Chapter 29 The Labor Market: Demand, Supply, and Outsourcing.

Chapter 29

The Labor Market: Demand, Supply, and Outsourcing

Copyright © 2008 Pearson Addison Wesley. All rights reserved. 29-2

Introduction

Technovate and 24/7 sound like U.S. based firms, but in fact, they are located in India.

The companies offer low-cost labor services to U.S. firms in need of customer service.

Many U.S. politicians assert these and other Indian call centers are “stealing” U.S. jobs.

This chapter will help you evaluate this claim.


Learning Objectives

• Understand why a firm’s marginal revenue product curve is its demand for labor curve

• Explain in what sense the demand for labor is a “derived” demand

• Identify the key factors influencing the elasticity of demand for inputs


Learning Objectives (cont'd)

• Describe how equilibrium wage rates are determined for perfectly competitive firms

• Explain what labor outsourcing is and how it will affect U.S. workers’ earnings and employment prospects

• Contrast the demand for labor and wage determination by a product market monopolist with outcomes that would arise under perfect competition


Chapter Outline

• Labor Demand for a Perfectly Competitive Firm

• The Market Demand for Labor

• Wage Determination in a Perfectly Competitive Market

• Labor Outsourcing, Wages, and Employment

• Monopoly in the Product Market

• The Utilization of Other Factors of Production


Did You Know That...

• The principles we have used to explain the market in which goods are sold will also describe the labor market?

• Profit-maximizing firms will hire labor up to the point where the marginal benefit equals the marginal cost?


Labor Demand for a Perfectly Competitive Firm

• We will start our analysis under the assumption that the market for input factors is perfectly competitive.

• We will further assume that the output market is perfectly competitive.

• This provides a benchmark against which to compare other labor markets or product markets that are not perfectly competitive.


Labor Demand for a Perfectly Competitive Firm (cont'd)

• Assumptions

Each employer is one of a very large number of employers.

Workers do not need special skills.

Workers are free to move from one employer to another.

The firm is a price taker in the labor market.



• Marginal Physical Product (MPP) of Labor

The change in output resulting from the addition of one more worker

The change in total output accounted for by hiring the worker, holding all other factors of production constant

Eventually declines because of the law of diminishing marginal product



• Marginal Revenue Product (MRP)

The marginal physical product (MPP) times the marginal revenue (MR)

The additional revenue obtained from a one-unit change in labor input



• The marginal revenue product represents the incremental worker’s contribution to the firm’s total revenues.


Figure 29-1 Marginal Revenue Product, Panel (a)


Figure 29-1 Marginal Revenue Product, Panel (b)



• Marginal Factor Cost (MFC)

The cost of using an additional unit of an input

For example, if a firm can hire all the workers it wants at the going wage rate, the MFC of labor is the wage rate.

Marginal factor cost =Change in total cost

Change in amount of resources used



• In a perfectly competitive labor market

The market determines the wage

The individual employer is a wage taker

All workers are hired for the same wage

MFC = wage



• The MRP curve demand for labor

The MRP curve is the demand curve for labor for the firm.

This tells us how many workers will be hired at various possible wage rates.

The firm will hire any worker who can contribute to revenues by more than they contribute to costs.



• General rule for hiring

The firm hires workers up to the point at which the additional cost associated with hiring the last worker is equal to the additional revenue generated by hiring that worker.



• Derived Demand

The factors of production are needed to manufacture a final good or to provide a final service.

Thus, the demand for labor is influenced by demand for the final product.


Figure 29-2 Demand for Labor, a Derived Demand


The Market Demand for Labor

• The downward-sloping portion of each firm’s MRP curve is also its demand curve for labor.

• When we go to the entire market for labor, we will also find that the quantity of labor demanded varies inversely with wage rate changes.


