# Economics principles tools and applications 9th by sullivan sheffrin perez chapter 32

Economics

NINTH EDITION

Chapter 32
Insert Cover Picture

The Labor Market and
The Distribution of
Income

Learning Objectives

32.1 Explain why competition generates wages equal to marginal revenue product.
32.2 Explain why an increase in the wage could increase, decrease, or not change hours worked.
32.3 Explain why wages differ across occupations and levels of human capital.
32.4 Describe recent changes in the distribution of income.
32.5 Describe the effects of government policies on poverty and the distribution of income.

32.1 THE DEMAND FOR LABOR (1 of 8)

Labor Demand by an Individual Firm in the Short Run
MARGINAL PRINCIPLE
Increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level at which the marginal benefit equals the
marginal cost.
The firm will pick the quantity of labor at which the marginal benefit of labor equals the marginal cost of labor.

32.1 THE DEMAND FOR LABOR (2 of 8)

Labor Demand by an Individual Firm in the Short Run
TABLE 32.1 Using the Marginal Principle to make a Lobor Decision
(1)

(2)

(3)

(4)

(5)

(6)

Workers

Balls

Marginal

Price

Marginal Revenue

Marginal Cost

Product of Labour (MRP)

When Wage = \$8

Product of Labour
1

26

26

\$0.50

\$13

\$8

2

50

24

0.50

12

8

3

72

22

0.50

11

8

4

92

20

0.50

10

8

5

108

16

0.50

8

8

6

120

12

0.50

6

8

7

128

8

0.50

4

8

8

130

2

0.50

1

8

PRINCIPLE OF DIMINISHING RETURNS
Suppose output is produced with two or more inputs and we increase one input while holding the other input or inputs fixed. Beyond some point—
called the point of diminishing returns —output will increase at a decreasing rate.

32.1 THE DEMAND FOR LABOR (3 of 8)

Labor Demand by an Individual Firm in the Short Run
Marginal product of labor
The change in output from one additional unit of labor.

Marginal-revenue product of labor (MRP)
The extra revenue generated from one additional unit of labor; MRP is equal to the price of output times the marginal product of labor.

32.1 THE DEMAND FOR LABOR (4 of 8)

Labor Demand by an Individual Firm in the Short Run
Using the marginal principle, the firm picks the quantity of workers at
which the marginal benefit (the marginal revenue product of labor) equals
the marginal cost (the wage).
The firm’s short-run demand curve for labor is the marginal revenue
product curve.

Short-run demand curve for labor
A curve showing the relationship between the wage and the quantity
of labor demanded over the short run, when the firm cannot change
its production facility.

32.1 THE DEMAND FOR LABOR (5 of 8)

Labor Demand by an Individual Firm in
the Short Run
An increase in the price of the good produced by workers
increases the marginal revenue product at each quantity of
workers, shifting the demand curve to the right.
At each wage, the firm will demand more workers. For example,
at a wage of \$8, the demand for labor increases from five
workers (point b) to seven workers (point d).

32.1 THE DEMAND FOR LABOR (6 of 8)

Market Demand for Labor in the Short Run
To draw the short-run market demand curve for labor, we add the labor demands of all the firms that use a particular type of labor.
If there were 100 firms and each hired 5 workers at a wage of \$8, the market demand for labor would be 500 workers.
Similarly, if the typical firm hired 3 workers at a wage of \$11, the market demand would be 300 workers.

32.1 THE DEMAND FOR LABOR (7 of 8)

Labor Demand in the Long Run
Long-run demand curve for labor
A curve showing the relationship between the wage and the quantity of labor demanded over the long run, when the number of firms in the market can
change and firms can modify their production facilities.

Output effect
The change in the quantity of labor demanded resulting from a change in the quantity of output produced.

Input-substitution effect
The change in the quantity of labor demanded resulting from an increase in the price of labor relative to the price of other inputs.

32.1 THE DEMAND FOR LABOR (8 of 8)

Labor Demand in the Long Run
In less-developed countries, labor is less costly relative to machinery
and equipment, so labor is substituted for these other inputs.

Examples:
Mining. Firms in some less-developed countries use thousands of workers digging by hand.
Furniture. Firms in some less-developed countries make furniture by hand.
Accounting. Some accountants in less-developed countries use simple calculators and ledger paper.

