The Marginal Product of Labor

In this video on the marginal product of labor, we discuss some commons questions such as: How are wages determined? Why do most Americans earn so much by global standards? What exactly is meant by ‘human capital’? Do labor unions help workers, and if so, by how much? How does discrimination affect labor markets? How is the demand for labor different than the demand for a good? We’ll discuss how to derive the demand for labor based on the marginal product of labor, and use real-world examples — such as the demand for janitors in a fast food restaurant — to illustrate this calculation. We’ll also cover an individual’s labor supply curve vs. market supply of labor.

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- In this set of lectures on labor
markets, we'll be looking at questions,

such as, "How are wages determined? Why
do Americans earn so much by global

standards? What's human capital and how
does it help us to increase wages? Do

labor unions help workers? And if so by
how much? And how does discrimination

affect labor markets?" We're going to
begin in this part of the lecture with the

determination of wages.

- In this set of lectures on labor
markets, we'll be looking at questions

such as, "How are wages determined? Why do
most Americans earn so much by global

standards? What's human capital? How does
it help us in increase wages? Do labor

unions help workers, and if so by how
much? And how does discrimination affect

labor markets?" We're going to begin in
this part of the lecture with the

determination of wages. What makes the
demand for labor different than the

demand for apples is that the demand for
labor is a derived demand. Firms hire

workers because the workers increase
their revenues. The key idea behind the

demand for labor
is the marginal

product of labor. The increase
in a firm's revenues created by hiring an

additional laborer and we're going to see
several important things about this

marginal product of labor. First, it
declines as more labor is added and this

is because the first laborer goes to the
most important task, the second labor goes

to the second most important task and so
forth. Moreover, firms will hire workers,

laborers as long as the wage is less than
the marginal product of labor. Let's take

a look at this in a table. This table
shows how a restaurant like McDonalds

might think about hiring janitors. The
first janitor is assigned to the most

important task cleaning the
restrooms once a day. That

task adds $35 an hour to the firms
revenues. Customers like restaurants with

clean restrooms. The second janitor
empties the trash, the third janitor hired

will also be assigned to cleaning
restrooms now done twice a day and that

use increases revenues by less by $24 an
hour. The demand curve for labor is

derived from the marginal product of
labor. Notice that as the wage goes down

the firm will want to hire more and more
janitors and as the firm hires more and

more janitors the marginal product of
labor falls. So let's take a closer look

at this derivation. Here's the marginal
product of labor schedule and here is the

demand for labor derived from that
schedule. Notice that if the wage were

greater than $35 an hour the firm would
demand no janitors. That's because the

very first janitor adds $35 an hour to the
firm's revenues. If the the wage is higher

than that, that janitor is not worth
hiring. As the wage falls however, more

and more janitors become worthwhile to
hire. If the market wage were $10, 7

janitors would be hired. If the market
wage were $30, only 1 janitor would be

hired. Now this is the demand for janitors
from a single firm. Now consider summing

up the quantity of janitors demanded at
each wage for all the firms in the market.

That's how we get to the market demand for
janitors. So let's go to the market

demand. So here's the market for janitors
in the United States. We have a demand

curve derived from the marginal product of
labor and a supply curve. Supply curve

says that as the wage increases the
quantity of janitor supplied will also

increase. That's intuitive but I want to
say a little bit more about the supply

curve in a moment because there's one
possible complication, which we should

discuss. For now however let's focus on
the main point which is that the wage is

determined as usual by the point where the
quantity demanded is equal to the quantity

supplied the intersection of the demand
and the supply curve. In the United

States, the wage for janitors is about $10
an hour and the quantity supplied is about

