ECON 390 – Labor Economics

Labor Market Equilibrium

(sources:  various, common knowledge)

            Market Equilibrium

If wages are below the equilibrium level, there is a shortage of labor and wages get bid up; if wages are above the equilibrium level, there is a surplus and wages get bid down.  We move along both the labor supply and labor demand curves.

Graph:

What about shifts?

Supply:  In a single occupation, labor supply responds to changes in expected ways.  Example:

1.   What happens to supply of orange-pickers if a new strain of poisonous fruit fly appears – or there are bad freezes in California?

Demand:  Shifts in labor demand are trickier, because you have to consider both the product market and the labor market. 

            One worker essentially has no effect on product price.  So if one worker grows more productive, he gets paid proportionally more (or so the theory goes).

            But if all workers in an industry get more productive, matters are more complex.

            Example:  Suppose all orange workers get faster.  In the product market, this means that the supply of oranges increases, so the price falls.  But in the labor market, does labor demand rise or fall?

It all depends on demand elasticity in the product market.  If the demand curve is relatively flat (elastic), then when the quantity supplied of oranges rises a lot, the price of oranges only falls a little.  Thus, MVP rises (on net) and labor demand increases.

            Remember:  MVP = MPP x P

                        So MPP is increasing, P is falling, but only a little, so overall change is positive.

Graphs:

            But if the demand curve is relatively steep (inelastic), then when the quantity of oranges rises a lot, the price of oranges drastically falls.  Thus, MVP falls and labor demand falls!

            MVP = MPP x P

                        In this case MPP is increasing, but the price decrease offsets it and then some, so overall change is negative.

Graphs:

            There are definitely cases where all-around increases in worker productivity have actually hurt workers in that industry.  Agriculture is the most prominent example.

            There are other cases where an occupation has grown substantially due to rises in worker productivity.  Computers are probably a good example.  As supply increased in the product market – it lead to an increase in the demand for labor in that industry.

            Market Equilibrium and Wages/Employment

Aggregate Labor Supply is determined by workers' labor/leisure trade-offs.  Aggregate Labor Demand is determined by workers' productivity.  So what determines average wages and employment?

If the wage is below the intersection of ALS and ALD, employers want to hire more workers than are willing to work.  They accordingly bid up the wage.

Graph:

If the wage is above the intersection of ALS and ALD, more workers are willing to work than employers want.  Workers bid down the real wage.

Graph:

At the intersection of (Aggregate Labor Supply) ALS and ALD (Aggregate Labor Demand), the quantity of labor hours employers desire to buy and the quantity of labor hours employees desire to sell are equal.

So what happens if...

1.                  Workers get stronger?

2.                  Someone invents a new productive technique?

3.                  Someone invents the dishwasher?

4.                  A new law bans the use of some machinery?

5.                  Workers slack off more on the job?

At this point – there are no legal restrictions or regulations.

Application: Multinational corporations and Third World Labor

Using what we've learned, what can we say about low wages in the Third World?

1.  How about: on average, workers are much more productive in the rich countries than in the poor countries.

Of course, this may be more the fault of bad economic policies than individual workers.

2.      What can we say about bad working conditions?  How about: when people are poor, they are more willing to trade-off fun for income?

3.  What would banning foreign employers from countries accomplish?