Instructor: Jeroen Jon De Leon

College of Business and Accountancy

XMICRO
Chapter 12: Labor Markets
Most of the inequality in incomes in the United States arises from differences in labor earnings. To
understand where these pay differences come from at the extremes and in the middle we need to
understand labor markets [1].
[1] these are the markets where people supply their labor to employers: business firms, government
agencies, and others
Product markets markets in which firms sell goods and services
Factor markets markets in which resources labor, capital, land and natural resources, and
entrepreneurship are sold to firms
When household demand more of a good, firms respond by producing more, which makes them
demand greater quantities of resources. Thus, the demand for a resource such as labor is a derived
demand [2].
[2] the demand for a resource that arises from, and varies with, the demand for the product it helps to
produce
The Wage Rate: price in labor market
- Commonly computed as hourly wage rate
Perfectly Competitive Labor Markets a market with many well-informed buyers and sellers of
standardized labor, with no barriers to entry and exit
Four characteristics:
(1) Many buyers and sellers wage-takers
(2) Standardized labor quality
(3) Easy entry and exit
(4) Well informed buyers and sellers
LABOR DEMAND demand by all firms for the type of labor being traded in a specific market
Labor demand curve curve indicating the total number of workers all firm in a labor market want to
employ at each wage rate; labor demand curve slopes downward: a rise in the wage rate, ceteris
paribus, causes quantity of labor demanded to fall
Change in wage rate: change in quantity demanded for labor
Labor is considered a variable input, used to calculate a firms marginal cost. When the wage rate rises, a
firms marginal cost curve shifts upward. This upward shift in the marginal cost curve decreases the
firms profit maximizing output level.
Thus, a change in the wage rate alters the profit-maximizing output level and therefore changes the
quantity of labor demanded output effect.
Wage (increases) = Output (declines) = Quantity of labor demanded (declines)
The second effect of changes in wage rate is the input-substitution effect [3].
[3] a change in the wage rate alters the price of labor relative to the costs of other inputs, and therefore
changes the quantity of labor demanded
Shifts in the Labor Demand Curve brought about by change in non-wage rate factor
(a) Changes in Demand for the Product when demand increases in the product market, the labor
demand curve will shift
(b) Changes involving other inputs
a. Complementary input an input that is used by a particular type of labor, making it
more productive; when an existing one becomes cheaper, the demand curve for labor
that uses the input will shift rightward

Instructor: Jeroen Jon De Leon

College of Business and Accountancy
XMICRO
b. Substitutable input an input that can be used instead of a particular type of labor;
when an existing one becomes cheaper, the demand curve for the type if labor it
replaces will shift leftward
LABOR SUPPLY households that supply their labor to firms
Opportunity costs: (a) hours allocated to works; and (b) hours allocated to leisure
Labor supply curve a curve indicating the number of people who want jobs in a labor market at each
wage rate; slopes upward (short-run): a rise in the wage rate causes the quantity of labor (already
qualified but previously not working in that labor market) supplied to rise
Shifts in the Labor supply curve
Changes in the number of qualified people if the number of qualified people rises, the labor
supply curve will shift rightward
Changes in other labor markets a change in the attractiveness of other jobs can shift the labor
supply curve in the market we are analyzing
Changes in tastes a change in tastes in favor of particular kinds of work or working conditions
will shift the supply curves rightward in those labor markets
Labor Market Equilibrium
a point where wage rate is in equilibrium with the quantity of supply and demand
at any point above the equilibrium wage rate, an excess supply of employment would ultimately
drive the market wage downward
at any point below the equilibrium wag rate, and excess demand for employment would drive
the wage rate upward as firms competed to hire scarce resources
Cause-and-Effect of changes in Market equilibrium
(a) An increase in labor demand
Increase in demand in the product market (i.e. health care services for nurses)
As the wage rate increases, the quantity of a specific labor falls, moving us leftward along
the labor demand curve (LD)
The rising wage rate attracts qualified labor supply (i.e. nurses) back into the labor market,
moving us rightward along the short-run labor supply curve (Ls)
Thus, an increase in labor demand raises both the equilibrium wage rate and the equilibrium
level of employment
(b) An increase in labor supply
This might be a delayed reaction to a prior wage increase
Also caused by lowering the cost of producing these qualified workers (i.e. scholarships etc)
As the number of qualified labor supply increases, the labor supply curve shifts rightward
Thus, the equilibrium wage rate declines, while equilibrium employment rises
Why do wages differ?
Wage inequality among and within occupations in the labor market is persistent.
To understand why, lets consider and imaginary word with three (3) assumptions:
(1) All labor markets are perfect competitive
(2) Except for differences in wages, all jobs are equally attractive to all workers
(3) In the long run, all workers can costlessly acquire the qualifications for any job
Note that, if all the above qualifications will be met, two markets will (in the long run) meet an
equilibrium wage rate. (i.e. preschool teachers and lawyers)
Thus, the labor supply curve for market A will shift leftward, while, the labor supply curve will continue
to shift rightward (due to entry and exit) and will only stop when there is no longer any reason for a
preschool teacher to want to be a pharmacist (that is, when both markets have the same wage rate).

