chapter 14 markets for factor inputs

Chapter 14 Slide 2Topics to be Discussed  Competitive Factor Markets  Equilibrium in a Competitive Factor Market  Factor Markets with Monopsony Power  Factor Markets with Monopoly P

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Chapter 14

Markets for Factor Inputs

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Chapter 14 Slide 2

Topics to be Discussed

 Competitive Factor Markets

 Equilibrium in a Competitive Factor

Market

 Factor Markets with Monopsony Power

 Factor Markets with Monopoly Power

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of production are price takers

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Chapter 14 Slide 4

Competitive Factor Markets

 Demand for a Factor Input When Only One Input Is Variable

 Demand for factor inputs is a derived demand…

derived from factor cost and output demand

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Chapter 14 Slide 5

Assume

Two inputs: Capital (K) and Labor (L)

Cost of K is r and the cost of labor is w

K is fixed and L is variable

Demand for a Factor Input When

Only One Input Is Variable

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Chapter 14 Slide 6

 Problem

How much labor to hire

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Chapter 14 Slide 7

 Measuring the Value of a Worker’s

Output

 Marginal Revenue Product of Labor (MRPL)

 MRP L = (MP L )(MR)

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Chapter 14 Slide 8

 Assume perfect competition in the

product market

 Then MR = P

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(P < MR)

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Chapter 14 Slide

11

 Choosing the profit-maximizing amount of labor

 If MRPL > w (the marginal cost of hiring a

worker): hire the worker

 If MRPL < w: hire less labor

 If MRPL = w: profit maximizing amount of labor

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and can hire as many workers as it wants at w*.

Hiring by a Firm in the

Labor Market (with Capital Fixed)

Quantity of Labor

Price of

Labor

Why not hire fewer

or more workers than L*.

MRP L = D L

L*

The profit maximizing firm will

hire L* units of labor at the point

where the marginal revenue product

of labor is equal to the wage rate.

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Chapter 14 Slide

13

relative to demand (baby boomers or female entry), a surplus of labor would exist and the wage rate would fall.

 Question

 How would this impact the quantity demanded for labor?

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Chapter 14 Slide

15

 Comparing Input and Output Markets

production of

MC MP

MP MR

MR) )(

(MP

MRP workers

of number

maximizing profit

at and

MR) )(

MP (

MRP

L

L L

L

L L

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Chapter 14 Slide

16

 Comparing Input and Output Markets

 In both markets, input and output choices occur where MR = MC

MR from the sale of the output

MC from the purchase of the input

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 Assume the wage rate falls

Several Inputs Are Variable

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product of both inputs.

Firm’s Demand Curve for Labor

(with Variable Capital)

When the wage rate is $20, A represents one point on the firm’s demand for labor curve When the wage rate falls to $15, the MRP curve shifts, generating a new point C on the firm’s demand for labor curve Thus A and C are

on the demand for labor curve, but

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Chapter 14 Slide

20

 Assume that all firms respond to a lower wage

 All firms would hire more workers

 Market supply would increase

 The market price will fall

 The quantity demanded for labor by the firm will be smaller

Industry Demand for Labor

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MRP L1

The Industry Demand for Labor

Labor (worker-hours)

Wage

($ per

hour)

Wage ($ per hour)

D L1

Horizontal sum if product price unchanged

120

MRP L2

L 1

Industry Demand Curve D L2

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Chapter 14 Slide

23

The Demand for Jet Fuel

 Observations

 Jet fuel is a factor (input) cost

 Cost of jet fuel

 1971 Jet fuel cost equaled 12.4% of total operating cost

 1980 Jet fuel cost equaled 30.0% of total operating cost

 1990’s Jet fuel cost equaled 15.0% of total operating cost

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 Ton-miles increased by 29.6% & jet fuel consumed rose by 8.8%

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Chapter 14 Slide

26

Short-run Price Elasticity

of Demand for Jet Fuel

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Chapter 14 Slide

28

The Short- and Long-Run

Demand for Jet Fuel

Quantity of Jet Fuel

Price

MRP LR MRP SR

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Chapter 14 Slide

29

 The Supply of Inputs to a Firm

 Determining how much of an input to purchase

Assume a perfectly competitive factor market

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Market Supply

of fabric

A Firm’s Input Supply in a

Competitive Factor Market

Yards of Fabric (thousands)

Price

($ per

yard)

Price ($ per yard)

D

Market Demand for fabric

100

ME = AE

Supply of Fabric Facing Firm

50

Demand for Fabric

MRP

Observations 1) The firm is a price taker at $10.

2) S = AE = ME = $10 3) ME = MRP @ 50 units

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Chapter 14 Slide

31

 The Market Supply of Inputs

 The market supply for physical inputs is upward sloping

Examples: jet fuel, fabric, steel

 The market supply for labor may be upward sloping and backward bending

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Chapter 14 Slide

32

 The Supply of Labor

 The choice to supply labor is based on utility maximization

 Leisure competes with labor for utility

 Wage rate measures the price of leisure

 Higher wage rate causes the price of leisure to increase

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Chapter 14 Slide

33

 Higher wages encourage workers to substitute work for leisure (i.e the substitution effect)

 Higher wages allow the worker to purchase more goods, including leisure which

reduces work hours (i.e the income effect)

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Chapter 14 Slide

34

 If the income effect exceeds the substitution effect the supply curve is backward bending

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Backward-Bending Supply of Labor

Hours of Work per Day

Wage ($ per

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C

Worker chooses point A:

•16 hours leisure, 8 hour work

Substitution and Income

Effects of a Wage Increase

Increase wage to $20 worker chooses:

20 hour leisure, 4 hours work income = $80

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Elasticities of Labor Supply (Hours Worked)

Head’s Hours Spouse’s Hours Head’s Hours with Respect to with Respect to with Respect to Group Head’s Wage Spouse’s Wage Spouse’s Wage

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Chapter 14 Slide

39

Equilibrium in a

 A competitive factor market is in

equilibrium when the price of the input equates the quantity demanded to the quantity supplied.