Short-Run versus Long-Run Demand
There is less flexibility in the short run because firms cannot enter or leave the market and they cannot modify their production facilities. As a result, the demand
for labor is less elastic in the short run. That means the short-run demand curve is steeper than the long-run demand curve.

APPLICATION 1

MARGINAL REVENUE PRODUCT IN MAJOR LEAGUE BASEBALL
APPLYING THE CONCEPTS #1: Are workers paid their Marginal Revenue Product (MRP)?
In 2011, the average salary in Major League Baseball (MLB) was \$3.3 million. A team will pay \$3.3 million for a player only if the player’s marginal revenue product (MRP) is at
least \$3.3 million. The MRP of a player equals his contribution to the firm’s total revenue from ticket sales and television contracts. For example, a player with a relatively
high slugging percentage increases the team’s winning percentage, increasing the revenue from ticket sales and TV.
A subset of MLB players are free agents, meaning that they are free to negotiate a contract with any MLB team. Given the competition between teams for the services of free
agents, their salaries are close to their MRPs. In contrast, two types of players are not allowed to change teams.

•Journeymen (3-6 years in the league) are restricted to a single team, but can enter salary arbitration to change their salaries
•Apprentices (up to 3 years in the league) are restricted to a single team and cannot change their salaries.
Given the immobility of journeymen and apprentices, we expect them to be paid less than their MRPs. According to a recent study, the average MRP of journeymen is about
\$1.08 million, which is about 17 percent higher than the average salary. For apprentices, the average MRP is about \$810,000, which is about 3.6 times the average salary.

32.2 THE SUPPLY OF LABOR

(1 of 2)

The Individual Labor-Supply Decision: How Many Hours?
Substitution effect for leisure demand
The change in leisure time resulting from a change in the wage (the price of leisure) relative to the price of other goods.

Income effect for leisure demand
The change in leisure time resulting from a change in real income caused by a change in the wage.

32.2 THE SUPPLY OF LABOR

(2 of 2)

The Market Supply Curve for Labor
An increase in the wage affects the quantity of nursing supplied in three ways:
Hours worked per employee. When the wage increases, some nurses will work more hours, some will work fewer hours, and some will work the same
number of hours.
Occupational choice. An increase in the nursing wage will cause some workers to switch from other occupations to nursing and motivate more new workers to
pick nursing over other occupations.
Migration. Some nurses in other cities will move to Florence to earn the higher wages offered there.

Market supply curve for labor
A curve showing the relationship between the wage and the quantity of labor supplied.

32.3 LABOR MARKET EQUILIBRIUM (1of 9)

At the market equilibrium shown by point a, the wage is \$15 per
hour and the quantity of labor is 16,000 hours.
The quantity supplied equals the quantity demanded, so there is
neither excess demand for labor nor excess supply of labor.

APPLICATION 2

CABBIES RESPOND TO AN INCREASE IN THE WAGE
APPLYING THE CONCEPTS #2: When the wages increases, will the typical person work more hours or fewer hours?
Taxi drivers have a lot of flexibility in choosing their work hours, and we can readily observe their response to an increase in the wage. An increase in the taxi
fare, which is regulated by cities, represents an increase in the wage earned by taxi drivers.
A recent study of the taxi market in New York City shows that an increase in the regulated fare (an increase in the wage) actually decreases the quantity of
labor supplied.
In 2004 a 19 percent increase in the regulated fare decreased the miles driven per cabbie by 5.6 percent. Overall, the elasticity of miles driven (quantity of labor
supplied) with respect to the fare per mile (the wage) is –0.22. In other words, a 10 percent increase in the wage decreases the quantity of labor supplied
by 2.2 percent.

32.3 LABOR MARKET EQUILIBRIUM (2 of 9)

Changes in Demand and Supply
An increase in the demand for nursing services shifts the demand
curve to the right, moving the equilibrium from point a to point b.
The equilibrium wage increases from \$15 to \$17 per hour, and the
equilibrium quantity increases from 16,000 hours to 19,000 hours.

32.3 LABOR MARKET EQUILIBRIUM (3 of 9)

The Markets Effects of the Minimum Wage
The market equilibrium is shown by point a: The wage is \$5.45 per
hour, and the quantity of labor is 50,000 hours.
A minimum wage of \$6.55 decreases the quantity of labor
demanded to 49,000 hours per day (point b).
Although some workers receive a higher wage, others lose their
jobs or work fewer hours.

