THE DEMAND FOR LABOR (ND) Depends on costs and benefits of hiring one extra

worker Cost – real wage of extra worker (w/P) Benefit – value of extra good (MPN) If real wage (w/P) MPN, the firm pays the extra

worker more than the worker produces, so the firm should reduce the number of workers to increase profits

If w/P MPN, the extra worker produces more than he is being paid, so the firm should increase the number of workers to increase profits

Firms’ profits are highest when w/P = MPN

THE MPN AND ND ND curve shows relationship between the wage rate

and qty of labor demanded

The profit-maximizing qty of labor demanded is when w/P = MPN

So, ND curve is the same as the MPN curve, since w/P = MPN at equilibrium

So the ND curve is downward sloping- firms want to hire less labor at higher w

Factors that shift the ND curve Supply shockso Beneficial supply shock (for example, an

increase in technology) raises MPN, ND curve shifts to the right, vice versa

Size of capital stocko Higher capital stock raises MPN, so shifts ND curve to

the right; opposite for lower capital stock

THE SUPPLY OF LABOR Supply of labor is determined by individuals The labor supply curve (NS) curve relates quantity

of labor supplied to real wage Increase in the current real wage should raise

quantity of labor supplied  NS curve slopes upward because higher wage

encourages people to work more

Factors that shift the NS curve Wealth: Higher W reduces NS -shifts NS curve to the

left Expected future w/P: Higher expected future w/P =

increase in W, so reduces NS -shifts NS curve to the left

Increase in working-age population (higher birth rate, immigration) - shifts NS curve to the right

Increase in labor force participation (increased female labor participation, elimination of mandatory retirement) -shifts NS curve to the right

Migration of workers increases NS

LABOR MARKET EQUILIBRIUM Labor supply equals labor demand Known as full-employment level of employment,N The market-clearing real wage is (real wage) Factors that shift labor supply or labor demand

affect and (real wage)Labor Market Equilibrium

Effects of Supply shocks on full-employment output Example: Adverse supply shock

A spell of unusually bad weather reduces MPN at every level of employment.- MPN (ND) curve shifts to the left- equilibrium in labor market moves from A to B- and fall

FULL-EMPLOYMENT/POTENTIAL OUTPUT (Yf) the level of output that firms supply when w/P and P

have fully adjusted. Occurs when the labor market is in equilibrium. Factors determining Yf o Full employment level of

employment, , which is determined by ND and NSo Production function relating

output and employment- If production function changes, MPN changes, labor D

curve changes, changes so Yf also changes- If NS increases, Yf increases, as there is now more

labor available to produce output. - a beneficial supply shock means the same quantities

of N and K produce more output, so Yf rises. - a beneficial supply shock increases ND at each real

wage and raises , which increases Yf

- Positive temporary supply shock affects output in 2 ways:

Increases Y directly because MPN increases Increases ND as MPN increases and increases , so

reduces Yf