Chapter 7: The labour market Perfectly Competitive Labor Market: - Assumptions of a perfectly competitive labor (service) market: - 1) Buyers and sellers of labor are price takers: they can t individually change wages. 2) All participants are perfectly informed: workers know the available job and wage opportunities, while firms know the potential workers in the labor market. 3) Workers can move freely between jobs or in and out of work. 4) Labor hours, once purchased from the workers, are used without problems to produce output. 5) Firms aim to maximize profits. Concepts: - Labor: The time and effort that people allocate to producing goods and services. Who demands labor? Firms demand (or buy) labors to produce goods and services. Who supplies labor? People who want job would supply (offer) their services to firms in return for wages (or compensation for works). Labor market: The place where wages are exchanged or determined for labor. Demand for Labor: - Why the Demand for labour is derived demand? Demand for labour is derived demand because labour is demanded not for itself but for the profits which it brings to the company. شكثر توظف الشركة عمال determined? Let us see how the demand for labour is Consider a small fishing firm; the firm s owner employs fishermen (workers) to catch fish and they sell fish to make profits. Given capital and technology (boat, nets, other fishing instruments). Firm s production function given in table below shows that if firm hires no worker, no catch and output (Q = 0). If it hires one worker, catch is Q = 3 kg per day, if it hires 2 workers, catch is Q = 8 kg /day and so on. How the demand for labour is determined? The demand for labour is determined by a firm to produce an output to maximize its profits The marginal physical product of labour (MPPL): is the extra output produced by hiring an extra unit of labour. For example, when the firm hires from 0 to 1 labour (one extra labour), output increases from 0 to 3kg, so the first labour s MPPL is 3 kg, and so on. Note: MPPL first increases then decreases (declines) as labour increases in accordance with diminishing returns to a factor of production. Q MPPL التغيير في الكمية )Q( على التغير في عدد العمال )نطرح كل وحدة مثل ما موضح بالجدول L وبعدين ناتج الطرح نقسمهم على بعض بالقانون( revenue product (MRP): is extra revenue gained by the firm from employing an extra unit labor. (MRP = MPPL x P, where P = price of fish). Note that the firm s goal is to sell fish and make profit. Suppose the price of fish is P = KD2/kg. so the column for MRP shows the MPPL multiplied by P. 1
Now price is P = KD2/kg and suppose the firm pays 4KD to each labor per day (W = 4KD/labour). The firm will: 1) keep on hiring more labours as long as MRP > W (that increases profit). 2) keep on firing labour as long as MRP < W (that reduces loss). 3) stop hiring or firing when MRP = W that maximizes the profit. so, the firm will hire 5 labours at which MRP = W = 4KD. Question: How many workers the firm will hire if daily wage is 5 KD/labour? the firm will hire 4 labours at which MRP = 6 > W = 5KD. Figure 1 Note in the figure 1 MRP is highest at L = 2. The figure shows that the firm hires 5 labours to maximize profit where wage is equal to MRP (W = MRP); that is, where wage line intersects the MRP curve. Because we assume that in perfect competition the firm is a price taker, the decline in MPPL means that the MRP curve is also declining. As in the figure 2. Figure 2 shows that if MRP > W, as in point A, firm will hire more labour that will increase profit. and Figure 2 when MRP < W, as in point B, firm will decrease labour that will reduce loss (or increase profit). and when MRP = W, as in point E, firm s profit is maximized, and LE amount of labour hours hired. W) E )افضل MRP = نقطة So firm that maximizes profits will demand labor up to the point at which W=MRP Why the firm s MRP curve is the firm s demand curve for labour (LD)? Also note that a firm s MRP curve is the firm s demand curve for labour (LD). This is because increase or decrease in wage rate will intersect different points in MRP curve which will give profit maximizing labour demand by the firm. That is, MRP curve traces out the demand for labour curve (LD). Demand for labour: the demand curve for labour in a perfectly competitive model is given by the marginal revenue product curve. The Supply of Labour: - What are the factors that determine the labour supply? 1) The factors determining the overall labour supply: - 1. social and demographic factors, such as the proportion of people of normal working age, and society s attitudes towards women or younger or older people working. 2. technical factors, such as the availability of washing machines, which have made work in the home more productive. 3. political factors, such as child-care facilities. 4. private economic factors, such as the availability of private sources of income. 2
