Labor Market Graph: Labor Supply, Wage Takers and Economic Rent

If your boss doubled your hourly pay, would you work more hours, or fewer? Plenty of people would choose fewer, and that's a sensible choice. So how can more pay mean less work? This is Module 5.1, part two: labor supply and the labor market.

Part one covered the buyers of factors. Now the sellers: in a factor market, households sell their labor and firms buy it, paying a wage. Every hour of work gives up an hour of leisure: time not spent working for pay, like friends, games or a lazy Sunday.

Quick refresher from Unit 1: opportunity cost is what you give up. Nadia walks dogs for $12 an hour and picks her own hours, so each hour off costs her $12.

So she decides hour by hour, working one more hour if its pay buys something worth more to her than the hour off.

Your textbook asks: what happens when pay rises? Quick refresher from Module 2.1: if a $6 lunch drops to $3, you switch toward it because it's now relatively cheap: the substitution effect. And you're $3 richer: the income effect.

Now double Nadia's pay to $24. Leisure's price is the wage, so each hour off costs $24. Pricier leisure pulls her toward more work: the substitution effect. But she's richer too, and leisure is a normal good, so she wants more of it: the income effect, pulling toward fewer hours. The substitution effect wins: at $12 she worked 25 hours a week; at $24, she works 35. Double it again, to $48, and the income effect wins: she cuts back to 30 hours. Her weekly pay still climbs, from $840 to $1,440.

Plot those points, wage up the vertical axis and hours along the horizontal: that's her individual labor supply curve, which your textbook draws rising, then bending backward at high wages. That answers the opening question: when the income effect wins, more pay means fewer hours.

So what just happened? One: $12 to $24 raised Nadia's hours from 25 to 35. Two: $48 cut them to 30. Three: substitution wins at low wages, income at high ones.

A market adds everyone's hours sideways. At $24 an hour, Nadia offers 35 hours, Omar 25 and Lena 40: 100 hours in all. Repeat that at every wage to trace the market labor supply curve.

So what just happened? One: at $24, the three offer 35, 25 and 40 hours. Two: added sideways, that's 100. Three: repeat at every wage for market supply.

Exam trap: the backward bend belongs to one person at high wages. The AP course says more labor is supplied at higher wages: market supply slopes up.

Now a whole labor market: lawn-care workers in a big city. Each company's labor demand is its MRP curve from part one; add them sideways for market demand. Your textbook's tip: it's just supply and demand, relabeled. Wage on the vertical axis, Quantity of Labor on the horizontal, D down, S up.

Quick refresher from Unit 2: from the crossing, run dashed lines across and down, and label both axes. Here that's W1, $130 a day, and L1, 2,400 workers.

At L1, the market's last worker adds $130 to revenue, and every worker is paid that: your textbook's equilibrium marginal revenue product.

So what just happened? One: firms' MRP curves add up to D. Two: S meets D at W1, $130 a day, and L1, 2,400 workers. Three: everyone earns that $130.

Zoom in on one company. A perfectly competitive labor market has many firms and workers, each too small to move the wage. The market sets it; each firm is a wage taker. Each extra worker adds exactly $130 to its costs: its marginal factor cost, MFC, also called marginal resource cost. Draw it side by side, market left, company right. A dashed line carries W1 across, where it becomes a flat line: the company's labor supply, S = MFC. Exam trap: the company's labor supply is flat, but its labor demand is not. Demand is still its MRP curve, sloping down. Never draw a flat labor demand curve.

Quick refresher from part one: for a price-taking seller like this company, MRP is marginal product times price. Lawns sell for $35. Worker one mows 8 a day: 8 times $35 is $280.

Workers two through six add 7, 6, 5, 4 and 3 lawns, so their MRPs are $245, $210, $175, $140 and $105. Hire every worker whose MRP is above the MFC. Worker five brings in $140, above $130: hire. Worker six would bring $105, below $130, cutting profit by $25. So it hires 5.

So what just happened? One: the flat MFC is the market's $130. Two: worker five's $140 is above it; worker six's $105 is below. Three: it hires 5.

