MicroEconomics theory and application 12th by browning an zupan chapter 16

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MICROECONOMICS: Theory & Applications

By Edgar K Browning & Mark A Zupan

John Wiley & Sons, Inc.

Chapter 16: Employment and Pricing of Inputs

Prepared by Dr Della Lee Sue, Marist College

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Learning Objectives

 Explore the factors influencing the demand for an input by an individual competitive form

 Derive the market demand curve for an input by aggregating the

demand curves of the various firms interested in hiring the input

 Investigate the general shape of an input supply curve

 Explain how the price and employment of inputs is determined in an industry

(continued)

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Learning Objectives (continued)

 Show how an input's price and employment level is determined in a multi-industry market

 Examine input demand and employment by an output market

monopoly

 Define what is meant by monopsony in input markets

 Explain the mathematics behind input demand by competitive and monopoly firms

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16.1 THE INPUT DEMAND CURVE OF

A COMPETITIVE FIRM

Explore the factors influencing the demand for an input by an individual competitive form

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The Input Demand Curve of a

Competitive Firm

 Change of focus from product markets to input markets

 Material in this chapter considers:

 Demand for inputs by competitive firms

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The Firm’s Demand Curve: One

Variable Input

 Marginal value product (MVP) – the extra revenue a competitive firm

receives by selling the additional output generated when employment of

an input is increased by one unit

 MVP curve = firm’s demand curve for a given input when all other

inputs are fixed

(continued)

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The Firm’s Demand Curve:

One Variable Input (continued)

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Figure 16.1 - A Competitive Firm’s

Demand for Labor: One Variable Input

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All Inputs Variable

 In order for a firm’s MVP curve to be equal to the demand curve for an input, there is an assumption that quantities of other inputs are fixed

 However, a change in an input’s price leads a firm to alter its

employment of other inputs as well => an input demand curve should allow a firm to adjust its use of these other inputs

 Consider effect of other inputs on the marginal productivity of an input

 Derive a long-run demand curve – all inputs can vary

 Assumptions:

 other inputs’ prices are unchanged

 final product’s price is constant

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Figure 16.2 – A Competitive Firm’s

Demand for Labor: All Inputs Variable

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An Alternative Approach

 Previous analysis obscures effect in the output market and the market for other inputs

 Reduction in wage rate:

 Isocost line is flatter

 Substitution of labor for capital

 Output increases

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Effects of an Input Price Change

 Substitution effect of an input price change – the change in input

employment when output is held constant and one input is substituted for another in response to an input price change

 Output effect of an input price change – the change in input

employment when output is altered in response to a change in the price

of an input

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Figure 16.3 – A Competitive Firm’s

Demand for Labor: All Inputs Variable

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16.2 INDUSTRY AND MARKET

DEMAND CURVES FOR AN INPUT

Derive the market demand curve for an input by aggregating the demand curves of the various firms interested in hiring the input

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Industry and Market Demand for an

Input

Two step process to derive market demand for an input,

 Determine each industry’s demand for the input

 Aggregate (horizontally sum) each industry’s demand curve for the input to obtain the total or market demand curve

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A Competitive Industry’s Demand

Curve for an Input

 When all firms simultaneously increase output, they can sell more total industry output only at a lower price:

 This reduces the marginal value product of labor

 Derived demand – an industry’s input demand curve, derived from

consumers’ demand for the final product produced by that input

 The industry demand curve is less elastic than the horizontal sum of individual demand curves in which the change in product price is not considered

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Figure 16.4 : The Competitive Industry’s Demand for Labor

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The Elasticity of an Industry’s Demand Curve for an Input

Four major determinants:

 The greater the elasticity of demand for the product produced by the industry, the more elastic the input demand

 An industry’s input demand is more elastic when it is easier to

substitute one input for another in production

 An industry’s demand for an input is more elastic when the supply of other inputs is more elastic

 The longer the time allowed for adjustment, the more elastic an

industry’s demand for an input becomes

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The Market Demand Curve for an Input

