Chapter 23: Problem 839

Why is it that in a perfectly competitive market, firms hiring labor, as a group will be forced to pay higher wage rates to obtain more workers?

Short Answer

Expert verified

In a perfectly competitive labor market, firms are forced to pay higher wage rates to obtain more workers due to the law of supply in the labor market and competition among firms. The law of supply states that as the wage rate increases, more workers will be willing to provide their labor services. To attract more workers, firms must offer higher wages, leading other firms to increase their wages as well to remain competitive. This causes a ripple effect, where higher wages lead to a greater labor supply, leading to a new equilibrium at a higher wage level.

Step by step solution

Understand Perfect Competition

A perfectly competitive market is one in which there are a large number of buyers and sellers, none of whom can influence the market price. Similarly, a perfectly competitive labor market has numerous employers and employees, with both having perfect knowledge about the market. Every worker has similar abilities, and every employer is looking to hire labor on a per-unit basis. Firms are price takers; they cannot influence the wages.

The Law of Supply in Labor Market

In a perfectly competitive labor market, the law of supply states that as the wage rate increases, more workers will be willing to provide their labor services. This is because a higher wage attracts more individuals towards employment, causing an increase in labor supply.

Demand for Labor

Firms demand labor to produce their goods and services. They hire workers up to the point where the marginal cost of hiring an additional worker equals the marginal revenue product of that worker. The firms' demand for labor is determined by their marginal revenue product of labor curve.

Wage Determination

In a perfectly competitive labor market, the equilibrium wage rate is determined by the intersection of the market supply curve for labor and the market demand curve for labor. This is the point where both employers' and employees' expectations are satisfied. Workers are paid according to their marginal revenue product.

Competition for Labor

To attract more workers, firms must offer higher wages. In a perfectly competitive labor market, if one firm increases its wage rate, the other firms must also increase their wages to remain competitive and attract labor. This causes a ripple effect, where higher wages lead to greater labor supply, leading to a new equilibrium in the labor market.

Conclusion

In a perfectly competitive market, firms hiring labor as a group will be forced to pay higher wage rates to obtain more workers because of the law of supply in the labor market and competition among firms. An increase in the wage rate will increase the labor supply, and firms must adjust their wages accordingly to attract workers. This results in a new equilibrium at a higher wage level.

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