Chapter Review: Key Points

1 The demand for any resource is related to the: (a) amounts of other factors employed, (b) production technology used, and (c) demand for the product. Because the demand for labor (or any factor) hinges on the demand for final products, it is a derived demand.

2 Marginal revenue product (MRP) is the firm's revenues generated by hiring the marginal unit of some input which is equal to MP x MPP_L. In perfect competition, this is the same as the value of the marginal product (VMP) which is equal to P x MPP_L.

3 Increases (decreases) in the demand for the product, in labor productivity, or in the amounts of other resources used will normally increase (decrease) the VMP and demand for labor. Technological changes may either increase or decrease labor demands. Automation is the replacement of workers by new technologies.

4 The elasticity of demand for labor Ls directly related to the: (a) elasticity of demand for the final product, (b) labor's share of total costs represented by the wage bill, (c) ease of factor substitution, and (d) time for adjustment.

5 The supply of labor depends on: (a) wage rates and structures, (b) labor force participation, (c) the number of hours people are willing to work, and (d) the education, training, and skills of workers.

6 Labor quality improves through investments in human capital that include formal education and on-the-job training. Education benefits both the individual and society at large. Training is classified as either general or specific: General training enhances a worker's productivity equally for many firms, while specific training only increases the worker's productivity for the current employer.

7 Workers experience both income and substitution effects when wage rates change. Increased wages cause labor to substitute work for leisure because work expands consumption opportunities and leisure is more costly. However, higher wages mean that for a given amount of labor effort, workers will earn more income, and, if leisure is a normal good, they will want to consume more leisure and work less. If the substitution effect is larger than the income effect, supplies are positively sloped. Backward-bending labor supplies result when income effects dominate substitution effects.

8 While the individual's labor supply curve may be backward-bending, the supply of labor to any industry will always be positively sloped. Industry supplies and demands for labor establish the equilibrium wage as each firm hires additional units of labor until the value of the marginal product equals the market wage rate.

9 Any resource will be employed up to the point where the additional revenue competitive firms receive (value of the marginal product, or VMP) just equals the cost of an additional unit of the resource (marginal factor cost, or MFC). In competitive labor markets, the marginal factor cost (MFC) equals the wage rate (w), so pure competition in all markets means that VMP = MRP = MFC = w.

10 Competitive demand curves for labor represent the marginal benefits to society from additional employment, and supply curves reflect the marginal cost to society of using those resources. Employing labor to the point where D_L = S_L is efficient because society's benefits from additional employment equals its costs. More or less employment than where D_L = S_L yields inefficient resource allocations since society gets more (or less) than it desires in an opportunity cost sense.

11 Turnover and quit rates are negatively related to the levels of specific training workers have received and to the wage premiums paid them. Firms that invest heavily in their employees have strong incentives to retain them and do so: (a) by paying higher wages than other firms will offer, and (b) through special rules based on seniority or pension provisions that reward longevity with the firm.

12 Wages paid to workers that exceed market clearing wages are called efficiency wages. Efficiency wages increase the costs of dismissal and are designed to reduce shirking (the moral hazard problem) by employees. Efficiency wages provide an explanation for involuntary unemployment in labor markets.

13 Signaling involves attempts by agents to communicate certain images to potential principals. Screening occurs when a principal sets minimum standards before employing an agent.

14 The most important determinants of wage differentials are (a) human capital, and (b) working conditions. All else equal, premium wages are paid to compensate workers who endure less pleasant jobs. (4233 digits)

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