McGraw-Hill/Irwin

Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 10:
Wage
Determination
Firms Demand for Labor
Labor is the most important of the resources
used by firms.
Labor demand is a derived demand, thus it
depends on
the productivity of labor
the price of the good or service it helps produce

Derived demand is the demand for a resource that
results from the demand for the product it helps
produce.
LO: 10-1
10-2
Marginal Revenue Product
and Marginal Revenue Cost
Marginal revenue product (MRP) of labor is the
change in a firms total revenue when it employs one
more unit of labor.
Marginal resource cost (MRC) of labor is the change
in a firms total cost when it employs one more unit of
labor.
In a competitive labor market MRC is equal to market wage
rate.

MRP =
Change in total revenue

Unit change in labor
MRC =
Change in total cost

Unit change in labor
LO: 10-1
10-3
Marginal Revenue Product of
Labor as Labor Demand Schedule
MRP = MRC can be written as MRP = wage rate.
The MRP schedule therefore constitutes the firms
demand for labor
because each point on this schedule (or curve)
indicates the quantity of labor units that the firm
would hire at each possible wage rate.
The market demand for labor is the horizontal
summation of all the individual firm demand curves
for labor.
LO: 10-1
10-4
Changes in Labor
Demand
The labor demand curve can shift if there are:
Changes in product demand: higher product demand
higher labor demand.
Changes in productivity: higher productivity of labor
higher labor demand. Productivity depends on:
Quantity of other resources
Technological advance
Quality of labor
Changes in the prices of other resources:
a decline in price of complementary resources increases labor
demand
a change in price of substitute resources has an ambiguous
effect on labor demand

LO: 10-2
10-5
Elasticity of Labor
Demand
Elasticity of Labor Demand (E
w
) is a
measure of the responsiveness of employers
to a change in the wage rate.
It is also called wage elasticity of demand.
E
w
< 1: labor demand is inelastic
E
w
> 1: labor demand is elastic
E
w
= 1: labor demand is unit-elastic
E
w
=
Percentage change in labor quantity

Percentage change in the wage rate
LO: 10-3
10-6
Changes in Elasticity of
Labor Demand
Wage elasticity of demand depends on:
Ease of resource substitutability: the greater the
substitutability, the more elastic is the labor demand
Elasticity of product demand: the greater the
elasticity of product demand, the greater the
elasticity of labor demand
Ratio of labor cost to total cost: the larger the share
of labor in total cost, the greater the elasticity of
labor demand
LO: 10-3
10-7
Market Supply of Labor
The supply curve for each type of labor slopes
upward, indicating that firms must pay a higher
wage rate in order to attract workers away from
the alternative job opportunities available to
them and workers not in the labor force.
The intersection of labor supply and labor
demand determines the equilibrium wage rate
and level of employment in a given labor
market.
LO: 10-4
10-8
Competitive Labor Market
Many employers compete for a specific type of
labor.
Many workers with identical skills supply that
type of labor.
Individual employers are wage takers.
An individual firms labor supply is perfectly elastic at
the market wage rate.
Firms use the MRP = MRC rule to determine
employment at market wage.
LO: 10-4
10-9
W
a
g
e

R
a
t
e

(
D
o
l
l
a
r
s
)

W
a
g
e

R
a
t
e

(
D
o
l
l
a
r
s
)

($10)
W
C
($10)
W
C
Labor Market Individual Firm
Quantity of Labor Quantity of Labor
Q
C
(1000)
0 0
D=MRP
( mrps)
d=mrp
q
C
(5)
s=MRC
S
Competitive Labor Market
LO: 10-4
10-10
Monopsony
In labor market monopsony, the single employer is a
wage maker.
A monopsonists labor supply curve is the same as the
market labor supply curve and is upward-sloping.
The MRC curve lies above the labor supply curve and MRC
exceeds the wage rate.
A monopsonist will use the MRP = MRC rule to determine
the quantity of labor to hire and the pay wage
corresponding to this quantity supplied.
A Monopsony is a market structure in which there is only a
single buyer of a good, service, or resource.
LO: 10-4
10-11
W
a
g
e

R
a
t
e

(
D
o
l
l
a
r
s
)

Quantity of Labor
0
S
MRP
MRC
c
b
a
W
c
W
m
Q
m
Q
c
In a
monopsony,
employment
and wage
are lower
than in a
competitive
labor market
Monopsony
LO: 10-4
10-12
Union Models
In some labor markets, workers sell their labor
services collectively through labor unions.
Unions work to raise wage rates for their
members.
Exclusive (craft) unions
Restrict supply of skilled
labor to increase the
wage rate received by
union members
Inclusive (industrial) unions
Include all workers in an
industry as members
put great pressure on firms
to agree to their wage
demands through the
threat of a strike
LO: 10-4
10-13
W
a
g
e

R
a
t
e

(
D
o
l
l
a
r
s
)

Quantity of Labor
D

S
1
Q
c
W
c
S
2
W
u
Q
u
Decrease
In Supply
Craft Union Model
LO: 10-5
10-14
Industrial Union Model
W
a
g
e

R
a
t
e

(
D
o
l
l
a
r
s
)

Quantity of Labor
D

S

Q
c
W
c
W
u
Q
u
Q
e
a
b
e
LO: 10-5
10-15
Wage Differentials
Wage differentials are the differences between
the wages of different groups of workers.
Wage differentials can arise either on the
demand or the supply side of labor markets.
A weak labor demand will result in a low equilibrium
wage but a strong labor demand will result in a high
equilibrium wage.
A low labor supply will result in a high equilibrium wage
while a higher labor supply results in a low equilibrium
wage.
Members of noncompeting groups differ in their mental
and physical abilities and in their level of education and
training and therefore, receive different compensation.
LO: 10-6
10-16