2) Factors determining the supply of a particular type of labour: - the supply with the demand for particular types of labour will determine the supply of potential workers to particular kinds of work. that provides an explanation of relative wages that is, wages in one job relative to those in another. For example: there is 2 jobs with the same skill requirements but with different conditions of work: job B: ordinary window cleaning. job A: window cleaning on high-rise buildings, it has poorer conditions (more risky) than B. The supply of job A depend on the wages and riskiness of the job relative to job B. In the figure 3 suppose that workers get 5 per hour for job B. For job A the labour supply L S will be zero for any wage at or below 5. At 6, workers (30) accept the risks of job A. At a wage of 7, more workers (40) will leave the safer job B Figure 3 for the extra rewards in job A. The variation in workers attitudes towards the risk causes the relative supply curve to be upward-sloping. The Supply of Labour: refers to the number of hours people offer their labour services (labour hours) at different wage rates. It involves an opportunity cost involving work instead of leisure (free time). Wage rate must be sufficient to overcome the opportunity cost of leisure. A typical labour supply curve (L S ) looks as shown in the figure 4. Any wage rate below W0, people would not supply any labour because wage rate is too low and leisure is better. It also shows as wage rate increases, people would like to work more hours or quantity of labour hours supplied increases. Figure 4 Labor market: labour supply and demand and 'compensating wage differences: The labour market or demand and supply of labour determines the wage rate as shown in the figure (5). W E is the equilibrium wage rate at which demand and supply of labour is equal. L E is the equilibrium amount of labour hours traded in the labour market. Changes in Labor Market: - An increase in demand for labour, L D curve shifts to the right (and it creates as excess demand for labour at initial wage) and wage rate increases as shown in figure (6). An increase in supply of labour, LS curve shifts to the right (and it creates as excess supply of labour at initial wage) and wage rate decreases as shown in figure (7). Figure 7 Figure 5 Figure 6 3
The perfectly competitive labour market and minimum-wage legislation: - Figure 8 shows effect of minimum wage legislation on employment under perfectly competitive labor Figure 8 market. Here equilibrium wage is W E and employment is L E labor hours. Now government thinks that W E is very low wage so government imposes minimum wage W M were anyone hires these labors must pay a minimum wage of W M. Benefit of such legislation is that people who keep their jobs would get a higher wage of W M, but the disadvantage is some people would lose their jobs because employment now is equal to L M and (LE LM) labor hours are no longer available. The extent of such cost depends on the size of wage rate and elasticity of demand and supply of labor curves. Minimum-Wage legislation in Imperfectly Competitive Labor Market: - what is the shape of labour supply curve under perfect and imperfect competitive market?? Figure 9 And if there is an assumption that Firms can t individually alter wages, This assumption is illustrated by the horizontal curve which shows an infinitely elastic supply of labor hours to a firm at the going wage rate. give us reasons why this assumption ارسموا الرسمه واشرحوها false?? may be In figure 9 The assumption is illustrated by the horizontal curve (L S1 : labour supply to a firm under perfect competition) which shows an infinitely elastic supply of labor hours to wage rate. Because firm can t individually alter wages. For two reasons this assumption may be false: 1) many workers may lack information about what jobs and wages are available elsewhere - so they accept the job.2) They may face transport and other costs that make it not worth to switch jobs. So, the supply curve of labour to a particular firm is likely to be upward-sloping not horizontal. This is illustrated by the curve L S2 : which is labour supply to a firm under imperfect competition. If the it was just under perfect competition: - 1. The upward-sloping labour supply curve was a market supply curve. 2. And the profit-maximizing level of employment was determined to be MRP = W. Figure 10: shows how wage and employment is determined under imperfect competition. And the relationship between L S Figure 10 (the wage rate the firm must offer to attract each level of labor supply), and MFC (the marginal cost to the firm of employing greater amount of labor). At point C were (W=MRP) is the equilibrium position. And when imperfectly competitive firm were replaced by a number of perfectly competitive firms. W C is the wage rate (were W=MRP). And L C is employment in a perfectly competitive labor market, And L S is the labor supply curve for a perfectly competitive labor market. تكملة شرح الرسمة بالصفحة التالية 4
