6.2.6

Wage Determination

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Market Equilibrium Wage

Firms will employ workers as long as the extra revenue the workers generate from producing goods and services is greater than the cost of employing them. The market equilibrium wage is where MRP=MC.

Illustrative background for MRP curveIllustrative background for MRP curve ?? "content

MRP curve

  • The MRP (marginal revenue product of labour) curve shows the extra revenue that each worker generates.
Illustrative background for MC curveIllustrative background for MC curve ?? "content

MC curve

  • The MC (marginal cost) curve shows the additional cost of employing each extra worker.
Illustrative background for Market equilibrium wage: MRP=MCIllustrative background for Market equilibrium wage: MRP=MC ?? "content

Market equilibrium wage: MRP=MC

  • The firm will hire the number of workers where the two lines meet. Hiring any more than that means the firm loses money employing the extra worker.
  • Hiring any less means the firm is missing out on potential profit.

The Model of Wage Determination

In a perfectly competitive labour market, wages are determined by the forces of demand and supply.

Illustrative background for Model of wage determinationIllustrative background for Model of wage determination ?? "content

Model of wage determination

  • In a perfectly competitive labour market, firms become price-takers, and so do not have control over the wage they pay.
  • It is determined by the interaction of market labour demand and supply.
  • This wage is equal to the marginal cost and average cost for the firm because the supply is perfectly elastic for an individuals firm's labour.
Illustrative background for WageIllustrative background for Wage ?? "content

Wage

  • The wage is the sum of economic rent (Triangle ATV) and transfer earnings (TVOQ).
  • The economic rent is what is in addition to the minimum wage required to keep labour employed.
  • As supply gets more elastic, economic rent reduces to zero (as the labour market for this particular job becomes more competitive).

The Role of Market Forces

The interaction in the market between demand and supply will determine the relative wage.

Illustrative background for Marginal revenue product (MRP)Illustrative background for Marginal revenue product (MRP) ?? "content

Marginal revenue product (MRP)

  • The higher the MRP, the more valuable the worker is, because the worker generates more revenue for the firm.
  • This should make the demand for more productive workers higher which should lead to a higher relative wage.
  • E.g Investment bankers are paid more than gardeners in an office building because they generate more revenue for the firm.
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Role of skills

  • The more skills a worker has, the more valuable they are. Skills are usually correlated with the MRP of a worker.
  • Fewer workers will have these skills, so their supply is more inelastic.
  • Workers with more inelastic supply will tend to get a higher relative wage.
    • E.g Investment bankers are more inelastic in supply than gardeners.
Illustrative background for Reasons for wage differentialsIllustrative background for Reasons for wage differentials ?? "content

Reasons for wage differentials

  • Workers are paid differently within the same occupation and in different occupations. We call the wage differences wage differentials.
  • Apart from skills differences, workers can receive different wages because of:
    • Location - wages differ by region.
    • Industry - some industries pay better than others.
    • Trade unions - these can have an impact on wage rates.

Jump to other topics

1Introduction to Markets

2Market Failure

3The UK Macroeconomy

4The UK Economy - Policies

5Business Behaviour

6Market Structures

7A Global Perspective

8Finance & Inequality

9Examples of Global Policy

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