32.3 LABOR MARKET EQUILIBRIUM (4 of 9)

Why Do Wages Differ Across Occupations?
The supply of workers in a particular occupation could be small for four reasons:
Few people with the required skills.
High training costs.
Undesirable working conditions.
Danger
Artificial barriers to entry.

32.3 LABOR MARKET EQUILIBRIUM (5 of 9)

Why Do Wages Differ Across Occupations?
If supply is low relative to demand—because few people have
the skills, training costs are high, or the job is undesirable—the
equilibrium wage will be high.

32.3 LABOR MARKET EQUILIBRIUM (6 of 9)

The Gender Pay Gap
A recent study explored several factors that contribute to the gender pay gap. The study observed a gap of about 20 percent among workers aged 26 to 34, and
identified four factors that contribute to the gender gap:

Difference in worker skills and productivity.

Differences in occupational preferences.

Occupational discrimination.

Wage discrimination.

32.3 LABOR MARKET EQUILIBRIUM (7 of 9)

Racial Discrimination
African American males who work full time earned 73 percent as much as their white counterparts, while African American females earn 85 percent as much as
their white counterparts.
Hispanic males earn 65 percent as much as white males, while Hispanic females earn 78 percent as much as white females.
For both males and females, part of the earnings gap is caused by differences in productivity:
On average, whites have more education and work experience, so they are paid higher wages. However, part of the wage gap is caused by racial
discrimination.
Earnings differences have decreased over the last few decades.

32.3 LABOR MARKET EQUILIBRIUM (8 of 9)

Why Do College Graduates Earn Higher Wages?
In 2009, the college premium—the increase in earnings from a college degree—was 74 percent.

Learning effect
The increase in a person’s wage resulting from the learning of skills required for certain occupations.

Signaling effect
The information about a person’s work skills conveyed by completing college.

32.3 LABOR MARKET EQUILIBRIUM (9 of 9)

Labor Unions and Wages
Labor union A group of workers organized to increase job security, improve working conditions, and increase wages and fringe benefits.
Featherbedding Work rules that increase the amount of labor required to produce a given quantity of output. Featherbedding may actually decrease the
demand for labor.

APPLICATION 3

APPLYING THE CONCEPTS #3: What explains differences in wages?
How does physical attractiveness affect earnings? Studies of the U.S. labor market show that beautiful people earn more than people of average books, and unattractive
people earn less.
The beauty premium is 5 percent for the 33 percent of workers who are considered beautiful or handsome, and the beauty premium is larger for men than for women.
The penalty for bad looks is about 8 percent for the 10 percent of workers who are considered plain or unattractive.
Why do beautiful people earn more income? According to biologists, beauty is a marker for underlying characteristics such as health and intelligence, and beautiful
people start with a slight edge in the labor market. Beautiful people get more opportunities to learn through experience, and they also acquire better professional
contacts. Because of these wider opportunities, a small difference in innate characteristics can be amplified into a large difference in earnings.
Another factor in the beauty premium is that some workers and consumers simply like dealing with attractive people, so there is a higher demand for beautiful workers,
resulting in higher wages.

32.4 THE DISTRIBUTION OF INCOME (1 of 2)

Income Distribution in 2007
To compute the numbers in the second column of the table (Percent of Market Income), we take four steps:
Rank the nation’s households according to market income.
Divide the households into five groups, or “quintiles.”
Compute each group’s income.
Compute each group’s share of market income.

TABLE 32.2 Distribution of Market Income, 1979-2007

Group

Share of Market

Share of Market

Percentage growth in

Income, 1979

Income, 2007

income, 1979-2007

Quintile 1 (percentiles 0-20)

2.9

2.5

18.3

Quintile 2 (percentiles 20-40)

10.1

7.3

27.5

Quintile 3 (percentiles 40-60)

15.3

12.2

35.2

Quintile 4 (percentiles 60-80)

22.4

19.0

43.3

Quintile 5 (percentiles 80-100)

49.6

59.9

75.6

Percentiles 80-99

39.1

38.6

65.0

Top 1 Percent

10.5

21.3

277.5

Source: Congressional Budget Office, Trends in the Distribution of Household Income between 1979 and 2007 (Washington, DC,2011).