Now say the market wage rises to W2, $160 a day. Module 5.2 shows why. The company's flat line rises with it. Worker four's $175 still beats $160, but worker five's $140 no longer does: keeping her would cut profit by $20. So it hires 4, sliding along an MRP curve that never moved.

So what just happened? One: the wage rose to $160. Two: the flat MFC line rose with it. Three: worker five now falls short, so it hires 4.

A firm can take the wage where it hires yet set prices where it sells: a famous dumpling restaurant prices its own menu but pays dishwashers the going wage. Exam trap: when a question says the labor market, draw the market graph, D down and S up with the wage and quantity at the crossing, never the company's flat line.

Land and capital have markets too. The AP course prices land with rent and capital with interest; your textbook calls both prices a rental rate. Your textbook draws land's supply steep, since new land is costly to create, and capital's flatter, since savings respond to the rental rate. And each unit earns its market's equilibrium MRP, just like labor.

So what just happened? One: the AP course prices land with rent, capital with interest; your textbook, a rental rate. Two: land's supply is steep, capital's flatter. Three: each unit earns the equilibrium MRP.

Last idea, from your textbook: economic rent, any payment to a factor above the least its owner would accept.

Quick refresher from Unit 2: producer surplus is the price minus the least a seller would accept. Sell a bike you'd let go for $40 at $55: $15 of surplus.

Economic rent is its factor-market cousin. Jamal would mow lawns for as little as $100 a day. Paid the original $130 wage, he earns $30 a day of economic rent. Now 40 acres of riverfront land that no one can add to. Its supply is vertical: it's there even at a price of zero, so its whole payment is economic rent. At $900 an acre a month, that's 40 times $900: $36,000 a month, all economic rent.

So what just happened? One: Jamal's $130 minus his $100 minimum is $30 of rent. Two: fixed land's supply is vertical. Three: all $36,000 a month is economic rent.

Exam moment: two questions the way the AP exam asks them, then one free-response part.

Question 1. A print shop hires press operators in a perfectly competitive labor market at $23 an hour. Which of the following describes the labor supply curve the shop faces? A) Vertical at the number of operators it hires B) Downward sloping, the same as its MRP curve C) Horizontal at $23, equal to its marginal factor cost D) Upward sloping, the same as market labor supply E) Upward sloping, with marginal factor cost above it

The answer is C. The shop can't move the wage, so each operator adds exactly $23 to cost: a flat line at $23, its MFC. A is a factor in fixed supply. B is the shop's labor demand. D is the market's curve. E is a single buyer of labor, from Module 5.4.

Question 2. In a perfectly competitive market for warehouse pickers, supply meets demand at $21 an hour and 6,000 pickers. One warehouse's MRP curve is $28 at 30 pickers, $21 at 40, $14 at 50 and zero at 70. To maximize profit, how many pickers does it hire? A) 30 B) 40 C) 50 D) 70 E) 6,000

The answer is B. Its MFC is the market's $21, so it hires where its MRP meets $21: 40 pickers. A stops while MRP is still above $21. C hires pickers whose MRP is below $21. D hires until MRP is zero. E is the market's quantity.

Free response, 1 point. Ridgeline Rafting hires river guides in a perfectly competitive labor market. Draw a correctly labeled graph of the labor market for river guides, showing the equilibrium wage and quantity, labeled W1 and L1.

What earns the point: labeled axes, Wage and Quantity of Labor; D sloping down; S sloping up; and W1 and L1 on the axes at their crossing. The costly mistake: drawing the company's flat wage line instead of the market, or leaving labels off. On a recent AP exam, about two students in five missed this point.

So what earned the point? One: the market graph, not the firm's. Two: D down, S up, axes labeled. Three: W1 and L1 at the crossing.

Recap: one person's labor supply can bend back, but market supply slopes up. The market sets the wage. Each wage-taking firm hires where its MRP meets that flat MFC. Next: Module 5.2, Changes in Factor Demand and Supply.