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Labor Demand
4-3
Introduction
Firms hire workers because consumers want to purchase a variety of goods and services Demand for workers is derived from the wants and desires of consumers Central questions: how many workers are hired and what are they paid?
4-4
4-5
4-6
The Total Product, the Marginal Product, and the Average Product Curves
140 120 100 25
Average Product
20
Output
Output
80 60 40 20 0 0 2 4 6 8 10 12
15 10 5 0 0 2 4 6 8 10 12
Marginal Product
Number of Workers
Number of Workers
The total product curve gives the relationship between output and the number of workers hired by the firm (holding capital fixed). The marginal product curve gives the output produced by each additional worker, and the average product curve gives the output per worker.
4-7
Profit Maximization
Objective of the firm is to maximize profits The profit function is:
- Profits = pq wE rK - Total Revenue = pq - Total Costs = (wE + rk)
4-8
4-9
38
VAPE
22
VMPE
Number of Workers
4 - 10
4 - 11
22 18
VMPE VMPE
12
Number of Workers
Because marginal product eventually declines, the short-run demand curve for labor is downward sloping. A drop in the wage from $22 to $18 increases the firms employment. An increase in the price of the output shifts the value of marginal product curve upward, and increases employment.
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The condition: produce to the point when MC = P (for the competitive firm, P = MR)
- W x 1/MPe = P
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T D 20 20
10
10 D T 15 28 30
Employment
30
56 60 Employment
4 - 16
Output Price
A profit-maximizing firm produces up to the point where the output price equals the marginal cost of production. This profitmaximizing condition is the same as the one requiring firms to hire workers up to the point where the wage equals the value of marginal product.
q*
Output
4 - 17
4 - 18
Isocost
The Isocost line indicates the possible combinations of labor and capital the firm can hire given a specified budget Isocost indicates equally costly combinations of inputs Higher isocost lines indicate higher costs
4 - 19
Isoquant Curves
Capital
X K Y q1
q0
All capital-labor combinations that lie along a single isoquant produce the same level of output. The input combinations at points X and Y produce q0 units of output. Input combinations that lie on higher isoquants produce more output.
Employment
4 - 20
Isocost Lines
Capital
C 1/r
C 0/r
All capital-labor combinations that lie along a single isocost curve are equally costly. Capital-labor combinations that lie on a higher isocost curve are more costly. The slope of an isoquant equals the ratio of input prices (-w/r).
C 0/ w
C1/w
Employment
4 - 21
C1/r A
C0/r
175
B q0 100
Employment
A firm minimizes the costs of producing q0 units of output by using the capital-labor combination at point P, where the isoquant is tangent to the isocost. All other capital-labor combinations (such as those given by points A and B) lie on a higher isocost curve.
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Cost Minimization
Profit maximization implies cost minimization The firm chooses a least cost combination of capital and labor This least cost choice is where the isocost line is tangent to the isoquant Marginal rate of substitution equals the price ratio of capital to labor
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C0/r
R
75 P
q0 q0
Wage is w0
Wage is w1
A wage reduction flattens the isocost curve. If the firm were to hold the initial cost outlay constant at C0 dollars, the isocost would rotate around C0 and the firm would move from point P to point R. A profitmaximizing firm, however, will not generally want to hold the cost outlay constant when the wage changes.
25
40
4 - 25
The Impact of a Wage Reduction on the Output and Employment of a Profit-Maximizing Firm
Dollars
Capital
MC0
MC1
150
A wage cut reduces the marginal cost of production and encourages the firm to expand (from producing 100 to 150 units). The firm moves from point P to point R, increasing the number of workers hired from 25 to 50.
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w0
The long-run demand curve for labor gives the firms employment at a given wage and is downward sloping.
w1
DLR
25
50
Employment
4 - 27
D C1/r
Q C 0/r R
P
200 D
100
Wage is w1 Wage is w0
A wage cut generates substitution and scale effects. The scale effect (the move from point P to point Q) encourages the firm to expand, increasing the firms employment. The substitution effect (from Q to R) encourages the firm to use a more labor-intensive method of production, further increasing employment.
25
40
50
Employment
4 - 28
Elasticity of Substitution
When two inputs can be substituted at a constant rate, the two inputs are called perfect substitutes When an isoquant is right-angled, the inputs are perfect complements The substitution effect is large when the two inputs are perfect substitutes There is no substitution effect when the inputs are perfect complements (since both inputs are required for production) The curvature of the isoquant measures elasticity of substitution
4 - 29
Isoquants
Capital Capital
Capital and labor are perfect substitutes if the isoquant is linear (so that two workers can always be substituted for one machine). The two inputs are perfect complements if the isoquant is right-angled. The firm then gets the same output when it hires 5 machines and 20 workers as when it hires 5 machines and 25 workers.
