Labor Markets, Wages, and Income Distribution
Core concepts
Labor demand is derived from the demand for output and depends on marginal revenue product (MRP = marginal product × output price). Firms hire until MRP equals the wage. Labor supply reflects workers' choices between work and leisure; the supply curve can bend backward at high wages (income effect dominating substitution effect).
Equilibrium wage occurs where labor demand equals labor supply. Differences in wages arise from human capital, compensating differentials (risk, unpleasantness), unions, discrimination, and market power (monopsony).
Income distribution measures how total income is spread; tools include the Lorenz curve and Gini coefficient (0 = perfect equality, 1 = perfect inequality). Poverty measures include absolute and relative thresholds. Government affects distribution through progressive taxation, transfers, minimum wages, and education.
Common traps
- Treating a minimum wage as always creating unemployment; it does only if set above equilibrium (binding).
- Assuming higher wages always increase labor supply; the backward-bending curve shows otherwise.
- Confusing the Gini coefficient with GDP per capita.
- Forgetting that labor demand is derived, not direct.
Worked example
A worker's marginal product is 10 units per hour, and the output sells for $6. MRP = $60 per hour, so the firm will hire up to a wage of $60. If the market wage is $45, hiring is profitable; if it rises to $70, the firm reduces hiring.
Rule of thumb
Hire until MRP = wage. A minimum wage bites only above equilibrium. Gini near 0 means equality; near 1 means concentration.