Labor Economics: Key Concepts and Applications

Posted on Feb 5, 2025 in Economy

Key Concepts in Labor Economics

The marginal product of labor tells us the additional [output produced by hiring one more worker].
Diminishing marginal returns [occur because] hiring more employees means that each has less capital [to work with].
Referring to [a] table… diminishing [returns set in with the] fourth [worker].
[Referring to a table, the statement] which is INCORRECT [is that] the marginal revenue from selling [an additional unit of output is constant].
[Referring to a table,] if wages are $50… [the firm should hire] five [workers].
If the firm hires to a point where [the marginal revenue product of labor is less than the wage], profits could be increased by reducing employment.
When deciding the salary [of a star athlete], the team must consider how much the sports [star will increase the team’s revenue].
The firm’s labor demand [curve] is the [downward-sloping portion of the marginal revenue] product of labor schedule.
If a tax is placed [on each worker hired], both wages and employment [will decrease].
An employer who is a monopolist in the product [market will] hire fewer employees [than a perfectly competitive employer].
An employer who is a monopsonist will hire fewer workers at a lower wage.
Monopsony implies that the marginal expense [of hiring an additional worker exceeds the wage].
For two substitutes in production, if the scale effect [dominates], then the inputs are gross complements.
[For two substitutes in production,] if the substitution [effect dominates], then the inputs are gross substitutes.
If two inputs are complements in production, then the inputs are gross complements.
In the long run, [a firm will minimize the cost of producing a given level of output when] the wage divided by [the marginal product of labor equals the rental rate on capital divided by the marginal product of capital].
If two inputs are substitutes [in production and an increase in the price of one input shifts the demand curve for the other input to the left, then] the scale effect is greater [than the substitution effect, and the two inputs are] gross complements.
Evidence suggests [that the labor supply of] workers [is relatively] inelastic.
When the price [of capital decreases, a firm will] employ more, less, or the same [amount of labor, depending on the relative magnitudes of the scale and substitution effects].
If an increase in the cost [of labor causes a firm to use less capital], the scale effect [has dominated the substitution effect].
If employers are paid [a subsidy of $0.75 per hour for hiring teenage workers], teenage workers will be paid by less than $0.75 per hour [more than they were paid without the subsidy].
In the short run, a firm cannot expand the [size of the plant].
When a firm [is a monopsonist] in the labor market, [it faces an upward-sloping supply curve of labor, its marginal expense of labor exceeds the wage, and it hires fewer workers than if it were a perfect competitor in the labor market. These are] all of the above.
[When a firm is a monopolist] in the product market, [it faces a downward-sloping demand curve for its product, its marginal revenue is less than its price, and it hires fewer workers than if it were a perfect competitor in the product market. These are] all of the above.
A firm will maximize [profits by hiring labor up to the point where] the marginal revenue [product of labor equals the wage (for a firm that is a perfect competitor in the labor market)].
The marginal revenue product [of labor is equal to the marginal product of labor multiplied by the marginal revenue, provided that] the firm faces competition in the labor market.
For a firm that possesses [monopsony power], MR x MPL = MEL.
In a monopsonistic labor [market, a minimum wage can increase both wages and employment. A union can increase both wages and employment. The firm hires fewer workers than it would if it were a perfect competitor in the labor market. These are] all of the above.
Figure 3-2 shows the short [run production function for a firm. The firm should hire] 17.5 units of labor.
Assume the price of labor equals $10… [If the marginal revenue product of labor is greater than $10, the firm should] increase L.
Suppose the price of capital [decreases. As a result,] the quantity of labor demanded will increase [if the scale effect dominates the substitution effect].
If the price of capital [increases, then] both b and c [are correct: (b) the quantity of labor demanded will decrease if the scale effect dominates the substitution effect, and (c) the quantity of labor demanded will increase if the substitution effect dominates the scale effect].

