Labor Markets and Wage Determination

Lesson 6.1: Labor Markets and Wage Determination

The Labor Market

Labor is a key factor of production. In labor markets, households supply labor and firms demand it. Like product markets, labor markets are governed by supply and demand — but with some key differences.

Derived Demand

Labor demand is derived, meaning it's based on the demand for the goods/services that labor helps produce.

If demand for cars rises, demand for auto workers rises too.

Marginal Productivity Theory

Firms hire workers based on marginal revenue product (MRP):
MRP=MP×PMRP = MP \times P
Where:

• MP = Marginal Product of Labor
• P = Price of the good

Firms hire labor until:
MRP=MRCMRP = MRC (Marginal Revenue Cost)

In perfectly competitive labor markets, wage = MRC.

Labor Supply

The supply of labor is based on:

• Wages (higher wages → more supply)
• Non-monetary factors (e.g., working conditions, job satisfaction)
• Population, education, culture

Wage Determination in Competitive Markets

• Equilibrium wage occurs where labor demand = labor supply
• Above equilibrium → surplus (unemployment)
• Below equilibrium → shortage (job vacancies)

Key Takeaways

• Firms demand labor based on productivity and price
• Workers supply labor based on wages and preferences
• Equilibrium wage ensures efficient labor allocation