A firm will find it profitable to hire workers up to the point at which their added cost of hiring another worker equals the added value that new worker will produce. This is called the marginal cost of labor, or MCLL.
As firms grow, they need to add new workers to keep producing at a steady rate. Firms that grow too quickly for their size run the risk of hiring too many workers, which raises the MCLL.
If a firm is not growing, then it does not need to hire new workers. However, if it does not hire new workers, then it will not produce more output. A shrinking firm has what is called a static supply of labor- that is, the number of workers it has and will have until changes are made.
The number of workers a firm has depends on several things: whether or not it subcontracts work to other firms or independent contractors, if it has employees or only contracted laborers, and how many hours employees work per week.
Explain the concept of labor supply
The concept of labor supply explains why firms will hire only as many workers as they need. A firm will not hire workers unless it needs to- and will not keep hiring workers unless it needs to.
A firm’s demand for labor is based on the value of the output it produces. If its output is relatively high in value, then it will need more workers to produce that output.
If the going rate for labor is high, then more people will want to work, and firms will have to compete with each other to hire them. This creates a supply of labor that firms have to take into account when deciding how many employees to hire and keep.
A firm that wants to maximize its profits will only hire and retain workers up to the point at which further employment would reduce profits.
Explain the concept of labor demand
The other side of the labor market is demand. The demand side of the market refers to jobs that are available and the people who want to work.
Businesses can hire as many workers as they can afford, but there will always be people willing to work at a fair wage. A firm will find it profitable to hire workers at a wage that is equal to the value of what they produce.
A worker may only produce $10 worth of value per hour, for example, but if the business can afford to pay them then they will. Their salary may be more than $10 per hour, however, because their skills may be valuable.
The idea that a firm will only hire workers up to the point at which their productivity declines is important for understanding why some people are unemployed.
A worker’s supply curve will be based on their utility maximization process
The concept of utility maximization is fundamental to economics. It is the idea that people act in order to increase their happiness or decrease their sadness.
People choose what to buy, what jobs to take, and how to spend their time based on how doing so will make them happy. This may seem like a superficial thing to say, but it is very profound.
Utility maximization goes far beyond buying things you like. It explains why people buy things in the first place, and why they take jobs in the first place. It explains why people who earn $10 an hour at one job stay there instead of taking a job that pays them $15 an hour. It explains why people who are paid a lot of money may not be any happier than someone who is paid less.
The idea behind utility maximization isn’t that people only want to maximize their utility or happiness, it’s that they want to maximize whatever it is that makes them happy.
A worker’s demand curve will be based on their wage rate preference
The demand curve for a worker is based on their value of the next job versus
their value of their current job. If they are currently employed, their current job has a
higher value to them than the next job would, so they will not be willing to work for less at
their current employer. If they are not employed, then the next job has a higher value to them,
so they will be willing to work for less.
An equilibrium wage rate will be determined by the market forces of labor supply and demand
The labor supply is the number of workers who are willing to work at a given wage rate. As the economy grows and produces more jobs, the supply of workers increases.
As the economy declines and produces fewer jobs, the supply of workers decreases. This is because people may choose to stay home and work on their own projects, or they may not be able to find work anywhere.
The higher the wage rate, the more people will be willing to work. As the wage rate decreases, people opt out of working, so the number of workers decreases as well. The same goes for those who stay home to work on their own projects—the wage rate determines whether it is worth it to leave your job to do so.
The equilibrium wage rate is determined by what amount of workers choose to leave their jobs to go on their own projects or find another job at a different wage rate. The number of such workers determines the labor supply at an equilibrium wage.
A firm will find it profitable to hire workers up to the point at which their labor productivity equals their wage rate
This means that the more productive a worker is, the more valuable they are to a company. The company will pay more for a highly skilled worker than someone with less skill who is asking for the same wage.
In general, the average productivity of workers in an industry affects the wage rate that companies offer. A company that produces products at an average level of quality will offer a similar wage rate for all its workers.
A company can choose to pay higher wages than its competitors, but only if it gets enough of a return on investment to make up for it. If a company pays workers more but doesn’t produce as much output, then it’s losing money.
Theoretically, companies could pay every employee infinitely more than every other employee, but there would eventually be no return on investment.
Government can affect the market equilibrium by changing either labor supply or demand
Introducing more labor into the market via immigration or population growth can increase supply, which can push down wages.
The government can also lower the demand for labor via unemployment benefits, education subsidies, or direct cash payments. All of these reduce the cost of leaving the workforce, which increases attrition.
Unemployment benefits may seem counterintuitive, but they actually increase the length of time a person stays out of the workforce. By having money to live on while looking for a new job, someone can stay unemployed longer without going broke.
Education subsidies and other forms of indirect payment incentivize people to enter different fields that the government deems valuable. These incentives may draw in more workers into the market, lowering supply and possibly pushing up wages.
The last way the government can affect wage equilibrium is by banning slavery. If there are no free workers to replace slaves with, then there is no point in hiring slaves over free workers.