Page 398 - The Principle of Economics

406 PART SIX
THE ECONOMICS OF LABOR MARKETS
Figure 18-4
EQUILIBRIUM IN A LABOR MARKET. Like all prices, the price of labor (the wage) depends on supply and demand. Because the demand curve reflects the value of the marginal product of labor, in equilibrium workers receive the value of their marginal contribution to the production of goods and services.
Wage (price of labor)
Equilibrium wage, W
0
Supply
Demand
Equilibrium employment, L
Quantity of Labor
At first, it might seem surprising that the wage can do both these things at once. In fact, there is no real puzzle here, but understanding why there is no puzzle is an important step to understanding wage determination.
Figure 18-4 shows the labor market in equilibrium. The wage and the quantity of labor have adjusted to balance supply and demand. When the market is in this equilibrium, each firm has bought as much labor as it finds profitable at the equi- librium wage. That is, each firm has followed the rule for profit maximization: It has hired workers until the value of the marginal product equals the wage. Hence, the wage must equal the value of marginal product of labor once it has brought supply and demand into equilibrium.
This brings us to an important lesson: Any event that changes the supply or de- mand for labor must change the equilibrium wage and the value of the marginal product by the same amount, because these must always be equal. To see how this works, let’s con- sider some events that shift these curves.
SHIFTS IN LABOR SUPPLY
Suppose that immigration increases the number of workers willing to pick apples. As Figure 18-5 shows, the supply of labor shifts to the right from S1 to S2. At the initial wage W1, the quantity of labor supplied now exceeds the quantity de- manded. This surplus of labor puts downward pressure on the wage of apple pick- ers, and the fall in the wage from W1 to W2 in turn makes it profitable for firms to hire more workers. As the number of workers employed in each apple orchard rises, the marginal product of a worker falls, and so does the value of the marginal product. In the new equilibrium, both the wage and the value of the marginal product of labor are lower than they were before the influx of new workers.