If we’re going to explain why some people earn a great deal of income while others earn very little, we must consider both the supply and the demand for labor. We usually ask ourselves why does the average college graduate earn over $40,000 while the average high school graduate earn less than $25,000?
To find answers to these questions we must examine the behavior of labor markets.
We first must start by looking at supply of labor, which is the willingness and ability to work specific amounts of time at alternative wage rates in a given period. Offering to sell your time and talents to anyone who’s willing to pay the right price. The reward of working comes in two forms:
1) The intrinsic satisfaction of working
2) A pay check
MBA grads say they care more about the intrinsic satisfaction than the pay. They also get huge paychecks however; those big paychecks are explained in part by the quantity of labor supplied. MBA grads often end up working 60 or more hours a week. The reason people are willing to work so many hours is that they want more income. Not working obviously has some value, too. We need some non work time just to recuperate form working. We also want some time to watch television, go to a soccer game in other word enjoy the goods and services we’ve purchased. The inevitable trade-off between labor and leisure explains the shape of individual labor supply curve. As we work more hours, our leisure time becomes scarce and more valuable. The upward slope of an individual’s labor supply curve is thus a reflection of two potential phenomena (look at p.305 figure 15.1):
1) The increasing opportunity cost of labor as leisure time declines
2) The decreasing marginal utility of income as a person works more hours.
Some people will work because of flexible hours or just to have time at home, for this reason people do not always go for what the wage is. Sometimes people are willing to work for lower money as long as they are happy at what they do.
Substitution effect of wages is an increased wage rate that encourages people to work more hours. This is the force that drives people up the labor supply curve, it’s the marginal utility of income. While you do cartwheels for $25 an hour, Bill Gates or Brad Pitt might not lift a finger for such a paltry amount.
A low-wage worker might also respond to higher wage rates by working less, not more. People receiving very low wages have to work long hours just to pay the rent. The increased income made possible by higher wage rates might permit them to work fewer hours. These negative labor supply responses to increase age rates are referred to as the income effect of the wage increase. The Market supply represents the sum of all individual labor supply decisions. Although it’s true that some individuals have backward-bending supply curves, these negative responses to higher wages are swamped by positive responses from the 135 million individuals who participate in the U.S. market.
The determinations of labor supply include:
2) Income and wealth
In 1890 the average worker was employed 60 hours a week at a wage rate of 20 cents an hour. In 1999 the average worker worked less than 35 hours per week at a wage rate of over $12 an hour. Contributing to this long-run leftward shift has been the spectacular rise in living standards, the development of income transfer programs that provide economics security when one isn’t working, and the increased diversity and attractiveness of leisure activities. Specifically elasticity of labor supply is the percentage change in the quantity of labor supplied divided by the percentage change in the wage rate:
Elasticity of In quantity of labor supplied
Labor Supply = %Change in wage rate
The elasticity of labor tells us how much more labor will be available if a higher wage is offered.
Marginal Revenue product is the change in total revenue associated with one additional unit of input. For example, most Strawberries pickers don not want to be paid in strawberries. At the end of a day in the fields, the last thing a picker wants to see is another strawberry. Marvin, like the rest of the pickers, wants to be paid in cash. To find out how much cash he might be paid, we need to know what a box of strawberries is worth. This is easy to determine. The market value of a box of strawberries is simply the price at which the grower can sell it. Marvin’s contribution to output can be measured in either marginal physical product (5 boxes per hour) or the dollar value of that product. Our observations on strawberry production are similar to those made in most industries. In the short run, the availability of land and capital is limited by prior investment decisions. Additional workers must share existing facilities. As a result, the marginal physical product of labor declines as the quantity of labor employed increase. The principles that guide the hiring decisions of a single strawberry grower can be extended to the entire labor market. This suggests that the market demand for labor depend on the number of employers and the marginal revenue product of labor in each firm and industry. On the supply side of the labor market we have already observed that the market supply of labor depends on the number of workers and each worker willingness to work at alternative wage rates. If the labor market is perfectly competitive, all employers will be able to hire as many workers as they want at the equilibrium wage. Like our strawberry grower, every competitive firm is assumed to have no discernible effect on market wages. Government imposed wage floor have two distinct effects that a minimum wage reduces the quantity of labor demanded, increases the quantity of labor supplied, and creates a market surplus. Because the federal minimum had not been raised for 5 years the 50 cents per hour hike in October 1996 caused few job losses. According to Federal Reserve estimates, the 1997 wage hike may have reduced employment growth by only 100,000 to 200,000 jobs. However, the further minimum wage rises above the markets equilibrium wage, the greater the job loss.
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