Definitions

Marginal (Physical) Product of Labor: Measure of the physical increase in the output of a firm or economy; it is the output that results from hiring one additional worker, all other factors remaining constant.
Law of (Eventually) Diminishing Marginal Returns: The eventual decrease in the marginal output of a production process as the amount of a single factor of production is increased.
Marginal Revenue: Increase in the gross revenue of a firm produced by selling an additional unit of output.
Monopsony: A market where a very large buyer is typically able to force prices of input to decline, contrasting with a monopoly where a large seller is able to drive up prices.
Normal Good vs. Inferior Good: An inferior good is a type of good for which demand declines as the level of income or real GDP in the economy increases. The opposite is a normal good, which experiences an increase in demand along with increases in the income level.
Marginal Revenue Product: The change in revenue that results from the addition of one extra unit when all other factors are kept equal.
Short Run vs. Long Run: The short run means that the quantity of labor is variable, but the quantity of capital and production processes are fixed. On the other hand, long run means that the quantity of labor, the quantity of capital, and production processes are all variable.
Nominal (or Money) Wage vs. Real Wage: ‘Real wages’ refers to the total amount of necessities, comforts, and other facilities which a worker may enjoy by working at a job. The term ‘nominal wage,’ however, simply refers to the amount of money that a worker may be getting.

Additional Considerations

The reason that dentists’ wages are higher than waitresses’ is the dentists’ academic requirements. Dentists expend many years studying a long and expensive career. They are required to have a college degree to be able to work. This means a lot of time and money the dentist spends to be a dentist, which establishes high entry barriers. While a waitress is not required to have a college degree, thus few, if any, entry barriers. They only need to have the willingness to work and to know how to do the job. So the supply of waitresses is always higher than the supply of dentists, relative to the demand.

Derivation of a Business Firm’s Labor Demand Curve

For a business that has a goal of profit maximization based on the demand curve, they are going to hire as many workers. They find it profitable, but the number of workers and their wages aren’t higher than the addition of profit, because if it was like that, the company is going to end up losing money, and that wouldn’t be profit-maximizing because what this means is that the company wants to make the maximum amount of total profit. So the demand can be high, but they are going to supply the workers that they need more and not less. MRPL is the demand for labor in this case, and MEL=W in this case.

Clark’s Theory of Distribution

Clark’s Theory of Distribution graphically helps us to “see” what portion of total output goes to the worker and what portion of total output goes to the landowner. Clark observed that under normal economic conditions, each worker receives a market equilibrium wage. However, the landowner receives what looks like a “surplus,” represented by the unshaded triangular area under the demand curve. If the landowner adds workers on a one-by-one basis, the law of diminishing returns indicates that the first worker will contribute the most to total output and that subsequent workers will contribute less and less to total output. In theory, the first workers contribute more to total production than they receive. Clark concluded that this surplus is actually not a surplus but an economic return—or rent—to the owner of the land resource.

Labor Supply Curve

The labor supply curve has some differences from other supply curves because it is highly determined by workers’ attitudes and preferences. There are two particular effects in the labor supply curve. The consumption effect has the normal shape of a supply curve, upward sloping; but at a certain point, it changes to the “leisure effect,” which looks like the supply is going to the left. This happens because the wage reaches a point at which the worker can get the same income or higher by working less at a higher wage. Also, there are three different shapes of labor supply curves depending on the workers’ attitudes and preferences. The first one is the workaholic example; these are people who like to work, so they would have a leisure effect but at a higher wage level than others. The second example is the philosopher, which will have a leisure effect at a lower level than the workaholics. And the third one is the Buddhist example, whose principal interest is not the economic income of the job but just the satisfaction of doing the job, so its labor supply curve is inelastic.

Monopsony vs. Competitive Employers

The monopsonist employer will always try to hire the fewest workers he can at the smallest wage rate. While the competitive employer is attached to the labor market changes, making him hire more workers at higher wages than the monopsonist. However, the unionization of workers can change the outcome for employment as well as the wage level.