FMA - Supply of Labor Lesson

Supply of Labor Lesson

The Basic Models for the Supply of Labor

After exploring how the demand for the factors of production is determined, it's time to pick up the second piece to the factor market - the supply side. To analyze the supply side of the factor market, labor will be our primary example. However, keep in mind that the basic rules for labor supply are transferable to any type of factor of production.

Supply of Labor Revenue Curve Video

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The Case of Perfect Competition

Labor supply is considered perfectly competitive when each firm that desires that particular type of labor can attract all the workers it wants at a given wage. The wage, as seen by the firm, is the wage set in the market. In a perfectly competitive labor market, the market wage and the marginal cost of labor (sometimes more generally referred to as marginal factor cost or marginal resource cost) are the same dollar amount. Remember, marginal cost is "additional cost" due to a one unit increase in a variable. In this case, the marginal cost of labor is the additional cost due to a one unit increase in labor.

Suppose a firm produces a product in a perfectly competitive goods market. The product sells for $5.00. It can hire all the workers it wants at a wage of $10 per worker (this is a perfectly competitive labor market).

Labor Cost Schedule for the Firm

Number of Laborers	Wage Rate	Total Wage Bill (Summation of the combined wages for workers)	MCL (change in total wage bill/change in # of laborers)
1	$10.00	$10.00	$10.00
2	$10.00	$20.00	$10.00
3	$10.00	$30.00	$10.00
4	$10.00	$40.00	$10.00

The perfectly competitive labor market below dictated a market wage for labor of $10. The firm perceives its labor supply curve as perfectly elastic. The labor supply curve is created using the number of laborers and the wage rate. The MCL (or MRC or MFC) curve is created using the number of laborers and the marginal cost of labor. Because the firm is operating in a perfectly competitive market, and the wage rate does not have to increase for the firm to hire additional laborers, the MCL curve is equivalent to the firm's labor supply curve.

Now let's assume the firm facing the labor supply curve above has the following marginal revenue product schedule:

Number of Laborers	MRP
1	$20
2	$15
3	$10
4	$5

Equilibrium Level of Labor PCF Graph

Equilibrium Level of Labor PCF Graph

MRP Schedule
X-Axis – Quantity of Laborers
Y-Axis – Wage
S is a horizontal line at wage amount $10.
S = Wage = MCL
MRP = D, is a decreasing curve. As the quantity of labor goes up, the wage goes down.
The two curves meet at quantity of labor point 3 and $10.

At this point, marginal analysis comes into play to determine how many workers the firm will hire. The general rule is that the firm will hire every laborer for which MRP ≥ MCL (or MFC, more generally). This should be somewhat intuitive at this point in the course. MRP represents the additional revenue a laborer generates for the firm. MCL represents the additional cost the laborer creates at the firm. So long as the extra revenue created is greater than the extra cost, the firm's total profit will increase by hiring the worker. Therefore, there is a profit maximizing level of labor for a firm. It is found where MRP = MCL. Beyond this point, MRP < MCL and the additional cost outweighs the additional revenue, driving profit levels down. In the case above, the firm would hire three workers. It would not hire the 4^th worker because that worker generates only an extra $5 in revenue, but would cost the firm an extra $10. The result would be a $5 decrease in profit.

Perfectly Competitive Factor and Output Markets Video

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The Case of the Non-Discriminating Monopsonist

Before we explore the supply curve as viewed by this type of firm, let's first take a moment to understand what is meant by the term monopsonist. A monopsony is a market structure in which there is only one buyer. Because there is only one buyer, the buyer's market power is hefty. The buyer has a significant influence over the price in the market. In the case of a labor market, a firm is a monopsonist if it must increase wage (remember, wage is the "price" paid for labor) to attract more workers. Specifically, a non-discriminating monopsonist will increase wages for all workers, not just the last worker hired. This results in the marginal cost of labor (MCL or, more generally, MFC) being greater than the wage. The MCL curve will lie above the labor supply curve on the graph for the firm.

Number of Laborers	Wage	Total Wage Bill	MCL
1	$10	$10	$10
2	$11	$22	$12
3	$12	$36	$14
4	$13	$52	$16

As you can see, the change in the total wage bill reflects the higher wage of the last worker and it includes an increase in the wages of the previous workers. If the 2^nd worker is hired at $11, then the 1^st worker will also be paid $11. The true cost of hiring an additional worker is represented by the MCL. The MCL curve will lie above the labor supply curve, as MCL > Wage. Therefore, when the firm is trying to decide the quantity of workers to hire, it looks for the equality of MRP and MCL to find the quantity, but will pay the wage found on the labor supply curve that corresponds to that quantity of labor.

MCL for Non-Discriminating Monopsonist Graph

X-Axis – Quantity of Laborers
Y-Axis – Wage
Graph has three curves – MCL, S = Wage, and D = MRP.

The Case of the Perfectly Discriminating Monopsonist

As the name would imply, firms that operate as perfectly discriminating monopsonists actually pay each worker a different wage. That is, they treat employees differently (i.e. the basic interpretation of discrimination). Because the firm has influence over the market, the firm can increase the wage rate to attract more workers. This results in an upward sloping labor supply curve. However, in this instance, the firm only pays the higher wage to the additional worker the firm hired. For a non-discriminating monopsonist, this means the labor supply curve and the MCL curve are the same. Look at how the total wage bill changes for the example firm below:

Number of Laborers	Wage	Total Wage Bill	MCL
1	$10	$10	$10
2	$11	$21	$11
3	$12	$33	$12
4	$13	$46	$13

Notice how the total wage bill is different for the perfectly discriminating monopsonist. At two workers, instead of multiplying 2 x $11 and having a total wage bill of $22, the total wage bill reflects the $10 paid to the 1^st worker and the $11 paid to the 2^nd wage for a total of $21. Each worker is paid a different amount. This results in the labor supply curve (wage) being equivalent to the MCL curve.

The generic labor graph for a perfectly discriminating monopsonist looks like so:

MCL for Perfectly Discriminating Monopsonist Graph

X-Axis – Quantity of Laborers
Y-Axis – Wage
Two curves exist, S = Wage = MCL and D = MRP.
S = Wage = MCL curve - as quantity of labor increases, wage increases.
D = MRP – as quantity of labor increases, wage decreases.
The two curves meet at point Q on the x-axis and $ Wage on the y-axis.

Monopsony Factor Market and Perfectly Competitive Output Market Video

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Monopsony Factor and Monopoly Output Video

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