11 The Determination of Wage

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11 The Determination of Wage
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The price of a factor of production wage is
determined by the interaction of the market
demand and supply for the Factor.
No. of Factors e.g. labour
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Demand Marginal Revenue Product
(MRP) ??????is the contribution to revenue
made by the employment of an additional unit of a
variable factor. e,g labour ?wage
General equationMRP MR X MP
Additional revenue by extra factor
Additional no.s of product of extra factor
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• QUESTION
• What is the difference between MRP and VMP of a
  factor.
• Why is the demand curve for a factor the same as
  the MRP downward sloping portion?

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The Supply Curve of Labour Market
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Choices available
Forgone leisure
Work

• Leisure

Leisure will forgone wage earning opp cost
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• A worker would either choose
• Work or Leisure in a day
• Indifferent Curve Analysis
• If there is an increase in the wage level / rate
  (w?) there will be two effects on the work
  Amount (QL)

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Indifferent curve analysis
Income (Good)

• 1. Substitution effect
• If W increases, a person will always
• Substitute work for leisure
• (w??QL?? Ve S.E)
• ? w?? Work amount increases

BL2
BL1
Working hours (Bad)
Sub. effect
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• 2. Income effect
• If W increases, whether a person will work
• More or less depending on whether leisure is
• A superior good or inferior good to him.
• If leisure is superior
• Increase in wage rate, work less
• (w??QL?? -ve income effect)
• ? ? Work amount decrease

Income (Good)
BL2
BL1
Working hours (Bad)
Sub.
Income
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• 2) If leisure is inferior
• ? dont like working
• Increase in wage rate,
• work less
• (w ??QL ?
• ? -ve income effect)
• ? ? Work amount decreases

Income (Good)
BL2
Sub.
Working hours (Bad)
Income
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Why can an individual supply curve be backward
bending?
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Backward-bending supply curve of an individual
labour
W3
Income (Good)
W2
W1
Working hours (Bad)
Wages
W3
W2
W1
Quantity
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MC QUESTIONS An individuals labor supply curve
may be backward bending because (22/94) a) The
substitution effect between work and leisure is
smaller than the income effect when wage
increases. w??QL? b) The substitution effect
between work and leisure is greater than the
income effect when wage increases. w??QL? c) The
workers preference of leisure has
decreased. d) The opportunity cost of leisure
increases when the wage increases.
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The market Supply of Labour

• IT can not be backward-bending.
• If the industry wants to increase the Qs of
  labour, it must pay a higher wage to attract
  workers away from other industry.
• So, the supply curve is upward sloping.

S
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Wage Determination in a Competitive Labour Market
P.15

• Both buyers (firms) suppliers (workers) are
  price takers. (too small in affecting the P)
• We and Qe is determined at the intersection of
  the demand (MRP) and supply curves.

Labour market
A firm
S
Constant hire price
We
MRPVMP
D
Labour
Labour
Qe
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Test
What is the factor demand curve of a firm under a
perfectly competitive factor market?
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Supply curve of Labor in Price-taking market
In price-taking market, the market supply curve
of labor is upward sloping. But the individual
firms supply curve of labor is horizontal. A
price-taking firm cannot affect the market wage
as the wage is determined by the market demand
and supply of labor. However, it can determine
its own amount of labor used in production by
equating VMP D Wage
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Test
An employer observes that when one employee is
sick and cannot come to work, the output value
will fall by 1000 per day. If two workers are
sick, the output value will fall by 2500 and
when three workers are sick, the output value
will fall by 4500. Suppose the wage of
hiring a worker is 1600 per day how many
worker should the employer fire? Explain.

• QL MRP TRP Wage Action
• 1000 1000 1600 Fire
• 2 1500 2500 1600 Fire
• 3 4500 Employ

1600
2000
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Functions of Labour Unions

• To facilitate contract negotiations
• To monitor employee performance
• To raise the wages of their members
• To raise the demand for labour
• To restrict the supply of labour
• To impose minimum wage rate

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Reasons for Income Differences

1. Relative demand and supply
2. Chance-taking differentials
3. Differences in productivities
4. Compensating differentials
5. Types of training
6. Geographical differences
7. Age-related differences
8. Differences between males and females

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Remark
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What are the reasons for wage differential? Assum
e there are two regions. Wage in region A is
initially higher than wage in region B. If
factors are allowed to mobile freely, Wa will
decrease gradually while Wb will increase
gradually. Finally, Wa Wb
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SEARCH THEORY Labor market is a search market.
Why?
Because of imperfect information of the market,
labor always attempt to search for better
alternatives, so as to seek out the most
favorable wage level.
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• Assume that leisure is a normal good. Which of
  the following is implied by an upward sloping
  labour supply curve? (26/95)
• Leisure and income are substitutes.
• The income effect of a wage increase is smaller
  than the substitution effect.
• There are laborers who may receive an economic
  rent.
• All of the above.