The basic approach we will take in studying the labor market may initially strike you as a bit heartless: We will treat labor as a commodity—something that is bought and sold in the marketplace—and regard the wage rate as the price of that commodity. The wage rate can be defined as an hourly rate (e.g., $20 per hour), a daily rate ($160 per day), or for any other time unit.
As a first approximation, we explain how a worker's wage rate is determined in the same way we'd explain the price of a bushel of wheat. That is, we look at how groups of economic decision makers come together in markets in order to trade (Key Step #1), with each decision maker trying to maximize something and each facing constraints (Key Step #2). We then look for the equilibrium price determined in those markets (Key Step #3) and—eventually—explore how various changes affect that equilibrium price (Key Step #4). We do this for one simple reason: It works.
Of course, labor is different from other things that are traded. First, sellers of wheat do not care who buys their product, as long as they get the market price. Sellers of labor, on the other hand, care about many things besides their wage rate when they look for a job: working conditions, friendly coworkers, commuting distance, possibilities for advancement, prestige, a sense of fulfillment, and more.
A second distinct feature of labor is the special meaning of the price in this market: the wage rate. Most of the income people earn over their lifetimes will come from their jobs, and their hourly, weekly, or yearly wage will determine how well they can feed, clothe, house, and otherwise provide for themselves and their families. This adds a special moral dimension to events in the labor market.
In this chapter, we apply the basic model of supply and demand to explain how wage rates and employment are determined and what causes them to change. Toward the end of the chapter, we'll also discuss some of the special features of the labor market, and continue to explore them in the next chapter.
DEFINING A LABOR MARKET Characterize the Market
If you are like most college students, you will be looking for a full-time job shortly after you graduate. From the economic point of view, you will become a seller in a labor market. But which labor market? As you've seen several times in this book, how broadly or narrowly we define a market depends on the specific questions we wish to answer.
For example, suppose we are interested in explaining why college graduates, on average, earn more than those with just high school diplomas. Then we would want to define the labor market very broadly: the market for all college-educated labor in the United States. In this market, you would be one of about 35 million sellers, and your employer would be one of hundreds of thousands of buyers.
On the other hand, we might be interested in finding out how salaries in some profession (say, medicine) are determined. For this purpose, we would use a narrower definition: the market for physicians in the United States. The sellers would be all individuals with medical degrees, and the buyers would be all the hospitals, universities, and private practices that hire them. Or, we could go even narrower, and ask why the wage rates of physicians in Boston are higher than the wage rates of physicians elsewhere. Here, the buyers and sellers would be limited to those already in the Boston area or those who could move there within the period we are considering. In this chapter, we will be asking many different questions about labor markets, and will need to look at both broadly and narrowly defined markets to answer them.
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