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principle of economic

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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

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