capital.

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The Marginal Product of Labor (b)

• Value of the marginal product (VMP)
• The revenue the additional worker earns for the
  firm
• The VMP is the value of the additional worker's
  marginal product VMP pMPL.
• The value of the marginal product curve is the
  firm's demand curve for labor.
• The VMP is downward sloping (like all demand
  curves) because of diminishing marginal returns
  to labor.
• Firms hire labor until
• VMP wage, or
• pMPL w

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The Marginal Product of Labor (c)
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The Labor Demand Curve (a)
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The Labor Demand Curve (b)

• If the demand for the product of a firm
  increases, the price increases.
• So the VMP increases.
• Therefore the demand for the factor labor
  increases.
• Employment increases and the wage increases.

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Indifference Curves
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Indifference Curves and Welfare Programs
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Indifference Curves and Welfare Programs
(continued)