Work vs. Leisure

  • In the labor market, the roles of firms and households are reversed

    • Labor is supplies by households and demanded by firms
  • Assume that an individual is capable of working as little or as many hours as possible

  • Individual Labor Supply Curve

    • the relationship between the wage rate and the number of labor supplied by the worker

    • If the substitution effect dominates, the curve slopes upward

    Wage rate $20 10 Individual labor supply curve 40 50 Quantity of
labor (hours)

  • If the income effect dominates, the quantity of labor supplies goes down

    Wage rate $20 10 Individual labor supply curve 30 40 Quantity of
labor (hours)

Backward-Bending Labor Supply Curve

  • Is a backward-bending labor supply curve possible?

  • At high wage rates, yes!

  • At the end of the 19th century, the average work week was 70 hours and few people retired at age 65

  • Today the typical workweek is between 35-40 hours as people substitute income for leisure

    Wage rate WI Individual labor supply curve c Quantity of labor
(hours per week)

Shift of the Labor Supply Curve

  • Changes in Preferences and Social Norms

    • In the US since the 1960s a large number of women entered the workforce
  • Changes in Population

  • Changes in Opportunities

    • In the 1960s, as opportunities for women increased, the supply of teachers decreased, raising the equilibrium wage of all reaming teachers


  • Changes in Wealth

    • In 1979, 71% of the American teenagers (16-19) were in the summer workforce. In 1989, it dropped to 63%. By 2009 the drop was down to 33%

    • As household wealth increases, teenagers tend to consume more leisure (ie. additional study, games)

Determining the Optimal Input Mix

  • Substitutes and Complements in Factor Markets

    • Capital and Labor can be substitutes in banking

    • You can substitute ATM machines for tellers

    • Office workers and computers can be complements

  • Cost Minimization

    • Optimal Input Mix is where MPL/Wage = MPK/Rental Rate

    • If MPL/Wage > MPK/Rental Rate, then hire the human worker

    • If MPK/Rental Rate > MPL/Wage, then the machines win! use more capital

  • Situation is very similar to the Utility Maximization rule of MUA/PA=MUB/PB, except in the context of factor market rather than consumer behavior

Capital vs. Labor

Quantity of Labor Quantity of Expo Markers 90 120 140 155 160 162

  • What is the MPL of the 4th worker?

    • 140 - 120 = 20
  • What is the MPL per dollar of the 5th worker if the wage rate per hour is $5

    • (155 - 140) / 5 = 3
  • How many workers would the business hire if it hired every worker for whom the marginal product per dollar is greater than or equal to 1 expo maker per dollar?

0 0
1 40 40 8
2 90 50 10
3 120 30 6
4 140 20 4
5 155 15 3
6 160 5 1
7 162 2 0.4
  • 6 workers, 160 expo markers
  • If the marginal product per dollar spent on labor is 1 expo marker per dollar, the marginal product of the last capital hired is 100 expo markers per dollar and the rental rate is $50 per day, is the firm minimizing its cost?

    • No, employ more capital and less labor

    • C:\\CE5A5F25\\EA5686BB-78FF-4844-9ADF-D3586C9ED368\_files\\image173.png

Theories of Income Distribution

  • Marginal Productivity and Wage Inequality

    • Compensating differentials

      • Across different jobs, wages are often higher or lower depending on a jobs "pleasant" factor
    • Differences in talent

      • Lebron James is paid higher than most basketball players because he has a higher level of ability than they do
    • Quantity of human capital

      • Those who invest in education tend to have higher wages than those that do not
  • Market Power

    • Unions, or organizations that try to raise wages and working conditions, tend to increase the equilibrium price of labor via "collective bargaining"
  • Efficiency wage

    • Type of incentive scheme used by workers to encourage hard work and reduce turnover

    • Employers will pay above the equilibrium wage or a premium above the "normal" wage rate in order to encourage staying with a company

  • Discrimination

    • Racial or Gender discrimination is NOT a natural consequence of market competition

    • In fact, companies can benefit by exploiting discrimination

    • Branch Rickey, in signing Jackie Robinson to play for Dodgers, got a huge bargain economically because no other African-American baseball players were playing in the major leagues

Factor Market Example

  • Assume Park's Place Pencils employs a fixed number of employees and rents a machine for a variable number of hours from a perfectly competitive market.

  • Using correctly labeled side-by-side graphs of the factor market of machines and the Park's Place Pencils, find the equilibrium rental price of machines in the factor market, and Park's Place equilibrium rental quantity of machines


  • Assume that the popularity of pencils increases, increasing the demand for pencils

  • What will happen to each of the following?

    • Marginal product curve for machine-hours

      • stays the same

      • MRP = P * MPL

      • P↑, MRP↑, MPL -

    • Marginal revenue product curve for machine-hours

      • Increases because price increases

      • MRP = P * MPL

  • J. Daniel Park, CEO of Park's Place Pencils is employing the cost-minimizing combination of inputs. The marginal product of labor is 60 pencils per worker hour and the wage rate is $15 per hour. The marginal product of the machine is 100 widgets per machine-hour. What is the hourly rental price of a machine

    • C:\\CE5A5F25\\EA5686BB-78FF-4844-9ADF-D3586C9ED368\_files\\image175.png

    • C:\\CE5A5F25\\EA5686BB-78FF-4844-9ADF-D3586C9ED368\_files\\image176.png

    • C:\\CE5A5F25\\EA5686BB-78FF-4844-9ADF-D3586C9ED368\_files\\image177.png

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