Labor Markets & Wages
Labor demand is MRPL = MPL × MR, and firms hire until MRPL = W. When the data refuse to move the wage, the answer is elastic labor demand.
Who supplies what
The labor market inverts your usual role: you are the supplier, firms demand, the price is the wage.
- Why MRPL slopes down
- MPL falls through diminishing returns — more workers without more capital or floor space — and MR is constant or falling. Not market power.
- Where supply comes from
- Utility maximization: leisure is priced at the wage, so the rational spending rule applies. A wage rise gives a substitution effect (work more) and an income effect (take more leisure). Which wins is empirical; the course assumes substitution, so supply slopes up.
The four shift stories
| Shock | Mechanism | Wage | Employment |
|---|---|---|---|
| Product demand falls 2008 housing bust, construction | Output price ▼ ⇒ MR ▼ ⇒ MRPL shifts in | ▼ | ▼ |
| More capital / better technology computers, late 1980s–90s | MPL ▲ ⇒ MRPL shifts out | ▲ | ▲ |
| Union wage above market autoworkers | Price floor on wages | ▲ for those employed | ▼ (unemployment) |
| Immigration of low-skilled workers | Labor supply shifts out | ▼ in theory | ▲ |
Complication on the technology row: productivity also shifts out product supply and pushes the output price down, so MRPL could fall. Historically it does not — capital and technology have raised wages and employment, probably because product demand is elastic enough.
The Mariel Boatlift
David Card's natural experiment: May–September 1980, roughly 125,000 Cubans left Mariel for the US, almost all to Miami. Cross-city studies fail because immigrant flows are not randomly assigned — immigrants move where labor demand is expanding, which can show zero correlation even when theory holds. The Marielitos left for political reasons.
Card found no obvious effect on average earnings, and none on wage inequality among non-Cubans in Miami. His explanations: some migration to Miami that would otherwise have happened did not, and labor demand may have been very elastic — Miami's low-skill industries could expand easily. Draw it as a nearly flat demand curve.
Rules that earn points
- Decide whether the shock hits demand or supply. Output prices and productivity hit demand; more workers hit supply.
- If demand, say which piece of MPL × MR moved.
- Draw the shift and name both the new W and L.
- If the data contradict theory, reach for elasticity.
- Drawing immigration as a labor demand shift. Workers supply labor.
- Saying MRPL slopes down because of market power. It is diminishing returns.
- Claiming Card disproves supply and demand. He shows demand was elastic and the treatment well-identified.
A large influx of low-skilled immigrants arrives in a city. In the market for low-skilled labor, this is:
- AAn outward shift of labor demand; wages rise
- BAn outward shift of labor supply; wages fall in theory and employment rises
- CAn inward shift of labor supply; wages rise
- DA movement along labor demand with no curve shifting
Answer
B — labor supply shifts out.
Workers supply labor; firms demand it. More workers at every wage means the supply curve moves right, so theory predicts a lower wage and higher employment.
A is the trap: immigrants also consume, which does raise product demand eventually — but in the market for their own labor they are on the supply side. Answer the market the question asks about.
The marginal revenue product of labor curve slopes downward primarily because:
- AFirms have market power and must cut wages to hire more
- BMPL falls through diminishing returns as workers are added to fixed capital
- CWorkers become less motivated as the firm grows
- DLabor supply slopes upward
Answer
B — diminishing returns.
More workers without more capital or floor space means each one adds less output. MR being constant or falling reinforces it.
A is the trap: the downward slope is not about market power. A perfectly competitive firm facing a fixed wage and a fixed output price still has a downward-sloping MRPL.
A competitive firm sells output at $20. The next worker would add 5 units of output per hour. The market wage is $80 per hour. The firm should:
- ANot hire, since MRPL = $80 exactly
- BHire, since MRPL = $100 > $80
- CNot hire, since MRPL = $5 < $80
- DHire, since output per worker exceeds the wage in units
Answer
B — MRPL = MPL × MR = 5 × $20 = $100, which exceeds the $80 wage.
The firm keeps hiring until MRPL = W; diminishing returns will pull MPL down toward that point.
C is the trap: dividing instead of multiplying, or comparing raw physical output to a dollar wage. MPL must be converted into revenue before it can be compared with W.
A union negotiates a wage above the market-clearing level. The result is:
- AHigher wages and higher employment, since workers are better paid
- BHigher wages for those employed, lower employment, and a gap between quantity supplied and quantity demanded
- CNo change, since firms simply absorb the cost
- DLower wages, because firms substitute toward capital
Answer
B — a price floor in the labor market.
Firms move back up the labor demand curve to LD; more workers want jobs at the higher wage, so quantity supplied rises to LS. The horizontal gap LS − LD is unemployment.
A is the trap: a higher price never raises quantity demanded. Those who keep their jobs gain; those who lose them do not.
The 2008 housing bubble bursts, cutting demand for construction services. Trace the effect through to construction workers' wages and employment, using both diagrams.
Model answer
Diagram 1, market for construction services: demand shifts in. Price falls from P₁ to P₂, quantity falls.
Diagram 2, market for construction workers: since MRPL = MPL × MR and MR is that output price, the fall in P lowers MRPL at every level of employment. Labor demand shifts in.
Result: wages and employment both fall. FRED data on hourly-paid construction employment show exactly this collapse after 2008.
- Two separate diagrams, correctly labelled — output market and labor market.
- Naming the channel: output price is MR, so a lower P lowers MRPL.
- Shifting labor demand, not labor supply.
- Both outcomes stated — wage and employment fall.
- Phrasing the shift as "at every level of employment", not just at one point.
Why is the Mariel Boatlift a better research design than comparing wages and immigrant counts across cities? What did Card find, and how did he explain it?
Model answer
Immigrant flows across cities are not randomly assigned. Immigrants often move to a city precisely because its labor demand is expanding — so demand and supply shift together, and you can find no correlation between immigration and wages even when the supply effect is exactly as theory predicts.
The boatlift breaks that: 125,000 Cubans arrived in Miami between May and September 1980 for political reasons, not because Miami's labor market was booming. That makes it a clean supply shock, with good wage and employment data before and after.
Card found no obvious effect on average earnings or on wage inequality among non-Cubans. His explanations: some other migration to Miami did not occur, and labor demand was very elastic because Miami's low-skill industries could expand easily.
- Naming the identification problem — immigrants sort toward expanding labor demand.
- Explaining that this can produce a zero correlation even if theory is right.
- The concrete facts: ~125,000 Cubans, May–September 1980, almost all to Miami, political cause.
- Card's actual finding, including the inequality result among non-Cubans.
- Elastic labor demand as the explanation — drawn as a nearly flat demand curve, not as "supply and demand failed".