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S L = AE

P * MPL

Labor Market Equilibrium

Number of Workers Number of Workers

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 Profits maximized

 Using less than the efficient level of input

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Chapter 14 Slide

43

 Economic Rent

 For a factor market, economic rent is the

difference between the payments made to

a factor of production and the minimum amount that must be spent to obtain the use of that factor.

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to hire workers.

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Chapter 14 Slide

45

Economic Rent

 Question

 What would be the economic rent if S L is

perfectly elastic or perfectly inelastic?

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Chapter 14 Slide

46

 Land: A Perfectly Inelastic Supply

 With land inelastically supplied, its price is determined entirely by demand, at least in the short run

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Chapter 14 Slide

47

Economic Rent

s 1

Economic Rent

s 2

Land Rent

Number of Acres

Price ($ per acre)

Supply of Land

D 2

D 1

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Chapter 14 Slide

48

Pay in the Military

 During the Civil War 90% of the armed forces were unskilled workers involved

in ground combat.

 Today, only 16% are unskilled workers involved in ground combat.

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Chapter 14 Slide

49

 Shortages of skilled personnel has

occurred? Why?

 Hint: If there is a shortage, the wage must

be below the…?

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Chapter 14 Slide

50

The Shortage of

Skilled Military Personnel

Number of Skilled Workers

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Chapter 14 Slide

51

 Military pay is based on years of service

not MRP.

 MRP increases and the private sector

pay is greater than military pay.

 Many leave the military.

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Chapter 14 Slide

53

Factor Markets with Monopsony Power

 Assume

 The output market is perfectly competitive

 Input market is pure monopsony

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Why is marginal expenditure

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Chapter 14 Slide

55

Factor Markets with Monopsony Power

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Chapter 14 Slide

56

Monopsony Power in

the Market for Baseball Players

 Baseball owners created a

monopsonistic cartel

 Reserve clause prevented competition for players

 1975 Free agency after six years

 1969 Average salary was $42,000 ($200,000 in 1999 dollars)

 1997 Average salary was $1,383,578

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Chapter 14 Slide

58

Teenage Labor Markets

and the Minimum Wage

 When the minimum wage rose in New Jersey in 1992 from $4.25 to $5.05, a survey conducted found a 13%

increase in employment.

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Chapter 14 Slide

59

 Explanations

 Reduction in fringe benefits

 Lower pay for more productive workers

 Monopsony market

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 Indicates of the need for further study

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Chapter 14 Slide

61

Factor Markets with Monopoly Power

 Just as buyers of inputs can have

monopsony power, sellers of inputs can have monopoly power.

 The most important example of

monopoly power in factor markets involves labor unions.

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demand for labor curve.

Monopoly Power of Sellers of Labor

Number of Workers

Wage per worker

A

L *

w *

The seller can maximize the number of workers

hired, at L*, by agreeing that workers will

work at wage w*.

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Chapter 14 Slide

63

Economic Rent

A

L 2

w 2

Finally, if the union wishes to maximize total

wages paid to workers, it should allow L 2

union members to be employed at a wage

rate of w 2 because the marginal revenue

to the union will then be zero.

L *

w *

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Chapter 14 Slide

64

 The primary determinant of controlling wage and economic rent is controlling the supply of labor

Factor Markets with Monopoly Power

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economy from w* to wU , employment in that sector falls.

For the total supply of labor to remain unchanged, the wage in the nonunionized sector

must fall from w* to wNU. .

MU

L

∆

w NU

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DL = MRP L

MR

5 10 15 20 25

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DL = MRP L MR

5 10 15 20 25

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Chapter 14 Slide

70

Bilateral Monopoly

 Who Will Win?

 The union will if its threat to strike is credible

 The firm will if its threat to hire non-union workers is credible

 If both make credible threats the wage will

be at w c

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of total wages paid.

 The demand for unionized employees has probably become increasingly elastic as firms find it easier to substitute capital for skilled labor

The Decline of Private Sector Unionism

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Chapter 14 Slide

75

Wage Inequality Have

Computers Changed the Labor Market?

 In 1984, 25.1% of all workers used computers

 1993 46.6%

 1999 nearly 60%

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Chapter 14 Slide

76

Wage Inequality Have

Computers Changed the Labor Market?

 Percent change in use of computers

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 College graduates using computers - 11%

 Non-computer users less than 4%

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 1963 The differential was only 19%

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 College graduation premium has more than doubled.

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Chapter 14 Slide

80

Summary

 In a competitive input market, the

demand for an input is given by the MRP, the product of the firm’s marginal

revenue, and the marginal product of the input.

 A firm in a competitive labor market will hire workers to the point at which the marginal revenue product of labor is equal to the wage rate.

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 When factor markets are competitive, the buyer of an input assumes that its purchase will have no effect on the

price of the input.

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Chapter 14 Slide

82

Summary

 The market supply of a factor such as

labor need not be upward sloping.

 Economic rent is the difference between the payments to factors of production

and the minimum payment that would

be needed to employ those factors.

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 When the input seller is a monopolist such as

a labor union, the seller chooses the point on the marginal revenue product curve that best suits its objective

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Chapter 14 Slide

84

Summary

 When a monopolistic union bargains

with a monopsonistic employer, the wage rate depends on the nature of the bargaining process.

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End of Chapter 14

Markets for Factor Inputs

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