Equilibrium Wage Distributions Joseph E. Share Twitter LinkedIn Email. Working Paper DOI Issue Date April Acknowledgements and Disclosures. Published Versions Stiglitz, Joseph E. Related Topics Other. Programs Public Economics. Alan J. Auerbach, the Robert D. The credible estimation of causal effects is a central task of applied econometrics. Since competitive industries are price takers and cannot change the price of output by changing their level of production, the MRPL curve will have the same downward slope as the MPL curve.
From the perspective of the firm, the MRPL is the marginal benefit to the firm of hiring an additional unit of labor. We know that a profit-maximizing firm will increase its factors of production until their marginal benefit is equal to the marginal cost.
Therefore, firms will continue to add labor hire workers until the MRPL equals the wage rate. Thus, workers earn a wage equal to the marginal revenue product of their labor. Marginal Product and Wages : The graph shows that a factor of production — in our case, labor — has a fixed supply in the long run, so the wage rate is determined by the factor demand curve — in our case, the marginal revenue product of labor.
The intersection of vertical supply and the downward sloping demand gives the wage rate. As in all competitive markets, the equilibrium price and quantity of labor is determined by supply and demand. More hours worked earn higher incomes but necessitate a cut in the amount of other things workers enjoy such as going to movies, hanging out with friends, or sleeping.
The opportunity cost of working is leisure time and vis versa. Considering this tradeoff, workers collectively offer a set of labor to the market which economists call the supply of labor. To see how changes in wages affect the supply of labor, suppose wages rise. This increases the cost of leisure and causes the supply of labor to rise — this is the substitution effect , which states that as the relative price of one good increases, consumption of that good will decrease.
However, there is also an income effect — an increased wage means higher income, and since leisure is a normal good, the quantity of leisure demanded will go up. In general, at low wage levels the substitution effect dominates the income effect and higher wages cause an increase in the supply of labor.
At high incomes, however, the negative income effect could offset the positive substitution effect and higher wage levels could actually cause labor to decrease. This creates a supply curve that bends backwards, initially increasing with the wage rate but later decreasing.
Backward Bending Supply : While normally hours of labor supplied will increase with the wage rate, the income effect may produce the opposite effect at high wage levels. People supply labor in order to increase their utility —just as they demand goods and services in order to increase their utility. The supply curve for labor will shift in response to changes in the same factors that shift demand for goods and services. These include changes in preferences, changes in income, changes in population, and changes in expectations.
A change in preferences that causes people to prefer more leisure, for example, will shift the supply curve to the left, creating a lower level of employment and a higher wage rate. An increase in the demand for labor will increase both the level of employment and the wage rate.
We have already seen that the demand for labor is based on the marginal product of labor and the price of output. Thus, any factor that affects productivity or output prices will also shift labor demand. Some of these factors include:. All of the above may cause the demand for labor to shift and change the equilibrium quantity and price of labor.
Unions are organizations of workers that seek to improve working conditions and raise the equilibrium wage rate. A labor union is an organization of workers who have banded together to achieve common goals. The primary activity of the union is to bargain with the employer on behalf of union members and negotiate labor contracts. The most common purpose of associations or unions is maintaining or improving the conditions of employment, which may include the negotiation of wages, work rules, complaint procedures, promotions, benefits, workplace safety, and policies.
The effect of unions on the labor market equilibrium can be analyzed like any other price increase. If employers those who demand labor have an inelastic demand for labor, the increase in wages the price of labor will not translate into a drop in employment quantity of labor supplied. If, however, their demand is elastic, employers will simply respond to union demands for higher wages by hiring fewer workers.
However, the reality of unions is more complex. As an organized body, unions are also active in the political realm.
They can lobby for legislation that will affect the market not only for labor, but also for the goods they produce. For example, unions may advocate for trade restrictions to protect the markets in which they work from foreign competition.
By preventing domestic firms from having to compete with unrestricted foreign firms, they can ensure that consumers do not have lower cost alternatives which would drive employers who pay a higher union wage out of business. Union Members Strike : One tool that unions may use to raise wages is to go on strike.
