Ch.

2 Labor
Table of Contents
1. Demand for Labor
1. Perfectly Competitive Firm’s Demand for Labor
1. SR Demand
2. LR Demand
2. Perfectly Competitive Market’s Demand for Labor
3. Imperfect Competitor’s Demand for Labor
2. Supply of Labor
1. Individual Worker’s Labor Supply
2. Market Supply Curve
3. Monopsony

2
The Perfectively Competitive Firm’s SR
Demand for Labor
} Two inputs: K, L
} SR: K is fixed
} Perfect competition  price taker: P = 2
} w: given (labor market is competitive)
} Question: How many units of labor should the firm
hire?

3
SR Production Function
단기생산함수

4
Typical Shape of SR Production Function
} Pass through the origin.
} The addition of the initial units of variable inputs
expands output at an increasing rate.
} Beyond some point (L=4), additional using of the
variable inputs give rise to smaller and smaller
increments in output.
} For some production functions, the level of output
may eventually decline with additional units of
variable inputs beyond some point (L=8).

5
Law of Diminishing Returns
수확 체감의 법칙

} Beyond some point, output grows at a diminishing

rate with increases in the variable input.

6
TP, MP, and AP
총, 한계, 평균 생산물

} MPL:The change in the total

product that occurs in
response to a unit change in
labor. (all other inputs held Q
fixed.) MPL 
 the slope of the TP curve at
that point L
Q
} APL:The total product divided
by the quantity of labor. APL 
 the slope of the line joining
the origin to the
L
corresponding point on the TP
curve.
7
 stage 1 stage 2 stage 3
8
The Competitive Firm’s SR D for Labor

Diminishing Returns VMP: the value, at current

market price, of the extra
9
output by an additional unit of
input
} 𝑀𝑃 = 10 − 0.05𝐿
} 𝑃=2
} 𝑉𝑀𝑃 = 𝑃 × 𝑀𝑃 = 20 − 0.1𝐿

} Optimality condition: 𝑤 = 𝑉𝑀𝑃

} → 12 = 20 − 0.1𝐿
} → 𝐿∗ = 80

10
The Perfectively Competitive Firm’s LR
Demand for Labor
} SR
} The only way for the firm to respond to a reduction in
the wage rate is to hire more labor
} LR
} All inputs are variable
} A reduction in the price of labor will cause the firm to
substitute labor for capital, reducing its MC still
further
} This additional cost reduction will cause an even
greater expansion of output than before
} The firm’s LR hiring response to a change in the wage
rate will be larger than its SR response

11
The Relationship between MPL and MC
MC = ∆VC / ∆Q = ∆wL / ∆Q = w• ∆L / ∆Q = w /
MPL
 The minimum value of MC corresponds to the
maximum value of MPL

AVC = VC / Q = wL / Q = w• L / Q = w / APL
 The minimum value of AVC corresponds to the
maximum value of APL

12
13
LR & SR Cost Curves

14 SMC is steeper than LMC.

The Effect of wage fall on SMC & LMC
𝑃 𝑆𝑀𝐶(𝑤 )
𝑆𝑀𝐶′(𝑤 )
𝐿𝑀𝐶(𝑤 )
𝐿𝑀𝐶′(𝑤 )

𝑃
𝑤 <𝑤

𝑄
𝑄∗ 𝑄∗ 𝑄∗

15
 𝑤

𝐾∗ > 𝐾∗

𝑉𝑀𝑃 (𝐾 ∗ )
𝑉𝑀𝑃 (𝐾 ∗ )

∗ ∗ ∗
𝐿
𝐿 𝐿 𝐿

16
SR and LR Demand for Labor

17
The Market Demand for Labor

18
} When the wage rate falls from 𝑤 to 𝑤 , each firm
hires more output.
} The increase in output causes output price to fall,
which reduces the value of labor’s marginal
product
} The market demand curve for labor is thus steeper
than the horizontal summation of the individual
demand curve
} [Implicit assumption]
} There is only one type of labor
} All of it is employed by a single competitive industry

19
An Imperfect Competitor’s
Demand For Labor
} Firms face downward-sloping demand curves, and
if they hire additional workers, they must cut their
prices in order to sell the additional output
} 𝑀𝑅𝑃(Marginal Revenue Product)
} The amount by which total revenue increases with the
employment of an additional unit of input
∆ ∆ ∆
} 𝑀𝑅𝑃 = =
∆ ∆ ∆

