Macroecon: Labor Market

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Chapter 3
Assumptions of firms about labor market
1. Workers are all alike
2. Wages are set by the market
3. Firm’s goal is to earn the highest possible profit
Wages = cost of an extra worker
The firm will hire until (value of extra worker = wage)
Production Function
A= productivity

Marginal product of labor(MPN)
MPN decreases as #workers inc.
The benefit of employing an additional worker in term of the extra output produced.

Marginal revenue product of labor(MRPN=P X MPN)
Benefit of employing an additional worker in terms of the extra revenue produced
MRPN>Wage to make a positive profit
w(real wage) = W(nominal wage)/P(output price)
MPN>W hiring more workers is profitable
A decrease in real wage raises the amount of labor demanded

MPN=wage (profit maximization)
Labor Demand curve
=same as MPN curve
Vertical axis – real wage
Horizontal axis – labor demanded
=> quantity of labor decreases as
LD curve not shifted by change in real wage
Shifted by supply shock, change in capital stock
A beneficial supply shock raises the MPN at all levels of labor input.
Labor demand is determined by firms

Labor Supply and Real Wages
* Substitution effect of a higher real wage
: workers work more when rewarded highly -> work more
: pure substitution effect-> one day rise in the real wage

* Income effect of a higher real wage
: workers become wealthier with higher income -> work less
: pure income effect-> increase in wealth

* Both: a long term increase in real wage

Labor Supply Curve
Relationship between labor supplied and real wage

Labor Market Equilibrium
Full employment is occurred when ND=NS

Temporary adverse supply shock
Ex. Bad weather
Decreases MPN at every level => decreases ND
Because it is temporary, it doesn’t affect future marginal product or future real wage=> labor supply curve does...
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