11 The Determination of Wage The price of a factor of production = wage is determined by the interaction of the market demand and supply for the Factor. P S Pf D 0 Q Qf No. of Factors e.g. labour Demand = Marginal Revenue Product (MRP) 邊際生產收入 is the contribution to revenue made by the employment of an additional unit of a variable factor. e,g labour wage General equation: MRP = MR X MP Additional revenue by extra Additional no.s of factor product of extra factor QUESTION 1) What is the difference between MRP and VMP of a factor. 2) Why is the demand curve for a factor the same as the MRP downward sloping portion? The Supply Curve of Labour Market Choices available Forgone leisure Work Leisure Leisure will forgone wage earning = opp cost A worker would either choose Work or Leisure in a day Indifferent Curve Analysis: • If there is an increase in the wage level / rate (w) there will be two effects on the work Amount (QL) Indifferent curve analysis: Income (Good) 1. Substitution effect BL2 a) If W increases, a person will always Substitute work for leisure (wQL +Ve S.E) BL1 w Work amount increases Sub. effect Working hours (Bad) 2. Income effect If W increases, whether a person will work More or less depending on whether leisure is A superior good or inferior good to him. Income (Good) 1) If leisure is superior Increase in wage rate, work less BL2 (wQL -ve income effect) Work amount decrease BL1 Working Sub. Income hours (Bad) 2) If leisure is inferior Income (Good) don’t like working Increase in wage rate, BL2 work less (w QL -ve income effect) Work amount decreases Sub. Working hours Income (Bad) Why can an individual supply curve be backward bending? Backward-bending supply curve of an individual labour Income (Good) W3 W2 W1 Working hours (Bad) Wages W3 W2 W1 Quantity MC QUESTIONS An individual’s labor supply curve may be backward bending because (22/94) a) The substitution effect between work and leisure is smaller than the income effect when wage increases. wQL b) The substitution effect between work and leisure is greater than the income effect when wage increases. wQL c) The worker’s preference of leisure has decreased. d) The opportunity cost of leisure increases when the wage increases. The market Supply of Labour • IT can not be backward-bending. • If the industry wants to increase the Qs of labour, it must pay a higher wage to attract workers away from other industry. • So, the supply curve is upward sloping. S Wage Determination in a Competitive Labour Market P.15 • Both buyers (firms) & suppliers (workers) are price takers. (too small in affecting the P) • We and Qe is determined at the intersection of the demand (MRP) and supply curves. Labour market A firm S Constant hire We price MRP=VMP D Labour Labour Qe Test What is the factor demand curve of a firm under a perfectly competitive factor market? Supply curve of Labor in Price-taking market In price-taking market, the market supply curve of labor is upward sloping. But the individual firm’s supply curve of labor is horizontal. A price-taking firm cannot affect the market wage as the wage is determined by the market demand and supply of labor. However, it can determine its own amount of labor used in production by equating VMP = D = Wage Test An employer observes that when one employee is sick and cannot come to work, the output value will fall by $1000 per day. If two workers are sick, the output value will fall by $2500 and when three workers are sick, the output value will fall by $4500. Suppose the wage of hiring a worker is $1600 per day how many worker should the employer fire? Explain. QL MRP TRP Wage Action 1 $1000 1000 $1600 Fire 2 1500 2500 1600 Fire 3 2000 4500 1600 Employ Functions of Labour Unions • To facilitate contract negotiations • To monitor employee performance • To raise the wages of their members – To raise the demand for labour – To restrict the supply of labour – To impose minimum wage rate Reasons for Income Differences 1. Relative demand and supply 2. Chance-taking differentials 3. Differences in productivities 4. Compensating differentials 5. Types of training 6. Geographical differences 7. Age-related differences 8. Differences between males and females Remark What are the reasons for wage differential? Assume there are two regions. Wage in region A is initially higher than wage in region B. If factors are allowed to mobile freely, Wa will decrease gradually while Wb will increase gradually. Finally, Wa = Wb SEARCH THEORY Labor market is a search market. Why? Because of imperfect information of the market, labor always attempt to search for better alternatives, so as to seek out the most favorable wage level. 2. Assume that leisure is a normal good. Which of the following is implied by an upward sloping labour supply curve? (26/95) a. Leisure and income are substitutes. b. The income effect of a wage increase is smaller than the substitution effect. c. There are laborers who may receive an economic rent. d. All of the above.