As you can see, I'm back at my chalkboard. It's fake of course, but that's a good thing, because if I was writing on a real chalkboard, you wouldn't be able to read my atrocious handwriting. In the previous video, I introduced the idea of labor or work being a commodity. And as a commodity, it's traded in economic markets. And so, like other commodities, we need to look at both the supply side and the demand side. So let's start with some definitions. First, labor supply. Labor supply is the amount of labor that an individual wants to sell into the labor market. So you can think of this as hours if you want. How many hours do you want to work per week. Now this is gonna be dependent on some other variables. We'll just call that stuff for the time being. How about the demand side? On the employer's side, labor demand captures how much labor an employer wants to hire. So again, if you want to think about how many hours an employer wants to hire for a week, that's fine. And this is also gonna depend on a variety of influences. So for the time being, we'll call that stuff as well. Okay, so let's continue with labor demand. To think about labor demand in a simple economic framework is to set up a problem where employers are optimizing a simple production function that's captured here with f as a function of L and K. Output as a function of two inputs, labor and capital. And the objective here is to maximize profits. So what's going to determine how much labor is utilized to optimize this production function of maximized profits. Well that's where the stuff comes in. So at a simple level, this is gonna depend on how expensive labor is, how productive labor is, how expensive other inputs are, and how strong the demand for whatever product or service this organization is trying to produce. Now on the supply side, it's a simple similar framework. Once again, economics treats this as an optimization problem for a rational, self interested agent to pursue. On the individual side, economic analysis proceeds by assuming that individuals are gonna maximize their household or their individual utility. So that's what this a U function is here, captures utility. And utility in its simplest form is usually set up as a function of consumption, or income and leisure. So individuals are going to maximize their utility based on the environmental constraints that they face. So, for example, wages, trade off between leisure and consumption and other income. So when wages are higher, for example, or when you have a strong preference for consumption, individuals are gonna be predicted to have higher labor supply if they're gonna sell more labor. When individuals have a stronger preference for leisure, or have higher levels of non-work income, then we predicted all else equal to supply less labor to the market. So for reinforcement, note again that economics assumes that agents do the very best they can for themselves. They're maximizing some objective function. Employers are maximizing profits, individuals are maximizing utility. This is to, again reinforce that agents are modeled as rational and self-interested in economic theory. Okay, so let's erase part of this board, and leave some of this for referring back to in a few seconds. Let's think about pulling the supply side and the demand side together to have a graphical representation of a basic labor market. So we setup a quick graph where we have the price of this commodity, the wage on the vertical axis and we'll have the amount, supply or demand to this commodity, labor on the horizontal axis. Start with labor supplied. We typically assume, at least in the aggregate, that the higher the wage, the more labor that's going to supplied. And for labor demand, for employers it's the opposite. The higher the price of this commodity, the less that they will demand. And what does this graph teach us? Well it can teach us a few things. First thing for starters is that it predicts that the wage rate for this labor market, the equilibrium will be where supply equals demand. Okay, now what about changes in supply, or changes in demand? Things that employers should try to keep their eye on. Well that's why I left these pieces of information on the right side. And so the factors up here that affected labor supply, decisions for individuals, are also factors that we can think of as shifting labor supply. So for example, if people's preference for leisure shifts, for whatever reason, then we'd expect their supply curve to shift, as well. And then these factors down here which determine labor demand on the employer side, those are factors that we would expect to shift the demand curve. And so if the price of capital changes, we would expect that to shift the demand curve for labor. Now you might notice that I've erased wages out of both of these categories. That's because changes in the price of labor will just cause employers and employees to move along these existing curve, not shift to a whole new curve. Okay, a second thing that we can use this simple graph as a reminder of, is marginal analysis, which we talked about in an earlier video. Now remember that the margin is the border or the edge between two actions or outcomes. So for example, it's the last hour that you want somebody to work, or in the example that I'm gonna use this graph to illustrate. Suppose that you want to hire or retain ten people for a work unit. The marginal worker is the one on the margin, the tenth worker, the last worker you have to retain or recruit. So this labor supply curve suggests that maybe the first nine will be easy to hire or easy to retain. They're willing to work for a wage less than the competitive wage rate. But it's the tenth worker that you need to be concerned with, in terms of recruitment or retention. And it's going to be that tenth worker, that worker on the margin, that's going to then determine wages and other terms and conditions of employment for the entire work group. So thinking about the margin, again, is very important in an economic analysis. It's something that a manager should keep in mind. The third thing that we can look at from this graph is the importance of perfect competition. Now all markets are competitive to one degree or another, but perfect competition, ideally competitive markets, have a special place in mainstream economic thought. And so markets are perfectly competitive when all agents, in this case employers as well as employees, have complete information, when transactions are costless, when property rights are legally protected and other requirements are met ,such that all agents are equal. When this is true, basic economic theory can show that there is no better way to allocate scarce resources. There's no better way to maximize overall welfare than relying on the invisible hand of competition in perfectly competitive markets. So, in mainstream economic thought, in the neo-market liberal ideology, markets are king and things that are seen as interfering with markets, things that are seen as distorting markets, like labor unions or government regulations. Those are seen as bad. Now whether agents actually are equal is a question we'll come back to in the next video. So, what should be take away from this video? One, all managers should pay attention to supply and demand. What is the strength of demand for labor in your workgroup? And what types of decisions are driving how much labor. How many hours of work or other types of labors supplied measures that individuals are willing to give to the organization and to your work group? Second, you need to pay attention to labor markets because you can't get too far off line with what the market will bear. So in practice labor markets typically aren't perfectly competitive, so you have some choice. Some employers choose to pay at market wages. Some choose to pay above market wages, below market wages, which suggests that markets aren't perfectly competitive. However, you can't get too far out of line from what the market will bear. Lastly, economic theory treats labor as a commodity, sees it as a factor of production. Very little that we've talked about in this video has been different for labor than it is for any other element, different from apples or anything else. But remember, when managing people don't rely solely on economic analysis. Yes labor has elements of being a commodity, but it involves people, so it's a very special commodity. Okay, class dismissed. Hopefully it's not too cliche for the teacher to eat his apple. [SOUND]