168 million hours per week. Overall, there
are about 4.2 million janitors in the

United States. So the key here is really
that we can use our tools of demand and

supply to understand the market for labor
so we can predict what will happen with an

increased demand for labor or a reduced
supply. Other factors which might

influence the demand
and supply of labor

we now know how to analyze
this market. Let's add one

qualification to the supply of labor. We
need to make a distinction between an

individual supply curve for labor and the
market supply curve for labor. So let's

suppose we have a janitor. Let's call him
Joe and let's imagine that his wage is

currently $16 an hour and he's working 40
hours a week. If the wage were to increase

to $20 an hour, Joe decide he may work
more, 50 hours per week in order to take

advantage of that higher wage but now
suppose that the wage increases even more

to $28 an hour. Well, will Joe choose to
work more at $28 an hour than he did at

20? Not necessarily. After all, there's
only so many hours in the week. Anyway,

Joe has other things to do with his time.
Now that his wage is higher Joe might want

to take his family on a vacation. His
income is pretty high as well now.

Twenty-eight dollars an hour 40 hours
a week Joe may decide he in fact would

like to work a little bit less. He in fact
would like to buy more leisure with the

income, which he is earning from his job.
So an individual’s labor supply curve could

possibly have a backward bending
component. There's nothing irrational or

peculiar about that.
Although it's possible for an individual

to have a backward bending labor supply
component it's less likely for the market

as a whole because even as the wage for
janitors increases and Joe works a little

bit less, there are lots of other people.
Mary, and Jose and Rita who are currently

employed, say waiting tables or as sales
staff who would be willing to work in

janitorial services if the wage were
higher. So consider a wage of $20 an hour -

the market supply has 320 million hours of
janitorial services. As the wage goes up

to $28, well Joe works a little bit less,
and maybe some of the other people in the

industry work a little bit less - people
who are already in the industry, but more

people enter the market for janitorial
services when the wage is $28 than when it

was $20. So as the wage increases the
quantity supplied of janitorial services

increases for two reasons. The people who
are already janitors may work more but

even more importantly as the wage for
janitors increases more people enter the

janitorial industry. So what this means is
that our labor supply curve will

typically have our usual shape, an upward
sloped labor supply curve even when some

individuals might have a backward slope
over some portion of the curve. The market

slope is going to have our typical shape.
So why do janitors in the United States

earn more than janitors in India? After
all they're doing pretty much the same

thing sweeping floors and so forth. It's
certainly isn't the case that janitors in

the United States are sweeping more floors
per hour or working so many more hours. If

you answered demand and supply give
yourselves half points. Let's go a little

bit deeper. The demand for janitors is
higher in the United States because the

United States is a more productive
economy than the Indian economy.

There's more and better capital to work
with, the office workers are more

productive and the American office
produces a more valuable product. The

result is that it's more valuable to keep
a US office building clean. That's one of

the reasons why American janitors earn
more. The demand for their services is

higher. This is a useful reminder you may
have a number of valuable skills perhaps

you're able to program a computer, or
write a report, or motivate sales staff

and so forth but your skills only have
value within a given context. If you were

transplanted to a different economy
your skills might be worth less.

Maybe because your skills would be less
useful but also because other people might

not have the money to pay for your skills.
It's better to be a barber in a rich

country than in a poor country even when
the same number of people need a haircut.

Okay so that's one reason why janitors in
the United States earn more. The demand

for their services is higher because the
United States is a more productive

economy. Wages of course are about demand
and about supply. So here's the other

half India has more workers than in the
United States and in particular India has

more low-skilled workers who eagerly
compete for the job of janitor. A janitor

could be a quite high paying job in India.
A well respected job in India. So Indian

janitors earn less because US firms are
more productive, the demand for labor is

higher and also because the supply of
low-skilled workers is greater in India.

Here's a graph summarizing what we just
said. Here's the demand and supply of

janitors in the Unites States with the
wage of $10 an hour and here's the demand

and supply in India. The demand is lower,
the supply is higher so the wage is lower.

Okay next time we'll be looking at some
of the factors, which can increase wages,

particularly human
capital and then we'll turn

to discrimination
and other topics.

- If you want to test yourself,
click "Practice questions," or if

you're ready to move on,
just click, "Next video."

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