- Explain and illustrate how wage and employment levels are determined in a perfectly competitive market and for an individual firm within that market.
- Describe the forces that can raise or lower the equilibrium wage in a competitive market and illustrate these processes.
- Describe the ways that government can increase wages and incomes.
We have seen that a firm’s demand for labor depends on the marginal product of labor and the price of the good the firm produces. We add the demand curves of individual firms to obtain the market demand curve for labor. The supply curve for labor depends on variables such as population and worker preferences. Supply in a particular market depends on variables such as worker preferences, the skills and training a job requires, and wages available in alternative occupations. Wages are determined by the intersection of demand and supply.
Once the wage in a particular market has been established, individual firms in perfect competition take it as given. Because each firm is a price taker, it faces a horizontal supply curve for labor at the market wage. For one firm, changing the quantity of labor it hires does not change the wage. In the context of the model of perfect competition, buyers and sellers are price takers. That means that a firm’s choices in hiring labor do not affect the wage.
The operation of labor markets in perfect competition is illustrated in Figure 12.10 “Wage Determination and Employment in Perfect Competition”. The wage W1 is determined by the intersection of demand and supply in Panel (a). Employment equals L1 units of labor per period. An individual firm takes that wage as given; it is the supply curve s1 facing the firm. This wage also equals the firm’s marginal factor cost. The firm hires l1 units of labor, a quantity determined by the intersection of its marginal revenue product curve for labor MRP1 and the supply curve s1. We use lowercase letters to show quantity for a single firm and uppercase letters to show quantity in the market.