Figure 29-3 Derivation of the Market Demand Curve for Labor

•Wage rate of $20•Firms will hire

2,000 workers

•Wage rate of $10•Firms will hire

3,000 workers


The Market Demand for Labor (cont'd)

• Price elasticity of demand for labor similar to elasticity for goods

• Percentage change in quantity demanded divided by percentage change in price of labor Inelastic < I

Unit-elastic = 1

Elastic > 1


Determinants of Demand Elasticity for Inputs

• The price elasticity of demand for a variable input will be greater

1. The greater the price elasticity of demand for the final product

2. The easier it is to employ substitute inputs

3. The larger the proportion of total costs accounted for by the particular variable input

4. The longer the time period available for adjustment


Wage Determination in a Perfectly Competitive Labor Market

• Having developed the demand curve for labor in a particular industry, let’s turn to the labor supply curve.

• By adding supply to our analysis, we can determine the equilibrium wage rate that workers earn in an industry.

• We can think in terms of a supply curve for labor that slopes upward in a particular industry.


Figure 29-4 The Equilibrium Wage Rate and the Electronic Organizer Industry


International Example: A Global Shortage Hits the Market for Mining Workers

• Manufacturing industries in nations such as India and China have grown rapidly during the 2000s.

• Demand for mined commodities (aluminum, copper, zinc, nickel) used as manufacturing inputs has soared.


International Example: A Global Shortage Hits the Market for Mining Workers (cont'd)

• Commodity prices have increased, which has raised the MRP of a key production input—mine workers.

• The quantity of qualified mining labor demanded has been pushed above the quantity of qualified labor supplied.

• Managers of mining companies commonly try to hire away other firms’ workers promising higher wages.


Shifts in Market Demand for and the Supply of Labor

• Reasons for labor demand curve shifts

1. Change in demand for the final product

2. Change in labor productivity

3. Change in the price of related inputs


Reasons for Labor Demand Curve Shifts

• A change in the demand for the final product that labor is producing will shift the market demand curve for labor in the same direction.

• A change in labor productivity will shift the market labor demand curve in the same direction.


Reasons for Labor Demand Curve Shifts (cont'd)

• A change in the price of a substitute input will cause demand for labor to change in the same direction.

• A change in the price of a complimentary input will cause the demand for labor to change in the opposite direction.


Reasons for Labor Supply Curve Shifts

• Labor supply curves may shift in a particular industry for a number of reasons.

1. Change in wages in other industries

2. Changes in working conditions

3. Job flexibility


Labor Outsourcing, Wages, and Employment

• Outsourcing

A firm’s employment of labor outside the country in which the firm is located


Labor Outsourcing, Wages, and Employment (cont'd)

• Outsourcing

Some U.S.-based companies outsource labor to other countries.

Some firms based around the globe outsource labor to the United States.


Figure 29-5 Outsourcing of U.S. Computer Technical-Support Services



• Question How are U.S. workers affected?

• Answers If cheaper labor is available in other countries, this

will dampen the demand for U.S. labor.

But as the volume of global commerce rises, there may be more of a demand by foreign firms to hire U.S. workers as well.



• Labor outsourcing by U.S. firms tends to reduce U.S. wages and employment.

• Whenever foreign firms engage in labor outsourcing to the United States, however, U.S. wages and employment increase.


Figure 29-6 Outsourcing of Accounting Services by Canadian Firms



• Short-run effects

Even in the best of times, workers experience short-run ups and downs in wages and jobs.

In the United States, after all, about 4 million jobs come and go every month.

To be sure, in the near term, workers earn lower pay and experience reduced employment.



• Long-term benefits

Labor allows for more specialization, which enhances trade.

If goods are produced and services are performed in those countries where the opportunity costs are lowest, then global economic growth is enhanced.



• Expanded production and consumption possibilities made possible by outsourcing and other forms of international trade generate higher total revenues across U.S. firms.



• Benefits for U.S. workers

Firms can outsource their labor needs and will operate more efficiently.

This means that the products they sell have lower prices.

In turn, each dollar in a worker’s paycheck has a greater purchasing power.



• In the long run, outsourcing helps boost the overall value of MRP in industries throughout the U.S. economy.

