Review Questions

1. What two terms are equal when a firm in a perfectly competitive market is employing the optimal amount of labor? How can this condition be rearranged so that the marginal cost of labor to the firm is on the right side of the equation?

   When the firm is hiring optimally, the marginal benefit of producing an additional unit of output (its marginal revenue) is equal to its marginal cost. To produce more units of output, the firm must use more labor; the marginal cost of one additional unit is the wage the firm pays the extra labor, divided by the number of additional units of output that labor generates. So, when the firm hires optimally, MR = W/MP_L. Multiply both sides of the equation by the marginal product of labor to get MR × MP_L = W. This states that the firm, when hiring optimally, hires until the marginal revenue product of labor (MR × MP_L) equals the wage (W)—the marginal cost of labor to the firm.

2. What happens to the optimal amount of labor hired when the wage increases in a perfectly competitive market? When the wage decreases?

   In a perfectly competitive market, as the wage increases, the quantity of labor demanded by firms decreases, and less labor is hired. As the wage decreases, the quantity of labor demanded by firms increases, and more labor is hired.

3. Name two components of the labor demand curve that can change, thus shifting the curve.

   The labor demand curve is the firm’s marginal revenue product of labor curve. So, anything that changes either the marginal product of labor or the marginal revenue of the firm’s output will change the demand for labor. The demand for labor will increase if the marginal product of labor increases due to a technological improvement or an increase in the firm’s physical capital. The demand for labor will also increase if the marginal revenue associated with various output levels increases due to an increase in the demand for the firm’s output.

4. How is the market demand for labor computed?

   To compute the market demand for labor, add up the quantity of labor all firms demand at each possible wage. In other words, the market demand for labor is the horizontal sum of all firms’ labor demand curves.

5. What is the relative price of leisure and consumption?

   When a worker chooses to spend an hour at leisure, he gives up the opportunity to consume the goods and services he could have purchased with an hour’s worth of earnings. So, the relative price of leisure and consumption is the worker’s wage.

6. Are firms’ decisions about hiring labor more responsive to wage changes in the short or the long run?

   A decrease in the wage makes less-productive workers more affordable and leads to an increase in hiring. Those additional workers make capital more productive. In the short run, capital is fixed; but in the long run, the firm will hire more capital. The additional capital raises the marginal product of labor and leads the firm to hire even more workers. So, the firm’s decision about how much labor to hire is more responsive in the long run than in the short run.

7. What is the marginal expenditure for a monopsonist?

   The marginal expenditure for a monopsonist is the additional expenditure that is incurred when the monopsonist purchases one more unit (in this chapter, one more unit of labor). Because the buyer is a monopsonist—a large buyer—each extra unit purchased drives up the price that must be paid for all units. So, the additional expenditure incurred by the firm includes the price of the last unit, P, plus the increase in the price that must be paid (ΔP/ΔQ) on all the other units purchased, Q. In equation form, ME = P + (ΔP/ΔQ) × Q.

8. Does a monopsonist buy fewer or more inputs than a price-taking firm when the two have the same MRP and input supply curves?

   A monopsonist buys fewer inputs than a price-taking firm when the two have the same MRP and input supply curves. A price-taking firm is so small it can buy all the inputs it wants without driving up the price of those inputs. But a monopsonist has such a large share of the market for inputs that, as it hires more, it drives up their price, making hiring less desirable.

9. How do unions maximize total earnings?

   Unions are a monopoly seller of labor. Like any monopoly seller, a union can maximize its total revenue (the total earnings of its members, in this case) by offering for sale the quantity of labor where its marginal revenue equals zero.

10. What do we call a market structure that exists when there is a major concentration of market power on both sides of the market?

    A market structure that exists when there is a major concentration of market power on both sides of the market is called a bilateral monopoly.