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Figure 18-5
A SHIFT IN LABOR SUPPLY.
When labor supply increases
from S1 to S2, perhaps because of
an immigration of new workers,
the equilibrium wage falls from
W1 to W2. At this lower wage,
firms hire more labor, so
employment rises from L1 to L2.
The change in the wage reflects a
change in the value of the
marginal product of labor: With
more workers, the added output
from an extra worker is smaller.
408 PART SIX THE ECONOMICS OF LABOR MARKETS
CASE STUDY PRODUCTIVITY AND WAGES
One of the Ten Principles of Economics in Chapter 1 is that our standard of living
depends on our ability to produce goods and services. We can now see how this
principle works in the market for labor. In particular, our analysis of labor demand
shows that wages equal productivity as measured by the value of the
marginal product of labor. Put simply, highly productive workers are highly
paid, and less productive workers are less highly paid.
This lesson is key to understanding why workers today are better off than
workers in previous generations. Table 18-2 presents some data on growth in
productivity and growth in wages (adjusted for inflation). From 1959 to 1997,
productivity as measured by output per hour of work grew about 1.8 percent
per year; at this rate, productivity doubles about every 40 years. Over this period,
wages grew at a similar rate of 1.7 percent per year.
producers make greater profit, and apple pickers earn higher wages. When the
price of apples falls, apple producers earn smaller profit, and apple pickers earn
lower wages. This lesson is well known to workers in industries with highly
volatile prices. Workers in oil fields, for instance, know from experience that their
earnings are closely linked to the world price of crude oil.
From these examples, you should now have a good understanding of how
wages are set in competitive labor markets. Labor supply and labor demand together
determine the equilibrium wage, and shifts in the supply or demand curve
for labor cause the equilibrium wage to change. At the same time, profit maximization
by the firms that demand labor ensures that the equilibrium wage always
equals the value of the marginal product of labor.
Wage
(price of
labor)
W1
W2
0 Quantity of
Labor
L1 L2
Supply
Demand, D1
2. . . . increases
the wage . . .
3. . . . and increases employment.
1. An increase in
labor demand . . .
D2
Figure 18-6
A SHIFT IN LABOR DEMAND.
When labor demand increases
from D1 to D2, perhaps because of
an increase in the price of the
firms’ output, the equilibrium
wage rises from W1 to W2, and
employment rises from L1 to L2.
Again, the change in the wage
reflects a change in the value of
the marginal product of labor:
With a higher output price, the
added output from an extra
worker is more valuable.
CHAPTER 18 THE MARKETS FOR THE FACTORS OF PRODUCTION 409
Table 18-2 also shows that, beginning around 1973, growth in productivity
slowed from 2.9 to 1.1 percent per year. This 1.8 percentage-point slowdown in
productivity coincided with a slowdown in wage growth of 1.9 percentage
points. Because of this productivity slowdown, workers in the 1980s and 1990s
did not experience the same rapid growth in living standards that their parents
enjoyed. A slowdown of 1.8 percentage points might not seem large, but accumulated
over many years, even a small change in a growth rate is significant. If
productivity and wages had grown at the same rate since 1973 as they did previously,
workers’ earnings would now be about 50 percent higher than they are.
The link between productivity and wages also sheds light on international
experience. Table 18-3 presents some data on productivity growth and wage
growth for a representative group of countries, ranked in order of their productivity
growth. Although these international data are far from precise, a close link
between the two variables is apparent. In South Korea, Hong Kong, and Singapore,
productivity has grown rapidly, and so have wages. In Mexico, Argentina,

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