20
Algebraic Approach
𝜋 = 𝑃 𝑄 𝐹 𝐿, 𝐾 − 𝑤𝐿 − 𝑟𝐾
F.O.C.
𝑃 𝑄 𝑀𝑃 𝐹 𝐿, 𝐾 + 𝑃 𝑄 𝑀𝑃 = 𝑤
{𝑃 𝑄 𝑄 + 𝑃 𝑄 }𝑀𝑃 = 𝑤
𝑀𝑅(𝑄)𝑀𝑃 = 𝑤
𝑀𝑅(𝐹(𝐿∗, 𝐾 ∗ ))𝑀𝑃 (𝐿∗, 𝐾 ∗ ) = 𝑤
Similarly,
𝑀𝑅(𝐹(𝐿∗, 𝐾 ∗))𝑀𝑃 (𝐿∗, 𝐾 ∗ ) = 𝑟

Optimality condition: 𝑀𝑅𝑃 = 𝑤

(cf. Perfect competition: 𝑉𝑀𝑃 = 𝑤)

As L increases, 𝑀𝑃 and 𝑀𝑅 decrease.

 Demand for Labor curve is downward sloping
21
} The monopolist’s LR demand for labor will be
more elastic than his SR demand.

} But we need not make any additional adjustments

to the 𝑀𝑅𝑃 curve when moving from the firm to
the industry demand curve, in either LR or the SR.
} The monopolist’s demand for labor is the industry
demand for labor.
} It already takes account of the fact that extra output
means a lower product price.

22
The Supply of Labor
} A worker’s decision making
} How many hours to work each day?
} w=10
} Two goods: income, leisure

23
The Optimal Choice of Leisure and Income

amount of paid labor = 9

24
Optimal Leisure Choices for Different Wage
Rates

25
The Labor Supply Curve for the ith worker

Backward-bending

26
Substitution Effect & Income Effect

S.E.

I.E.

27
Example 1. The Labor Supply Curve for a
Worker Seeking a Target Level of Income

Smith wants to earn $200/day

because with that amount he can
live comfortably and meet all his
financial obligations.

 LS curve is backward- bending

in the entire range of wage.

28
Market Supply Curve
} Even though many individuals may have backwad-
bending supply curves – indeed, even though the
nation as a whole may have a backward-bending
supply curve – the supply curve for any particular
category of labor is nonetheless almost certain to
be upward sloping.
} The reason is that wage increases on one category of
labor not only change the number of hours worked by
(-)
people already in that category, but also lure people
(+)
into that category from other categories.

29
Example 3
} Rising enrollments in MBA programs have
increased the demand for economics faculty in
business schools.
} If most economists are currently teaching in liberal
arts schools, how will this increase in business
school demands affect salaries and employment of
economists in the two environments?

30
An Increase in Demand by One Category
of Employer

Liberal arts colleges Business school

31
Two interesting points
} 1) The tendency of salaries for workers in a given
occupation to equalize across sectors of the economy
that employ that occupation

32
Two interesting points
} 2) A small occupational subsector can experience a
large proportional rise in demand w/o appreciably
bidding up wages throughout the occupation
} Because business schools employed only a small fraction
of the total number of academic economists to begin
with, these schools could increase their employment
substantially w/o having to pay dramatically higher wage.
} General rule: the effective elasticity of S to any small
occupational subsector will be much higher than to the
occupational market taken as a whole .

33
An Increase in Demand by One Category
of Employer

(𝑄 −𝑄 ) (𝑄 −𝑄 )
≫
𝑄 𝑄

Business school (Liberal arts +

Business school)
34
Empirical Issue
} Economist who teach in business schools earn
about 20% higher salaries than those who teach in
liberal arts colleges
} The implicit assumption that economists regard
the two working environments as being equally
attractive is invalid
} It seems to be necessary to pay economists a
premium to induce them to move from a liberal
arts to a business school environment
Why?
(1) Fewer number of Econ faculty in a business school
(2) No Econ major students in a business school

