# (B) Supply and demand for labor including Marginal revenue product

Labor Economics

The supply for labor can be defined as the quantity of workers who are willing and able to supply work in a market or occupation at various wages. Demand for labor is the quantity of employers that are willing to hire workers in a market or occupation at various wages. These employers follow the general rule of only hiring a worker if that worker can generate additional revenue to cover the additional cost of hiring the worker. This additional revenue is called marginal revenue product and is simply the output of the worker multiplied by the price of that output.

The supply curve is an upward sloping curve as the more wages an occupation pays, the more workers are willing to enter the occupation. Alternatively, the demand curve slopes downward, as the law of diminishing marginal returns dictates that the output per worker will decrease as the employer hires more workers.

Shifts in the labor demand curve can occur when something changes the amount of output per worker or when something changes the price per output. For example, a change in government tax regulations might result in more complicated tax returns, increasing the price of tax return preparation services. Since the value of the output of tax preparers has increased, the labor demand curve would shift to the right. Likewise, providing more or better training to accounting students graduating from colleges would increase the output level of these new tax preparers. This increase in marginal revenue product of hiring additional preparers will also shift the demand curve to the right.

Studying the supply and demand of labor leads to an explanation of why workers in different occupations earn different amounts. The equilibrium market wage of any occupation is the wage where the supply and demand curves intersect. Thus, as the supply of workers in one occupation is less than that of another, the occupation with a lesser supply will pay higher wages than the occupation in greater supply. An example of this is illustrated in the graphs below.

We must put the supply and demand curves together to explain why workers in different occupations earn different amounts. Figure 1, for example, shows supply and demand diagrams for registered nurses and hotel clerks. In 2000, the median annual earnings of registered nurses were \$44,840, while those for hotel clerks were only \$16,380.

As illustrated above, nurses earn more than hotel clerks. This is because nurses are usually more educated and therefore more productive than hotel clerks, making the demand for nurses higher than the demand for hotel clerks. Conversely, the supply of nurses is less than that of hotel clerks, since it is more difficult to become qualifed for the nursing occupation. The lower supply and higher demand for nurses is the reason for the higher wages paid to nurses.

This same concept can be applied when looking at the overall wages paid to workers with more education. The reason that so many people go on to college or other post high school training is that the marginal revenue product for these workers is higher, increasing their demand and in turn increasing the wage paid. "In 2000, the median earnings of males in the age group 25-34 who graduated from college were 60 percent higher than those who had only completed high school or a GED, while those of females were 95 percent higher." (Alden).

In addition to education, there are other reasons for difference in wages. This can be seen when comparing occupations requiring the same amount of education. Below is an illustration of the supply and demand curves for workers in the fitness trainer occupation and hazardous materials removal occupation. Figure 2 shows that the median wages paid to hazardous materials removal workers is higher than those paid to fitness trainers. If education level and earnings were the only consideration in the demand and supply of workers, then it makes sense that fitness trainers would quit their jobs and become hazardous materials removal workers, which we know doesn't happen.

Assuming that fitness workers did quit their jobs to become hazardous materials removal workers, the supply of hazardous materails removal workers would increase and the supply of fitness workers would decrease. This would cause the hazardous materials removal workers wages to decrease and the fitness trainers wages to increase, and this scenario would occur until the wages for each occupation became about the same. The reason this doesn't happen is that there are more considerations for supply of workers besides the wage paid. In this case, the workers choosing to be fitness trainers do so because they personally enjoy being a fitness trainer rather than a hazardous materials removal worker and are willing to accept a lower wage.

Other factors contributing to supply, demand and wages in an occupation are natural talent, riskiness of the occupation, discrimination, among others. For example, professional athletes, models, actors and actresses are all highly paid professions, but although most people have the desire to be in one or more of those occupations, most people do not have the natural ability needed to do so. That keeps the supply low for these occupations, and therefore the wages high. Another example of an occupation that maintains high wages is a fisherman on an Alaskan fishing boat. Workers are hestitant to enter this occupation due to the personal dangers that exist in performing the job.

Current events can cause immediate changes in labor markets. For example, a major storm, like hurricane Katrina, can instantly spike the demand for construction trade workers to rebuild the area. The increase in demand will increase the wages and eventually increase the supply of those workers. Another disaster, 9/11 had the opposite effect on the airline industry. The perceived risk of working in that industry rose, creating a decrease in the supply of those workers. Future events impact the growth or decline of labor markets. For example, as the average age of Americans increase, so does the demand for nurses to care for the aging population.

Marginal Revenue Product of Labor

As mentioned earlier, marginal revenue product of labor is the output of a worker multiplied by the price of the output. This is a simple and straightforward concept when assuming the employer is operating in a perfectively competitive market. If employers are maximizing proft, they will hire workers up to the point where the marginal revenue product of labor is equal to the wage. Employers in monopoly or imperfect competition, however, face downward sloping demand curves in their markets. This means that as the output increases from hiring additional workers, the price of the output will need to be lowered. This is actually the more realistic scenario is also another contributing factor of different wages in different occupations.

Below is an illustration of how the marginal revenue product affects labor demand. If a decline occurs in the wage rate as shown in the left graph, the employer will hire additional workers to take advantage of the cheaper input for the given level of output. An increase in the wage rate has the opposite effect. The right graph illustrates an increase in marginal revenue productivity that would occur when labor productivity increases or an increase in the employers output demand raises the price of the output. The result is the demand curve shifting to the right and an increase in the total employment of the market.

Question 1 - Which of the following is likely to cause an increase in the demand of workers in an occupation?

A. The price of the employer's output declines
B. Workers become better trained
C. The local government increases payroll taxes

Question 2 - Which of the following is likely to cause an increase in the supply of wokers in an occupation?

A. Government licensing for a profession becomes more strict
B. New medical information becomes available informing the public of occupational hazards in the profession
C. Technological advances make it easier to perform the job duties of the occupation.

Question 3 - What happens to the demand for labor when the marginal revenue product increases?

A. It shifts to the right
B. It shifts to the left
C. It stays the same

Question 4 - An increase in the wage rate will most likely cause:

A. The demand curve to rotate clockwise
B. A shortage of workers
C. The demand for labor to decrease

Question 5 - Two occupations have the same education and skill requirements, but different degrees of occupational hazards. The occupation that is safer will most likely:

A. Have a surplus of workers
B. Pay a higher average wage
C. Pay a lower average wage

1 - B
2 - C
3 - A
4 - C
5 - B

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Bromely, Ray. "Resources and Their Use". Pcecon.com. Accessed October 24, 2007. http://www.pcecon.com/notes/laborResources.html

"Demand for labor". Tutor2u.com. Accessed October 24, 2007. http://www.tutor2u.net/economics/content/topics/labourmarket/labour_demand.htm

"Labour Economics". Wikipedia.com. Accessed October 24, 2007. http://en.wikipedia.org/wiki/Labor_economics

"Marginal revenue productivity theory of wages." Wikipedia.com. Accessed October 24, 2007. http://en.wikipedia.org/wiki/Marginal_revenue_product