Economic Principles I

Lecture 15:
The Labour Market: Bilateral Market
Power?
What is Special about the Market
for Labour?
Demand in the labour market is derived
from demand in the output market
Labour markets are highly localised and
subject to imperfect competition
Labour markets are highly segmented in
terms of levels and types of skills (historic
human capital investments)
Demand for Factors of
Production
Underlies the cost function
Depends on prices of factors: e.g. if capital
becomes less expensive (or technology
improves, or wages rise), shift to capital-
intensive production
The marginal principle, revisited: marginal
cost of hiring extra labour contrasted with
marginal benefit of doing so
Short-run Demand for Labour (1)
Marginal physical product of labour (MPP
L
)
Marginal value product of labour (MVP
L
) in
competitive output markets
Marginal factor cost of labour (MFC
L
)

Short run Demand for Labour (2)
Wages
Labour hired
Wage rate w
0
MVP
L

L
0
Industry Labour Demand
Wages
Labour hired
w
0
w
1
E
0
MVP
L
2
D
L

E
1
E
2
MVP
L
1
Demand for Labour when
Markets are not Perfect
Wages
Labour hired
MVP
L

Wage rate w
0
L
0
MRP
L

L
1
MFC
L

L
2
L
3
Without
competition in the
output market,
marginal revenue
product falls faster
as increased
output reduces
price
Without
competition in the
labour market,
marginal factor
cost rises as more
hires increase
wages
Labour Supply
Possibility of individual backward bending
supply curve
Real wage rise effect on participation
Labour pool serving several employers:
bidding up wages to attract workers and
spillover effects
Transfer Earnings and Rent
Wages
Labour hired
Supply
Demand
w
0
L
0
w
1
B

A

Transfer
earnings
Economic
rent
E

Trade Union and Monopsony
Employer: Bilateral Market Power
Wages
Labour hired
S/MC
D/MRP
MFC
MR
Monopoly
wage
Monopsony
wage
L
0
L
1
The bargaining
space is between
the monopoly
wage and the
monopsony wage
The Markets for Factors
Hire up to where Marginal Factor Cost =
Marginal Benefit (value of marginal product
or marginal revenue product)
Equivalently, ratios of marginal productivity
to factor price should be equal:
r
MPP
w
MPP
K L

Economic Principles I
Lecture 15:
The Labour Market: Bilateral Market
Power?