THE DEMAND FOR LABOR (ND)

• Depends on costs and benefits of hiring one extra

worker
• Cost – real wage of extra worker (w/P)
• Benefit – value of extra good (MPN)
• If real wage (w/P) > MPN, the firm pays the extra
worker more than the worker produces, so the firm should
reduce the number of workers to increase profits
• If w/P < MPN, the extra worker produces more than he
is being paid, so the firm should increase the number of
workers to increase profits
• Firms’ profits are highest when w/P = MPN

THE MPN AND ND

• ND curve shows relationship between the wage rate
and qty of labor demanded
• The profit-maximizing qty of labor demanded is when
w/P = MPN
• So, ND curve is the same as the MPN curve, since w/P
= MPN at equilibrium
• So the ND curve is downward sloping
- firms want to hire less labor at higher w

Factors that shift the ND curve

• Supply shocks
o Beneficial supply shock (for example, an
increase in technology) raises MPN, ND curve shifts to
the right, vice versa
• Size of capital stock
o Higher capital stock raises MPN, so shifts ND curve
to the right; opposite for lower capital stock
THE SUPPLY OF LABOR
• Supply of labor is determined by individuals
• The labor supply curve (NS) curve relates quantity
of labor supplied to real wage
• Increase in the current real wage should raise
quantity of labor supplied
• NS curve slopes upward because higher wage
encourages people to work more

Factors that shift the NS curve

• Wealth: Higher W reduces NS -shifts NS curve to the
left
• Expected future w/P: Higher expected future w/P =
increase in W, so reduces NS -shifts NS curve to the left
• Increase in working-age population (higher birth rate,
immigration) - shifts NS curve to the right
• Increase in labor force participation (increased female
labor participation, elimination of mandatory retirement)
-shifts NS curve to the right
• Migration of workers increases NS
LABOR MARKET EQUILIBRIUM
• Labor supply equals labor demand
• Known as full-employment level of employment,N
• The market-clearing real wage is w (real wage)
• Factors that shift labor supply or labor demand
affect N and w (real wage)
Labor Market Equilibrium

Effects of Supply shocks on full-employment output

Example: Adverse supply shock
A spell of unusually bad weather reduces MPN at
every level of employment.
- MPN (ND) curve shifts to the left
- equilibrium in labor market moves from A to B
- N and w fall
FULL-EMPLOYMENT/POTENTIAL OUTPUT (Yf)
• the level of output that firms supply when w/P and P
have fully adjusted.
• Occurs when the labor market is in equilibrium.
• Factors determining Yf
o Full employment level of
employment, N , which is determined by ND and NS
o Production function relating
output and employment
- If production function changes, MPN changes, labor D
curve changes, N changes so Yf also changes
- If NS increases, Yf increases, as there is now more
labor available to produce output.
- a beneficial supply shock means the same quantities
of N and K produce more output, so Yf rises.
- a beneficial supply shock increases ND at each real
wage and raises N , which increases Yf
- Positive temporary supply shock affects output in 2
ways:
 Increases Y directly because MPN increases
 Increases ND as MPN increases and increases N , so
reduces Yf