4 - 30
Elasticity Measurement
Intuitively, elasticity of substitution is the percentage change in capital to labor (a ratio) given a percentage change in the price ratio (wages to real interest) %K/L%w/r This is the percentage change in the capital:labor ratio given a 1% change in the relative price of the inputs
4 - 31
In the long run, the firm can take full advantage of the economic opportunities introduced by a change in the wage. As a result, the long-run demand curve is more elastic than the shortrun demand curve.
Employment
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Application
Affirmative action and production costs
- A firm is color blind if race does not enter the hiring decision at all - Discrimination shifts the hiring decision away from the cost minimization tangency point on the isoquant
4 - 34
Affirmative Action
Black Labor
q*
White Labor
The discriminatory firm chooses the input mix at point P, ignoring the costminimizing rule that the isoquant be tangent to the isocost. An affirmative action program can force the firm to move to point Q, resulting in more efficient production and lower costs.
4 - 35
Affirmative Action
Black Labor
A color-blind firm is at point P, hiring relatively more whites because of the shape of the isoquants. An affirmative action program increases this firms costs.
P q* White Labor
4 - 36
Marshalls Rules
Labor Demand is more elastic when:
Elasticity of substitution is greater Elasticity of demand for the firms output is greater The greater labors share in total costs of production The greater the supply elasticity of other factors of production (such as capital)
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The Demand Curve for a Factor of Production is Affected by the Prices of Other Inputs
Price of input i Price of input i
(a)
(b)
D1 D0 Employment of input i D1
D0
Employment of input i
The labor demand curve for input i shifts when the price of another input changes. (a) If the price of a substitutable input rises, the demand curve for input i shifts up. (b) If the price of a complement rises, the demand curve for input i shifts down.
4 - 39
w*
wlow Demand
In a competitive labor market, equilibrium is attained at the point where supply equals demand. The going wage is w* and E* workers are employed.
ED
E*
ES
Employment
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4 - 41
5 0.5 4
Ratio
3 0.4
2 0.3 1
Nominal Wage
0.2
1938
1944
1950
1956
1962
1968
1974
1980
1986
1992
1998
2004
2010
Year
Source: U.S. Bureau of the Census, Statistical Abstract of the United States. Washington, DC, Government Printing Office, various issues; U.S. Bureau of the Census, Historical Statistics of the United States, Colonial Times to 1970, Washington, DC, 1975; and U.S. Bureau of Labor Statistics, Employment and Earnings, Washington, DC, Government Printing Office, January 2006.
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w*
E*
ES
Employment
A minimum wage set at w forces employers to cut employment (from E* to E). The higher wage also encourages (ES - E*) additional workers to enter the market. The minimum wage, therefore, creates unemployment.
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SU
w* w*
(If workers migrate to uncovered sector)
DC E EC Employment EU EU EU
DU Employment
If the minimum wage applies only to jobs in the covered sector, the displaced workers might move to the uncovered sector, shifting the supply curve to the right and reducing the uncovered sectors wage. If it is easy to get a minimum wage job, workers in the uncovered sector might quit their jobs and wait in the covered sector until a job opens up, shifting the supply curve in the uncovered sector to the left and raising the uncovered sectors wage.
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4 - 45
C0 Change in Employment
-25
+50
Changing employment quickly is costly, and these costs increase at an increasing rate. If government policies prevent firms from firing workers, the costs of trimming the workforce will rise even faster than the costs of expanding the firm.
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150 B
100
50
Time
Variable adjustment costs encourage the firm to adjust the employment level slowly. The expansion from 100 to 150 workers might occur more rapidly than the contraction from 100 to 50 workers if government policies tax firms that cut employment.
4 - 47
Shifts in Labor Supply and Labor Demand Curves Generate the Observed Data on Wages and Employment
S0 Dollars
S1 Z w0 R w2 Q w1 D1 Z P
D0
E0
E1
E2
Employment
4 - 48
80 60 40 20 0 -20 40 45
Mobilization rate
50
55
4 - 49
90 80 70 60 50 40 30 20 40 45
Mobilization rate
50
55
4 - 50
End of Chapter 4