35
Monopsony (수요독점)
} A single-employer labor market
} Company town
} Workers either cannot or will not leave the area, and
new firms cannot enter
} AFC (average factor cost)
} Average payment per worker necessary to achieve any
given level of employment
} S = AFC
} TFC = AFC * L
} MFC (marginal factor cost)
∆
} 𝑀𝐹𝐶 = = 𝑙𝑖𝑚
∆

36
Average and Marginal Factor Cost

8 4.00(=0.04*100) + 4.04 = 8.04

8.00

𝐴𝐹𝐶 = 𝑎 + 𝑏𝐿
𝑇𝐹𝐶 = 𝑎𝐿 + 𝑏𝐿
𝑀𝐹𝐶 = 𝑎 + 2𝑏𝐿

𝐿 = 100 → 𝐴𝐹𝐶 = 4, 𝑇𝐹𝐶 = 400

𝐿 = 101 → 𝐴𝐹𝐶 = 4.04, 𝑇𝐹𝐶 = 408.04
∆𝑇𝐹𝐶 = 8.04
𝑀𝐹𝐶(𝐿 = 100) = 8.00
𝑀𝐹𝐶 is the linear approximation to ∆𝑇𝐹𝐶
37
The Profit-Maximizing Wage and
Employment Levels for a Monopsonist

A competitive firm
or a monopolist
in its product market

38
Comparing Monopsony and Competition
in the Labor Market

𝐿∗: inefficient
: It does not exhaust
all potential gains
from trade

39
Correction & Clarification
} Perfect Competition
} Many sellers & many buyers
} Monopoly
} One seller & many buyers

} Monopsony
} One buyer & many sellers (in the labor market)
} Perfect competition or monopoly in the product market

40
A Statutory Minimum Wage
(Competitive Labor Market)

Reduce
employment

= 𝑉𝑀𝑃 or 𝑀𝑅𝑃

41
The Minimum Wage Law in the Case of
Monopsony

Increase
Employment

= 𝑉𝑀𝑃 or 𝑀𝑅𝑃

The minimum wage law increases both the wage

42 and the employment.
Exercise
} Demand for Labor: 𝑤 = 12 − 𝐿
} S (AFC): 𝑤 = 2 + 2𝐿
} MFC: 𝑤 = 2 + 4𝐿
} 𝑤 =8
} Before the minimum wage law
} 12 − 𝐿 = 2 + 4𝐿 → 𝐿 = 2, 𝑤 = 6
} After the minimum wage
} 𝑤 = 8 → 𝐷 = 4, 𝑆 = 3 → 𝐿 = 3
} 𝑤 = 10
} 𝑤 = 10 → 𝐷 = 2, 𝑆 = 4 → 𝐿 = 2

43
 𝑀𝐹𝐶: 𝑤 = 2 + 4𝐿

𝑤
𝑆: 𝑤 = 2 + 2𝐿
12

10

𝐷
𝐿
2 12

44
 𝑀𝐹𝐶: 𝑤 = 2 + 4𝐿

𝑤
𝑆: 𝑤 = 2 + 2𝐿
12

10

8 𝑤 =8

𝐷
𝐿
2 3 4 12

45
 𝑀𝐹𝐶: 𝑤 = 2 + 4𝐿

𝑤
𝑆: 𝑤 = 2 + 2𝐿
12

10 𝑤 = 10

𝐷
𝐿
2 3 4 12

46
Problem #3
Find the monopsonist’s optimal labor demand and
wage paid.

L AFC TFC MFC VMP

0 0 0 0 16
10 2 20 4 12
20 4 80 8 8
30 6 180 12 4

47
Problem #3
Find the monopsonist’s optimal labor demand and
wage paid.

L AFC TFC MFC VMP

0 0 0 0 16
10 2 20 4 12
20 4 80 8 8
30 6 180 12 4

Optimality condition: MFC = VMP  L = 20

Wage can be found along AFC at this amount of Labor  w = 4

48
Problem #4
A perfect competitive firm has 𝑀𝑃 = 22 − 𝐿.

a. Find and graph its value of the marginal product of l

abor at a product price 𝑃 = 5.

b. Find its optimal quantity demanded of labor at a wa

ge of 𝑤 = $10/ℎ𝑟.

