288 Reading: Labor Markets at Work
Labor Markets at Work
We have seen that a firm’s demand for labor depends on the marginal product of labor and the price of the good the firm produces. We add the demand curves of individual firms to obtain the market demand curve for labor. The supply curve for labor depends on variables such as population and worker preferences. Supply in a particular market depends on variables such as worker preferences, the skills and training a job requires, and wages available in alternative occupations. Wages are determined by the intersection of demand and supply. Once the wage in a particular market has been established, individual firms in perfect competition take it as given. Because each firm is a price taker, it faces a horizontal supply curve for labor at the market wage. For one firm, changing the quantity of labor it hires does not change the wage. In the context of the model of perfect competition, buyers and sellers are price takers. That means that a firm’s choices in hiring labor do not affect the wage.
The operation of labor markets in perfect competition is illustrated in Figure 12.8. The wage W1 is determined by the intersection of demand and supply in Panel (a). Employment equals L1 units of labor per period. An individual firm takes that wage as given; it is the supply curve s1 facing the firm. This wage also equals the firm’s marginal factor cost. The firm hires l1 units of labor, a quantity determined by the intersection of its marginal revenue product curve for labor MRP1 and the supply curve s1. We use lowercase letters to show quantity for a single firm and uppercase letters to show quantity in the market.
Changes in Demand and Supply
If wages are determined by demand and supply, then changes in demand and supply should affect wages. An increase in demand or a reduction in supply will raise wages; an increase in supply or a reduction in demand will lower them.
Panel (a) of Figure 12.9 shows how an increase in the demand for labor affects wages and employment. The shift in demand to D2 pushes the wage to W2and boosts employment to L2. Such an increase implies that the marginal product of labor has increased, that the number of firms has risen, or that the price of the good the labor produces has gone up. As we have seen, the marginal product of labor could rise because of an increase in the use of other factors of production, an improvement in technology, or an increase in human capital.
Clearly, a rising demand for labor has been the dominant trend in the market for U.S. labor through most of the nation’s history. Wages and employment have generally risen as the availability of capital and other factors of production have increased, as technology has advanced, and as human capital has increased. All have increased the productivity of labor, and all have acted to increase wages.
Panel (b) of Figure 12.9 shows a reduction in the demand for labor to D2. Wages and employment both fall. Given that the d