Labor Markets Part 1 September 19 2016 1 47 I The first market in our analysis I I I I I Firms choose labor demand optimally Households choose labor supply optimally Government may affect optimal choices using various policy tools taxes transfers The equilibrium objects are the labor input quantitiy and the real wage price For now focus on short run analysis Capital is fixed I we will relax this assumption following the discussion of optimal investment 2 47 Start from the end What is the structure that leads to this description of the labor market 3 47 Competitive Markets I I The key property of competitive markets is that all agents are price takers I Assume that no agents can influence the prices of inputs or outputs alone I Requires 1 all agents sufficiently small 2 homogeneity of inputs outputs and 3 frictionless reallocation Assume that firms operate in competitive markets and I use F K N technology to produce output sell at a price P I hire labor N for a price w per unit I rent capital K for a price r per unit 4 47 A Primer on Firm Optimization I What is the firms objective Maximize Nominal Profits I Taking prices Pt wt and rt as given max Pt At F Kt Nt wt Nt rt Kt Kt Nt I First order conditions with respect to Kt and Nt Pt AFK t rt 0 Pt AFN t wt 0 I Factors are paid their marginal products wt rt M P Nt AFN t M P Kt AFK t Pt Pt I This is a central result that we ll keep using and discuss in more detail as we discuss the labor market and investment decisions 5 47 Let s slow down I Suppose the price of a bag is 5 How many workers will the firm hire if the wage rate is 38 6 47 Let s slow down I Suppose the price of a bag is 5 How many workers will the firm hire if the wage rate is 38 7 47 Let s slow down I Suppose the price of a bag is 5 How many workers will the firm hire if the wage rate is 27 8 47 Let s slow down I Suppose the price of a bag is 5 How many workers will the firm hire if the wage rate is 27 9 47 Let s slow down I Let s look at the profits 10 47 Let s slow down I Let s look at the profits 11 47 Let s slow down I Suppose a tech advancement doubles the output how many workers will they hire if W 38 12 47 Let s slow down I Suppose a tech advancement doubles the output how many workers will they hire if W 38 13 47 The demand for labor I The labor demand curve relates the real wage rate and the quantity of labor demanded I It is the same as the Marginal productivity labor curve since firms equate the wage to the MP I So the labor demand curve is downward sloping firms want to hire less labor the higher the real wage 14 47 The demand for labor 15 47 The demand for labor 16 47 Let s go back to our model What is the structure that leads to this description of the labor market 17 47 Assumptions I All workers are identical I All firms are identical I A single good stuff is produced I Firms and workers are price takers I No agent can influence prices alone I All agents sufficiently small I i e definition of competitive markets I Short run level of capital K exogenously given K K I No frictions in the labor market I Firms use production technology as in the production model I Labor demand maximize firms profits I Labor supply maximize workers utility 18 47 Labor Demand I Firm profits is revenue cost I Denote profits by I Firm would like to chose N such that profits are maximized max max P Y wN max P AF K N wN N I N N First order condition with respect to N PA F K N w 0 N MPN I A F K N w N P w P Why is this a logical optimality condition I Why M P N I Why M P N w P w P is not optimal is not optimal 19 47 The Labor Demand Curve I Why a negative slope Why is the real wage flat I What shifts the curve What causes a movement along the curve 20 47 Shift vs Moving along I I The demand curve NEVER shifts as a result of a change in the real wage I real wage is an endogenous variable I if the real wage changes the firm responds by moving along the curve Curve Shifters are exogenous forces that increases or decreases M P N for any given level of N I the firm would like to hire more or less given a real wage I what are the curve shifters in our model A and K F K N MPN A N 21 47 Labor Supply I Given technology TFP K wages w and prices p how much labor should households supply I Households Consumers Workersderive utility from consumption C and leisure 1 N I Endowed with normalized 1 unit of time for work leisure I Consumption 1 More is better 2 Last unit is less satisfying than the one before I Leisure 1 More is better 2 Last unit is less satisfying than the one before I Labor 1 More is worse 2 Last unit is more painful than the one before 22 47 The Utility Function A utility function is an object that we can use in order to characterize preferences I Utility from consumption and leisure U C N U C 1 I The Marginal Utility represents the change in utility caused by a small change in C or N or UC UN I U C N C U C N N U C 1 Utility orders preferences magnitude less important review your micro consumer theory 23 47 Properties of the Utility Function I More consumption is better UC 0 I The last unit is less satisfying UCC I More leisure is better UN 0 I The last unit is less satisfying I More labor is worse UN 0 I The last unit is more painful UN N 2 U C N C 2 2 U C 1 2 2 U C l C 2 0 0 2 U C N N 2 0 24 47 The indifference curve I Have Consumption on the Y Axis and Hours worked on the X axis I How does the indifference curve look like 25 47 The indifference curve I Have Consumption on the Y Axis and Hours worked on the X axis I How does the indifference curve look like I In what direction does utility increase 26 47 The indifference curve I Have Consumption on the Y Axis and Hours worked on the X axis I How does the …