49
Problem #4
A perfect competitive firm has 𝑀𝑃 = 22 − 𝐿.

a. Find and graph its value of the marginal product of l

abor at a product price 𝑃 = 5.
𝑉𝑀𝑃 = 𝑃 𝑀𝑃 = 110 − 5𝐿

b. Find its optimal quantity demanded of labor at a wa

ge of 𝑤 = $10/ℎ𝑟.
𝑉𝑀𝑃 = 𝑤 → 110 − 5𝐿 = 10 → 𝐿∗ = 20

50
Problem #6
Two antipoverty programs: (1) A payment of $10/day is
to be given this year to each person who was classified
as a poor last year; and (2) each person classified as
poor will be given a benefit equal to 20 percent of the
wage income he earns each day this year.
a. Assuming that poor persons have the option of
working at $4/hr, show how each program would
affect the daily budget constraint of a representative
poor worker during the current year.
b. Which program would be most likely to reduce the
number of hours worked?

51
Problem #6
𝑤

107.52
106

96

program (1)

program (2)

𝐿(𝐿𝑒𝑖𝑠𝑢𝑟𝑒)
1.9 24

52
Problem #6
𝑤
Program (1): only income effect
107.52
106 Program (2): substitution effect
& smaller income effect
96

program (1)

program (2)

𝐿(𝐿𝑒𝑖𝑠𝑢𝑟𝑒)
1.9 24

53
Problem #6
𝑤

115.2 program (2): 𝑤 = 115.2 − 4.8𝐿

106

96

program 1 : 𝑤 = 106 − 4𝐿

𝐿(𝐿𝑒𝑖𝑠𝑢𝑟𝑒)
11.5 24

54
Problem #6
𝑤
Program (1): only income effect
115.2 program (2)
106 Program (2): substitution effect
& smaller income effect
96

program 1

𝐿(𝐿𝑒𝑖𝑠𝑢𝑟𝑒)
11.5 24

55
Problem #8
• Acme is the sole supplier of security systems in the
product market and the sole employer of locksmiths
in the labor market.
• The demand curve for security systems is given by
𝑃 = 100 − 𝑄.
• The short-run production function for security system
is given by 𝑄 = 4𝐿.
• The supply curve for locksmith is given by 𝑊 = 40 +
20𝐿.
• How many locksmiths will Acme hire, and what wage
will it pay?

56
Problem #8
• Demand for product: 𝑃 = 100 − 𝑄
• Product function: 𝑄 = 4𝐿.
• Supply curve for labor: 𝑊 = 40 + 2𝐿.
• How many locksmiths will Acme hire, and what wage
will it pay?
• 𝑀𝑅 = 100 − 2𝑄 = 100 − 8𝐿
• 𝑀𝑃 = 4
• 𝑀𝑅𝑃 = 𝑀𝑅 𝑀𝑃 = 400 − 32𝐿
• 𝑀𝐹𝐶 = 40 + 4𝐿
• Optimality condition: 𝑀𝑅𝑃 = 𝑀𝐹𝐶
→ 𝐿∗ = 10
→ 𝑊 ∗ = 60

57
Problem #8
• Demand for product: 𝑃 = 100 − 𝑄
• Product function: 𝑄 = 4𝐿.
• Supply curve for labor: 𝑊 = 40 + 2𝐿.
• How many locksmiths will Acme hire, and what wage
will it pay?

Another Approach
• 𝜋 = 𝑃𝑄 − 𝑊𝐿 = 100𝑄 − 𝑄 − 40 + 2𝐿 𝐿
= 400𝐿 − 16𝐿 − 40𝐿 − 2𝐿 = 360𝐿 − 18𝐿
• = 360 − 36𝐿 = 0 → 𝐿∗ = 10

58
Problem #16
• A firm produces according to the production function
𝑄=𝐾 𝐿 .
• If it sells its output in a perfectly competitive market
at a price of 10, and if 𝐾 is fixed at 4 units, what is
this firm’s short run demand curve for labor?

59
Problem #16
• A firm produces according to the production function
𝑄=𝐾 𝐿 .
• If it sells its output in a perfectly competitive market
at a price of 10, and if 𝐾 is fixed at 4 units, what is
this firm’s short run demand curve for labor?
• 𝑄 = 2𝐿 → 𝑀𝑃 = → V𝑀𝑃 =
• Optimality condition: V𝑀𝑃 = 𝑤
10
→ =𝑤
𝐿
∗
100
→𝐿 =
𝑤

60
Homework
} Problems. 1, 2, 5, 7, 9, 17

61