L22 perfect labour

Microeconomics: Perfect Labour Markets

Aims of the Factor Markets Lectures

• Transition from market structure affecting outcomes to the focus on input markets (factors of production).

• Buyers of Outputs: Individuals or households seeking to satisfy preferences.

• Buyers of Inputs: Firms producing outputs for profit.

• Demand for Inputs: Derived demand, different from the demand for outputs.

• Key Questions to Analyze:

  • How do firms decide on labor employment levels?

  • Relation of input prices to output prices.

  • Impact of market structure on employment.

Factors of Production

• Inputs required to produce output:

  • Labour: People available for work.

    • Units: Number of people, hours of work.

    • Cost to firm: Wages or salaries.

  • Capital: Machinery and equipment.

    • Units: Number of machines/tools/factories.

    • Cost to firm: Rent, purchase price.

  • Land: Site of production, often included with capital.

• Short-run variability: Only labour is variable; increasing output leads to diminishing returns (next labor unit less productive).

• Long-run variability: Capital can replace labour.

Aims of This Lecture

• Introduction to Perfect Labour Markets.

• Focus on how labour markets differ from other markets and how structure affects operations.

• Investigate employment levels and wage rates in a perfectly competitive labor market.

Lecture Outline

1. Supply of labour

2. Demand for labour

3. Assumptions for perfectly competitive labour markets

4. Appropriate market structure

5. Equilibrium in the short-run

• Reading: Core: Lipsey & Chrystal, Ch. 9 & 10; Extra: Perloff, Ch. 15

Supply of Labour (Individual Workers)

• Work incurs two main costs:

  1. Sacrifice of leisure.

  2. Potential unpleasantness of work.

• Disutility increases with each additional hour, thus higher wages are required:

  • Substitution Effect: Higher wages lead to increased participation in work due to opportunity costs.

  • Income Effect: Higher wages allow for greater leisure purchasing.

Supply of Labour (Market Level)

• Individual employer's labour supply influenced by market structure:

  • Wage Taker: Perfectly elastic supply curve.

  • Wage Maker: Upward sloping supply curve.

• Market labour supply generally upward sloping, influenced by:

  • Number of qualified candidates.

  • Non-wage benefits or job costs.

  • Job switch difficulty (elasticity).

Demand for Labour

• Marginal Input Rule: Firms should employ labor until:

  • MRPL (Marginal Revenue Product of Labour) = MCL (Marginal Cost of Labour).

• MRPL definition: Revenue change due to one more labor unit.

• If MRPL > MCL, hiring one more unit increases revenues more than costs.

Marginal Revenue Product of Labour

• MRPL calculated as:

  • MRPL = MR x MPPL, where MPPL is the additional output from one extra unit of labour.

  • Relation to costs demonstrated as MCL / MPPL indicates cost of extra unit per output gained.

Assumptions of Perfectly Competitive Labour Markets

• A(1): Firms operate in competitive output market; they accept market prices as given.

• A(2): Firms are wage takers; can hire as much labor as needed without affecting wage rate.

• A(3): Complete information for all participants:

  • Workers aware of jobs and terms.

  • Employers aware of available labor and productivity.

• A(4): Workers also act as wage takers without influencing market price.

• A(5): Free entry for workers at no extra cost; barriers absent.

Appropriate Market Structure

• A: SIZE & NUMBER OF SELLERS: Many small working participants.

• B: BARRIERS TO ENTRY: Low barriers for a freely entering workforce.

• C: SELLER SUBSTITUTABILITY: Workers viewed as equivalent unless productivity varies.

• D: SIZE & NUMBER OF BUYERS: Many small firms purchasing labor; minimal market wage influence.

Equilibrium in the Labour Market (Short Run)

• Market equilibrium achieved when:

  1. Firms optimally choose labor levels per market wage.

  2. Workers optimally supply given wage levels.

  3. Supply matches demand in terms of quantities provided.

• Price in output market and corresponding market wage are driven by supply & demand dynamics.

Summary

• When employers and workers are both wage takers, competition leads to many employers vying for equally productive workers.

• The short-run wage aligns with labor productivity: w = MRPL.

• Supernormal profits attainable by sellers under these conditions.

Learning Outcomes

1. Explain how labour supply responds to wage variations.

2. State assumptions of a perfectly competitive labor market.

3. Describe market structure appropriate for labor assumptions.

4. Derive short-run equilibrium using diagrams.