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Chapter 9 Full Notes

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ECON 1131
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Chapter 9 Supply and Demand in Competitive Labor Markets Labor markets require the same conditions as competitive product markets: 1. Large numbers of buyers and sellers in a given labor market 2. Homogeneous labor from the perspective of the buyer (any number of workers would be equally productive to a firm) 3. Accurate information about wages and market conditions that is available to everyone 4. Easy entry into and exit from a market by both suppliers and demanders The Supply and Demand for Labor The Supply of Labor  The amount of income to be earned is the heart of the matter in the labor supply decision  The consumer’s modified economic problem: o Assume each individual has a single option- to work at one job at a fixed hourly wage, people are free to choose how many hours they work a day o Objectives: maximize utility/satisfaction- this depends on their motivation for working  Individual’s preferred balance between income and leisure time o Alternatives: how much time to spend working o Constraints: time, not income, is the scarce resource  The wage that the individual receives determines the amount of income earned for each hour of leisure time sacrificed  Individual has to select the combination that yields the maximum amount of satisfaction  The individual supply curve o Depends on wage rates and preferences for leisure time vs. income o Hold preferences constant, how many hours does the individual want to work at different wage rates o The shape of the labor supply curve depends on the combined interaction of the substitution and income effects of a wage change (just as these effects determine the shape of the demand curve for a product) o The supply curve for labor need not be upward sloping  Because the substitution and income effects tug in opposite directions on the desire to work  The substitution effect o The substitution effect of a wage increase favors additional hours of work o If the wage rate decreases, leisure is less costly in terms of income foregone, so the individual substitutes toward leisure and works fewer hours o Substitution effect causes the labor supply curve to be upward sloping- hours of work increase as wage increases and decrease as wage decreases  The income effect o At the higher wage the individual can have more income for the same amount of leisure o Income and leisure are both goods, so the individual tends to consume more of both o More leisure time means fewer hours of work o Income effect of a wage increase decreases the amount of labor supplied o Awage decrease reduces purchasing power, which tends to reduce both income and leisure time, hours of work increase o Income effect causes the labor supply to be downward sloping  Hours decrease as wage increases and hours increase as wage decreases  Whether the individual supply curve for labor is upward or downward sloping depends on the relative strength of the substitution and income effects Labor Supply in the United States th  The overall supply of labor was downward sloping throughout the 20 century  The income effect appears to have dominated the substitution effect  Men and women respond differently to changes in wages  The labor supply curve for men appears to be slightly downward sloping o Income effect is just a little bit stronger  The labor supply curve for women is definitely upward sloping o Substitution effect dominates the income effect for women  Abackward bending individual labor supply curve?  At low wages, the substitution effect dominates and the labor supply curve is upward sloping o People prefer increased income to increased leisure time as wages rise  At high wages the situation reverses o People already have relatively high incomes, so they take park of the gains from increased wages as more leisure time- income effect dominates and supply curve bends backward The Value of Time  The simple income-leisure model highlights the value of time in economic decision making  Full price: the price of a product plus the value of the time spent shopping for and actually consuming the product  Increase in women in labor force: o Women are quite willing to substitute market production for home production if given the opportunity to earn higher wages o The time required to produce a given level of home services has declined significantly since 1950 The Overall Market Supply Curve  Shows for various average wage rates, how much labor individuals want to supply across all occupations  Overall labor supply curve is almost vertical in the US b/c it is a blend of male downward sloping curves and female upward sloping curves Supply to an Occupation  Occupation specific supply curves are almost certainly upward sloping because different occupations are natural substitutes for one another so long as individuals are willing and able to work in more than one occupation  Decreases in wages drive people towards competing occupations  Occupational choice enhances the substitution effect, which makes the occupation specific supply curve upward sloping The Demand for Labor  The supply of labor to a firm o The firm has no control over the wage it pays for a particular kind of labor in a competitive market o It faces the established market wage and can hire as much labor as it wants at that wage  The supply of labor is perfectly elastic (horizontal) at the market wage  The market wage defines the marginal cost of hiring additional labor  The firm’s demand for labor o Firm’s goal is to maximize profit, it will hire labor until the wage (or marginal cost) equals the marginal revenue from hiring labor, the additional revenue obtained from the last worker hired o The hiring decision rule is just another specific application of this general principle: **continue an economic activity until marginal benefit equals marginal cost** o Marginal product: the additional output
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