• Consequently, the ultimate long-run effect of outsourcing is an increase in demand for labor in most industries.

• Increased labor demand pushes up wages and boosts employment, and economists estimate outsourcing has created more jobs than it has destroyed.



• International labor outsourcing is also known as “labor offshoring.”

• One U.S. firm has found a way to literally engage in “offshore” outsourcing activities.


E-Commerce Example: Outsourcing Computer Programming Very Close to the Border

• A company called SeaCode has hundreds of workers from nations such as India and Russia on a cruise ship off the U.S. coast.

• Most of the workers are computer programmers that SeaCode hires to write software for U.S. businesses.

• In this way, people from abroad who cannot obtain immigration visas can earn roughly $1,800 per month.


Monopoly in the Product Market

• Now we assume that the firm sells its product in an imperfectly competitive market (we assume the firm purchases inputs under perfect competition still).

• In other words, we are considering output market structures of monopoly, oligopoly, and monopolistic competition.

• For the remainder of the chapter, we simply refer to a monopoly situation for ease of analysis.


Monopoly in the Product Market (cont'd)

• Constructing the monopolist’s input demand curve

In reconstructing the demand schedule for an input, we must recognize thatThe marginal physical product falls because

of the law of diminishing marginal product as more workers are added.

The price (and marginal revenue) received for the product sold also falls as more is produced and sold.


Figure 29-7 A Monopolist’s Marginal Revenue Product, Panel (a)


Figure 29-7 A Monopolist’s Marginal Revenue Product, Panel (b)


Monopoly in the Product Market (cont'd)

• Question Why does the monopolist hire fewer workers?

• Answer The marginal benefit to the monopolist of hiring

an additional worker is affected by the fact that the monopolist faces a reduction in the price charged on all units in order to be able to sell more of her product.


The Utilization of Other Factors of Production

• Profit maximization revisited

MRP of labor = Price of labor (wage)

MRP of land = Price of land (rent)

MRP of capital = Price of capital (cost per unit of service)


The Utilization of Other Factors of Production (cont'd)

• Cost minimization

To minimize total costs for a particular rate of production, the firm will hire factors of production up to the point at which the marginal physical product per last dollar spent on each factor is equalized.


The Utilization of Other Factors of Production (cont'd)

• Cost minimization

MPP of labor

Price of labor=

MPP of capital

Price of capital

MPP of land

Price of land=


Issues and Applications: Now Indian Outsourcing Specialists are Also Outsourcing

• An outsourcing specialist chooses to outsource.

• Indian outsourcing firms increasingly look abroad for talent.

• For India, outsourcing has become a two-way street.


Summary Discussion of Learning Objectives

• Why a firm’s marginal revenue product curve is its labor demand curve In competitive markets, firms hire labor to the

point at which the wage equals MRP.

• The demand for labor as a “derived demand” The demand for labor by perfectly competitive

firms is derived from the demand for the final products they produce.


Summary Discussion of Learning Objectives (cont'd)

• Key factors affecting the elasticity of demand for inputs

Price elasticity of demand for the final product

Ease of substitution of other inputs

Proportion of total costs

Time period



• How equilibrium wage rates at perfectly competitive firms are determined The wage at which the quantity of labor supplied

by all workers equals the quantity of labor demanded by all firms

• U.S. wage and employment effects of labor outsourcing Decreased demand for U.S. workers when

cheaper labor is available overseas Increased demand for some U.S. labor



• Contrasting the demand for labor and wage determination under monopoly with outcomes under perfect competition

A monopolist’s labor demand curve is to the left of that of a perfectly competitive industry.

Marginal revenue for a monopolist is less than price.

Fewer workers are employed by the monopolist.

End of Chapter 29

The Labor Market: Demand, Supply, and Outsourcing

Chapter 29 The Labor Market: Demand, Supply, and Outsourcing.

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Transcript of Chapter 29 The Labor Market: Demand, Supply, and Outsourcing.