7 - Labour Market And Wage Determination

Question 1

What’s value of marginal product (VMP)

Answer 1

The value, at the current market price of the extra output produced by an additional unit of input (labour)

• How much value each unit of labour adds

E.g. 1 labour makes 20 units and sells each unit for £20. He makes £400 which is his value added

Question 2

What’s the hiring rule for perfectly competitive firms

Answer 2

Keep hiring until, wage rate is equal to Value of marginal product (VMP)

• Marginal expense of labour is equal to marginal revenue of labour to profit maximise

Question 3

VMPL formula

Answer 3

P x MPL = w

• Price of Output X Additional units of output produced by additional labour

Question 4

• When VMPL > W no equilibrium means what
• When VMPL < W not equilibrium means what

Answer 4

• When VMP of Labour is greater than Wage then they add more value than they cost (Hire labour)
• When VMP of Labour is less than Wage then unit of labour adds less value than they cost (Fire labour)

Question 5

In the short run what will happen to marginal product of labour, if you hire more labour

Answer 5

Marginal product of labour (MPL) will DECLINE in the short run if you hire more labour, as capital is fixed (diminishing returns)

• One input (capital or labour) is fixed in the short run

Question 6

In the long-run what can firms do

Answer 6

Vary all its inputs (I.e. labour and capital)

• One of them does not have to be fixed like in the short run

Question 7

What’s the main factor effecting labour demand

Answer 7

Elasticity

Question 8

Is labour demand elastic or inelastic in the long run

Answer 8

Labour Demand is:
- Inelastic in the short run
- Elastic in the long run

Question 9

Why is labour demand elastic in the long run

Answer 9

• This is because firms can substitute the services for labour for those of other inputs (capital)
• Both inputs are flexible in the long run
• If wage decreases, in the long-run, firms can switch from using capital to labour, as it’ll be cheaper for their production
• Me responsive to change in cost (wage)

Question 10

Why is demand for labour inelastic in the short run

Answer 10

• It cannot substitute the services for labour for those of other inputs (capital) as capital is fixed
• Therefore, will have to remain hiring labour
• Less responsive to change in cost (wage)

Question 11

What is price level in the labour market

Answer 11

Price level is NOT exogenous in the labour market, therefore VMPL depends on the output prices

Question 12

What happens when wage decreases (graph in book)

Answer 12

• Hire more labour as its cheap, produce more output
• Price in the output market decrease as well
• VMPL curve shifts inwards

Question 13

Imperfect competition (monopoly, monopolistic Comp, oligopoly)

What is marginal revenue product (MRP)

Answer 13

Amount by which total revenue increases with the employment of an additional unit of input

Question 14

What 2 things are equal at the quantity of which imperfect competition markets hire to

Answer 14

When wage rate is equal to Marginal Revenue Product (MRP)

• Because we assume labour market is still perfectly competitive which is why it equals wage rate

Question 15

For a firm in a non-competitive market (monopoly, monopolistic Comp, oligopoly) Marginal revenue product (MRP) diminishes as the quantity of labour employed increases, for 2 reasons:

Answer 15

1) Diminishing marginal product of labour
2) Decreasing marginal revenue

Question 16

Why does Marginal revenue curve lie below demand curve

Answer 16

Firm has to lower the price to sell additional units of output

• In this case price does not equal marginal revenue

Question 17

Formula for Marginal revenue product of labour (MRPL)

Answer 17

MR x MPL = wage rate

Question 18

Different between Value of marginal product (VMP) and Marginal revenue product (MRP)

Answer 18

VMP and MRP mean similar things, however:

• VMP assumes perfect competition with perfectly competitive labour market.
• MRP assumes imperfect competition with perfectly competitive labour market

Question 19

Labour supply

What are the 2 goods people have a choice between

Answer 19

• Income (Work) and leisure (play, sleep, eating, activities)

Question 20

What’s the standard consumer choice problem

Answer 20

Individual is assumed to have preferences over the two goods that can be summarised in form of an indifference map

Question 21

How can we model this decision-making (work or not to work)

Answer 21

• Indifference curve analysis
• Assume 7 days of 24 hours available
• Assume labour is homogenous and waged

Question 22

What’s the substitution effect and income effect

Answer 22

• Substitution effect = As wages rise, a person works more and substitutes work for leisure as the opportunity cost of leisure rises = Mainly younger people
• Income effect = As wages rise, a person works less as their income has risen thus allowing them to spend more time on leisure = Mainly older people

Question 23

What’s the main supply curve that shows the decision change when wage rate changes

Answer 23

Backward bending supply curve

• The first bit of the bend (bottom part) is substitution effect as they work more
• The second part (top part) is income effect as they work less

Question 24

Why’s substitution effect always positive

Answer 24

Because it encourages people to work more

• Income effect can be positive or negative

Question 25

Is market supply curve of labour upwards or downwards sloping and why

Answer 25

Upwards sloping because when wage increases in one category (industry), this doesn’t just change numbers of hours worked in that category (industry), but provides incentive to change number of hours in another category (industry)

• E.g. Price (wage) of hairdressers increases, provides incentive for people to train and change into that industry

Question 26

What’s a monopsony

Answer 26

A market with just one buyer

• Single powerful buyer of a particular type of labour; for example the main buyer of the labour of doctor’s and nurses is the NHS

Question 27

Why do monopsonist firms control labour market

Answer 27

As it has the market power to set the market wage rate

Question 28

In a monopsony what does the marginal cost of labour (MCL) exceed

Answer 28

Marginal cost of labour exceeds the average cost of labour (the wage rate) for all levels of labour employed

Question 29

What is the optimal level of employment for a monopsonist

Answer 29

Level which MFC and demand for labour are equal

Question 30

What is Average factor cost (AFC)

Answer 30

Another name for an input supply curve

Question 31

What is Total factor cost (TFC)

Answer 31

The product of the employment level of an input and its average factor cost.

• Number of employees x AFC

Question 32

What is marginal factor cost (MFC)

Answer 32

Amount by which total factor cost changes with the employment of an additional unit of input

Question 33

What do monopsonies have the power to do

Answer 33

They have the power to charge less and employ less because they are the single buyer of that input

Question 34

What’s non-market discrimination

Answer 34

Different wages across various population groups - effects lower productivity before job applicants even contact the employer

Question 35

What’s customer discrimination

Answer 35

The firms customers don’t wish to deal with minority employees

Question 36

What’s employer discrimination

Answer 36

Wage differentials that arise from an arbitrary preference by the employer for one group of workers over another

Question 37

What’s employee taste-based discrimination

Answer 37

Employees may not want to interact with people belonging to a certain group/s, which the employer considers during the hiring process