Privacy Policy. Skip to main content. Search for:. Labor Market Equilibrium and Wage Determinants. Learning Objectives Employ the marginal decision rule to determine the equilibrium cost of labor.
Key Takeaways Key Points Firms will hire more labor when the marginal revenue product of labor is greater than the wage rate, and stop hiring as soon as the two values are equal. Key Terms marginal product : The extra output that can be produced by using one more unit of the input. The Wage Rate The wage rate is determined by the intersection of supply of and demand for labor. Learning Objectives Describe the factors that determine the wage rate.
Key Takeaways Key Points An increase in demand or a reduction in supply will raise wages; an increase in supply or a reduction in demand will lower them. The demand curve depends on the marginal product of labor and the price of the good labor produces. If the demand curve shifts to the right, either because productivity or the price of output has increased, wages will be pushed up. In the long run the supply of labor is simply a function of the population size, but in the short run it depends on variables such as worker preferences, the skills and training a job requires, and wages available in alternative occupations.
Union : an organization of workers who have banded together to achieve common goals. Compensation Differentials Some differences in wage rates across places, occupations, and demographic groups can be explained by compensation differentials.
Learning Objectives Describe nonmonetary factors that affect wage rates. Key Takeaways Key Points Although basic economic theory suggests that there ought to be one prevailing wage rate for all labor, this is not the case. Wage differences are called compensation differentials and can be explained by many factors, such as differences in the skills of the workers, the country or geographical area in which jobs are performed, or the characteristics of the jobs themselves.
If a certain area is a desirable place to live, the supply of labor will be higher than in other areas and wages will be lower. This is a type of geographical differential. Discrimination against gender or racial groups can cause compensation differentials. A compensating differential is the additional amount of income that a given worker must be offered in order to motivate them to accept a given undesirable job, relative to other jobs that worker could perform.
Key Terms differential : a qualitative or quantitative difference between similar or comparable things discrimination : Distinct treatment of an individual or group to their disadvantage; treatment or consideration based on class or category rather than individual merit; partiality; prejudice; bigotry.
Performance and Pay Theoretically there is a direct connection between job performance and pay, but in reality other factors often distort this relationship. Learning Objectives Identify the relationship between performance and wages. If one employee is very productive he or she will have a high marginal revenue product.
Key Terms commission : A fee charged by an agent or broker for carrying out a transaction piece work : Work that a worker is paid for according to the number of units produced, rather than the number of hours worked. Marginal Revenue Productivity and Wages In a perfectly competitive market, the wage rate is equal to the marginal revenue product of labor.
Learning Objectives Explain how wages are determines by marginal revenue productivity. Key Takeaways Key Points In the long run the supply of labor is a simple function of the size of the population, so in order to understand changes in wage rates we focus on the demand for labor. The marginal product of labor MPL is the increase in output that a firm experiences from adding one additional unit of labor. The marginal benefit to the firm of hiring an additional unit of labor is called the marginal revenue product of labor MRPL.
It is calculated by multiplying MPL by the price of the output. Key Terms marginal benefit : The extra benefit received from a small increase in the consumption of a good or service. It is calculated as the increase in total benefit divided by the increase in consumption. Changes in Equilibrium for Shifts in Market Supply and Market Demand A shift in the supply or demand of labor will cause a change in the market equilibrium.
Learning Objectives Discuss the factors that influence the shape and position of the labor supply curve. Key Takeaways Key Points The opportunity cost of leisure is the wages lost while not working; as wages rise, the cost of leisure increases. The substitution effect means that when wages rise, people are likely to substitute more labor for less leisure. However, the income effect means that as people become wealthier, their demand for normal goods such as leisure increases.
Typically the substitution effect dominates the supply of labor at normal wage rates, but the income effect may come to dominate at higher wage rates. This creates a backward bending labor supply curve.
The supply curve for labor will shift in response to changes in preferences, changes in income, changes in population, and changes in expectations. The demand curve for labor will shift in response to changes in human capital, changes in technology, changes in the price of complements or substitutes for output, and changes in consumer preferences.
Key Terms normal good : A good for which demand increases when income increases and falls when income decreases but price remains constant. Opportunity cost : The cost of any activity measured in terms of the value of the next best alternative forgone that is not chosen.
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