# 11 The Determination of Wage

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```					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
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
(wQL +Ve S.E)                                     BL1

 w Work amount increases

Sub. effect Working
hours
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
(wQL -ve income effect)
  Work amount decrease
BL1

Working
Sub. Income hours
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
Why can an individual supply curve
be backward bending?
Backward-bending supply curve of an individual labour
Income (Good)     W3
W2

W1

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. wQL
b) The substitution effect between work and
leisure is greater than the income effect
when wage increases. wQL
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

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.

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