The labor supply curve for an imperfectly competitive firm is given by the MFC curve. The firm which aims to maximize profits would fail if it set labor hours at the point C where W=MRP; because (marginal factor cost (MFC): the marginal factor cost of labor is the extra cost of employing an extra unit of labor), is not identical to the wage rate if the firm faces an upward-sloping labor supply curve. For an imperfectly competitive firm, profit maximizing point is when MFC=MRP=LD, that is at point B. And the imperfectly competitive firm would pay a wage rate of W A given by the relevant point on the labor supply curve point A. So an imperfectly competitive firm pays lower wage (WA < WC) and employs less (LA < LC) compared to firms under competitive market. In the perfect competition: the horizontal labor supply curve implies that the MFC=W. In the imperfect competition: the upward-sloping supply curve implies that MFC =(wage rate: the cost attributed to the one extra hour) + the small change in the wage of all other hours worked. That is MFC < W. Only when the MFC = MRP profits will maximized as illustrated by point B: - If labour hours > point B, profits raised by increasing them, MFC > MRP. if labour hours < point B, profits raised by decreasing them, MFC > MRP. Minimum Wage in Imperfectly Competitive Labor Market: - What is the impact of minimum wage legislation Figure 11 on an imperfectly competitive market? Figure 11 shows minimum wage legislation impact on an imperfectly competitive market where government imposes a minimum wage of WM which is greater than WA but lower than WC; (WA > WM > WC(. In this case the imperfectly competitive firm, with a minimum wage legislation, would employ more labor hours from LA to LM. So M is the maximizing point under the minimum wages legislation which increases profits for the imperfectly competitive firm. The impact of minimum wage legislation on an imperfectly competitive market: positive impact increasing wages and higher living standards. The impact of minimum wage legislation on perfectly competitive market: positive impact increasing wages, and negative impact some employees will lose their job. Q1. Why is the labour market different from other markets? Explain using examples? Labour demand is different for the following reason: - -The money that is being exchanged is wages. -The wage paid to an employee don t automatically guarantee that a satisfactory done. The labour market scope is geographically far less wide than other important markets. Q2. Economists argue that the demand for labour is the demand for a factor of production. Discuss using graphics how the demand of labour is derived. Demand for labour is derived demand because labour is demanded not for itself but for the profits which it brings to the company. Figure beside shows the demand for labour which is downwardsloping because we assume that in perfect competition the firm is a price taker, the decline in MPPL means that the MRP curve is also declining. 5
The figure also shows that the firm hires 5 labours to maximize profit where wage is equal to MRP (W = MRP); that is, where wage line intersects the MRP curve.demand for labour: the demand curve for labour in a perfectly competitive model is given by the marginal revenue product curve. Q3. Suppose that an increase in the demand of labour will happen in the country. Draw graphically the implications of such a policy and explain what will happen on the graph? If an increase in demand for labour will happen in the country,the demand curve will shift to the right from W 2 L D1 to L D2 (and it creates as excess demand for W 1 labour at initial wage) and wage rate increases from W 1 to W 2, and the quantity of labour supplied will also increased shows as a movement along the supply curve. Consider the following information for a perfectly competitive firm that can sell as many outputs as it wants for $5 per unit. Complete the following table: - L 1 L 2 L D2 1 workers units produced per day (TP) product of labour (MPL) Price of unit (P) 0 0 5 1 50 5 2 90 5 3 125 5 4 150 5 5 170 5 6 185 5 7 195 5 revenue product (MRP) Total revenue (TR) If this firm must pay a wage rate of $75 per worker per day, show how many workers should it hire to maximize its profits?? workers units produced per day (TP) product of labour (MPL) Price of unit (P) revenue product (MRP) Total revenue (TR) 0 0-5 0 0 1 50 50 5 250 250 2 90 40 5 200 450 3 125 35 5 175 625 4 150 25 5 125 750 5 170 20 5 100 850 6 185 15 5 75 925 7 195 10 5 50 975 نحل الجدول من القوانين التالية ونختار عدد العمال الي يكون فيه MRP يساوي او اكبر من W. TR P Q Q MPPL L MRP MPPL P The firm should hire 6 workers because at this number of workers MRP = W = 75 6