Question

Describe how the firm sets an efficiency wage above the competitive level. Why are there no market forces forcing the profit-maximizing firm to reduce the wage to the competitive level?

Answer 1

Answer::-
In a perfectly competitive market, all firms are assumed to be very small compared to the market.
Now the price is set at the market level, and as a small firm you take it as given; you couldn't sell at a higher price since nobody would buy from you. Now in the long run, you should be at the minimum point of your cost curve, ensuring you make just normal profits. The price is your MR and at the minimum point of your AC curve your MC cuts it: MC=MR and AC=AR.
If the market price is higher than this, new entrants will sniff the opportunity created by super normal profits and the market supply curve shifts right/up, reducing price until there are no more super ormal profits to be earned.
If market price is lower, then firms are making losses, some exit and supply curve shifts left driving price up.
In equilibrium, each firm is producing at the minmum point of the AC, where MC=MR=P.
Hence the firm temporarily raises production when P>min AC and makes supernormal profits.

He will maximize profit by employing labor upto the point where revenue earned by the last unit of labor (the last worker) will equal to marginal cost paid to that last unit of labor (wage rate paid to last worker), that is,

Output price x Marginal product of labor = Wage rate