Instructor: Jeroen Jon De Leon

College of Business and Accountancy
XMICRO
Sources of Wage inequality
Compensating Wage Differentials a differences in wages that makes two jobs equally
attractive to a worker; when one jobs is more or less attractive than another for reasons other
than a difference in pay
o Nonmonetary job characteristics any aspect of a job other than the wage that
matters to a potential or current employee; jobs considered intrinsically less attractive
will tend to pay higher wages, other things being equal
o Human Capital requirements jobs that require more costly training will tend to pay
higher wages
Differences in Ability
o Differences in Ability to be Qualified all else equal, jobs that require skills that
relatively few people have the ability to acquire will pay persistently higher wage rates
in excess of compensating wage differentials
o Differences in Ability among those Qualified this violates the standardized labor
assumption of a perfectly competitive labor market; all else equal, those with greater
ability to perform a job better based on talent, experience, motivation, or
perseverance will be more valuable to their employers, and will generally be able to
command a higher wage rate
o **the Economics of Superstars in labor markets for talented professionals, in which
there is mass-distribution of their product and substantial agreement about rankings,
small differences in ability can lead to disproportionate differences in pay
Barriers to Entry
Occupational Licensing these requirements raise the cost of acquiring human capital
Union Wage Setting in a competitive labor market, a union by raising the wage firms pay
decreases total employment in the union sector; this, in turn, causes wages in the nonunion
sector to drop. The combined result is a wage differential between union and nonunion wages.
Discrimination occurs when a group of people have different opportunities because of
characteristics that have nothing to do with their abilities
o Employer prejudice when prejudice originates with employers, competitive labor
markets work to discourage discrimination and reduce or eliminate any wag gap
between the favored and the disfavored group
o Employee and Customer prejudice when prejudice originates with the firms
employees or customers, market forces may encourage, rather than discourage,
discrimination and can lead to a permanent wage gap between the favored and
disfavored groups
o Statistical discrimination individuals are excluded based on the statistical probability of
behavior in their group, rather than their own personal traits; discrimination without
prejudice
o Discrimination and Wage differentials the simple wage gap between two groups tend
to overstate the impact of job-market discrimination on earnings, because it fails to
account for differences in worker skill, experience, and job choice; however, controlling
for these characteristics may understate the impact of discrimination, since these
characteristics may in part result from discrimination
The Minimum Wage Controversy
To most people, the benefits of a higher minimum wage are obvious: it increases the pay of those who
earn at least, and thus help reduce economic inequality.

Instructor: Jeroen Jon De Leon

College of Business and Accountancy
XMICRO

Some Important Provisos to consider..

Who pays for a higher minimum wage?
A higher minimum wage rate raises average and marginal costs in industries that employ
minimum wage labor. Thus, the result is a rise in product prices
Prices must remain permanently higher, to match the higher long-run average costs. Thus, the
long-run burden of the minimum wage in competitive industries falls entirely on the consumers
(who may be rich or poor) which makes income redistribution not fully achieved
Who benefits from a higher minimum wage?
Many who benefit from a higher minimum wage are economically better off than those who pay
for it
Labor Market Effects of the Minimum Wage
Effects in the Covered, Unskilled Market
Effects in Other Labor Market
THEREFORE: a higher minimum wage benefits those unskilled workers who maintain their jobs
and are paid more. It also benefits skilled workers by raising their equilibrium wages. But it
harms those unskilled workers who cannot find work and those who work in the uncovered
sector, where wages decrease.
The Earned Income Tax Credit (EITC) Alternative
Advantages:
Only available to low-income households and provides greater benefits to those supporting
children
The funds for the EITC come from a progressive federal tax system, making it genuinely
redistributive from higher income to lower income households
The EITC tends to increase employment