# Labor Markets and Income

## The Theory of Labor Markets

The labor market, like all markets, has a demand and a supply.  Why do firms demand labor?  Why is an employer willing to pay you for your labor?  It’s not because the employer likes you or is socially conscious.  Rather, it’s because your labor is worth something to the employer--your work brings in revenues to the firm.  How much is an employer willing to pay?  That depends on the skills and experience you bring to the firm.
If a firm wants to maximize profits, it will never pay more (in terms of wages and benefits) for a worker than the value of their marginal productivity to the firm.  We call this the first rule of labor markets.
Suppose a worker can produce two widgets per hour and the firm can sell each widget for $4 each.  Then the worker is generating $8 per hour in revenues to the firm, and a profit-maximizing employer will pay the worker up to, but no more than, $8 per hour, because that is what the worker is worth to the firm.
Recall the definition of marginal product.  Marginal product is the additional output a firm can produce by adding one more worker to the production process.  Since employers often hire labor by the hour, we’ll define marginal product as the additional output the firm produces by adding one more worker hour to the production process.  In this chapter, we assume that workers in a particular labor market are homogeneous—they have the same background, experience and skills and they put in the same amount of effort.  Thus, marginal product depends on the capital and technology with which workers have to work.
A typist can type more pages per hour with an electric typewriter than a manual typewriter, and the typist can type even more pages per hour with a personal computer and word processing software.  A ditch digger can dig more cubic feet of dirt in an hour with a backhoe than with a shovel.
Thus, we can define the demand for labor as the marginal product of labor times the value of that output to the firm.
On what does the value of each worker’s marginal product depend?  If we assume that the employer sells its output in a perfectly competitive market, the value of each worker’s output will be the market price of the product. Thus, 
Demand for Labor = MPL x P = Value of the Marginal Product of Labor
We show this in , which is an expanded version of 
Note that the value of each additional worker is less than the value of the ones who came before.

### Demand for Labor in Perfectly Competitive Output Markets

The question for any firm is how much labor to hire.
We can define a Perfectly Competitive Labor Market as one where firms can hire all the labor they want at the going market wage.  Think about secretaries in a large city.  Employers who need secretaries can probably hire as many as they need if they pay the going wage rate.
Graphically, this means that firms face a horizontal supply curve for labor, as Figure 14.3 shows.
Given the market wage, profit maximizing firms hire workers up to the point where: Wmkt = VMPL 

### Demand for Labor in Imperfectly Competitive Output Markets

If the employer does not sell its output in a perfectly competitive industry, they face a downward sloping demand curve for output, which means that in order to sell additional output the firm must lower its price.  This is true if the firm is a monopoly, but it’s also true if the firm is an oligopoly or monopolistically competitive.  In this situation, the value of a worker’s marginal product is the marginal revenue, not the price.  Thus, the demand for labor is the marginal product times the marginal revenue.
The Demand for Labor = MPL x MR = Marginal Revenue Product
Everything else remains the same as we described above in the discussion of the labor demand in perfectly competitive labor markets.  Given the market wage, profit-maximizing firms will hire workers up to the point where the market wage equals the marginal revenue product, as  shows. 

### What Determines the Going Market Wage Rate?

In the chapter on Labor and Financial Markets, we learned that the labor market has demand and supply curves like other markets.  The demand for labor curve is a downward sloping function of the wage rate.  The market demand for labor is the horizontal sum of all firms’ demands for labor.  The supply of labor curve is an upward sloping function of the wage rate.  This is because if wages for a particular type of labor increase in a particular labor market, people with appropriate skills may change jobs, and vacancies will attract people from outside the geographic area.  The market supply of labor is the horizontal summation of all individuals’ supplies of labor.
Like all equilibrium prices, the market wage rate is determined through the interaction of supply and demand in the labor market.  Thus, we can see in  for competitive markets the wage rate and number of workers hired. 
The FRED database has a great deal of data on labor markets, starting at
the wage rate and number of workers hired.

The United States Census Bureau for the Bureau of Labor Statistics publishes The Current Population Survey, which is a monthly survey of households (you can find a link to it by going to the FRED database found in the previous link), which provides data on labor supply, including numerous measures of the labor force size (disaggregated by age, gender and educational attainment), labor force participation rates for different demographic groups, and employment.  It also includes more than 3,500 measures of earnings by different demographic groups.  
The Current Employment Statistics, which is a survey of businesses, offers alternative estimates of employment across all sectors of the economy.
The FRED database, found in the previous link, also has a link labeled "Productivity and Costs" has a wide range of data on productivity, labor costs, and profits across the business sector.

### Key Concepts and Summary

A firm demands labor because of the value of the labor’s marginal productivity.  For a firm operating in a perfectly competitive output market, this will be the value of the marginal product, which we define as the marginal product of labor multiplied by the firm’s output price.  For a firm which is not perfectly competitive, the appropriate concept is the marginal revenue product, which we define as the marginal product of labor multiplied by the firm’s marginal revenue.  Profit maximizing firms employ labor up to the point where the market wage is equal to the firm’s demand for labor.  In a competitive labor market, we determine market wage  through the interaction between the market supply and market demand for labor.


### Self-Check Questions


### Review Questions


### References

AFL-CIO. “Training and Apprenticeships.” http://www.aflcio.org/Learn-About-Unions/Training-and-Apprenticeships.
Cook, Lisa D. 2020. "Policies To Broaden Participation in the Innovation Process." The Hamilton Project. https://www.hamiltonproject.org/assets/files/Cook_PP_LO_8.13.pdf.
Darity Jr., William A. 1998. "Evidence of Discrimination in Employment: Codes of Color, Codes of Gender." Journal of Economic Perspectives 12 (2): 63–90.
Central Intelligence Agency. “The World Factbook.” https://www.cia.gov/library/publications/the-world-factbook/index.html.
Clark, John Bates. Essentials of Economic Theory: As Applied to Modern Problems of Industry and Public Policy. New York: A. M. Kelley, 1907, 501.
United Auto Workers (UAW). “About: Who We Are.” http://www.uaw.org/page/who-we-are.
United States Department of Labor: Bureau of Labor Statistics. “Economic News Release: Union Members Summary.” Last modified January 23, 2013. http://www.bls.gov/news.release/union2.nr0.htm.
United States Department of Labor, Bureau of Labor Statistics. 2015. “Economic News; Union Members Summary.” Accessed April 13, 2015. http://www.bls.gov/news.release/union2.nr0.htm.