The market demand curve for an input is determined by (horizontally) aggregating the various industry demand curves for the input

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16.3 THE SUPPLY OF INPUTS

Investigate the general shape of an input supply curve

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The Supply of Inputs

 The general shape of an input supply curve depends critically on the market for which the supply curve is drawn

 Although the supply of labor to all industries might be perfectly

inelastic, the supply curve of labor for any particular industry is not necessarily perfectly inelastic:

 Variations in number of workers across industries

 For individual industries, input supply curves will tend to be elastic

 The input supply curve will be less elastic for more broadly defined markets

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Figure 16.5 – The Supply Curve of Labor to the Economy and to a Particular Industry

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16.4 INDUSTRY DETERMINATION OF PRICE AND EMPLOYMENT INPUTS

Explain how the price and employment of inputs is determined in an industry

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Industry Determination of Price and

 In a competitive market, input owners are compensated according

to how much value the inputs they supply add to the value of the output

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Figure 16.6 – The Equilibrium Wage and

Employment Level for a Competitive Industry

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Process of Input Price Equalization

across Industries

 If wages are higher in one industry, workers would move to that

industry

 Process continues until wages are equal across industries

 Result: Competitive markets establish uniform input prices across firms, industries, and regions when identically productive inputs are

compared

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Figure 16.7 - Input Price Equalization

Across Industries

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16.5 INPUT PRICE DETERMINATION

IN A MULTI-INDUSTRY MARKET

Show how an input's price and employment level is determined in a multi-industry market

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Input Price Determination in a

Multi-Industry Market

 The interaction between the number of people willing and able to work

as engineers and the total demand for engineers by all firms and

industries determines the wage rate for engineers

 An input supply curve to a given industry is based on given demand conditions in other industries

 The smaller the share of the total market accounted for by an industry, the more elastic its input supply curve

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Figure 16.8 - Input Price Determination

in a Multi-Industry Setting

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16.6 INPUT DEMAND AND

EMPLOYMENT BY AN OUTPUT

MARKET MONOPOLY

Examine input demand and employment by an output market monopoly

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Input Demand and Employment by an

Output Market Monopoly

 Marginal revenue product – the product of an input’s marginal

product and the marginal revenue that can be derived from selling that marginal product

 Input demand curves of an output monopoly

 slope downward:

 the input’s marginal productivity declines

 marginal revenue from selling output declines as more of any input is consumed

 are lower than they would be if the output market were competitive

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Figure 16.9 – An Output Monopolist’s

Demand for an Input

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16.7 MONOPSONY IN INPUT

MARKETS

Define what is meant by monopsony in input markets

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Monopsony in Input Markets

 Monopsony – an input market in which a firm is the sole purchaser of

an input

 Marginal input cost – the cost of using an additional unit of an input

 Average input cost – the total cost of an input divided by the unites of

that input used by a firm

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Comparison between Monopsony and

Monopoly

 Output market monopoly:

 Restricts output

 Charges higher price

 because it faces a downward-sloping demand curve for its product

 Input market monopsony:

 Restricts employment

 Pays a lower wage

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Figure 16.10 - An Input Market

Monopsony

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16.8 THE CALCULUS BEHIND INPUT DEMAND AND COMPETITIVE AND

Explain the mathematics behind input demand by competitive and

monopoly firms

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The Calculus behind Input Demand by

Competitive and Monopoly Firms

Firm’s Objective: Maximize Profit

 Profit = Total Revenue – Total Cost

 Profit is a function of the quantities of inputs used

 The partial derivatives of the profit function with respect to both inputs must be equal to zero

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Input Demand of a Competitive Firm

 Output price and input prices are constant

 1st Order Condition: The firm should use an input up to the point where the input’s marginal value product equals its price

 2nd Order Condition: The marginal value product curve is negatively sloped

(continued)

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Input Demand of a Competitive Firm

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(continued)

A competitive firm maximizes profit by hiring each input

up to the point where the input’s MVP equals its price.

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Input Demand by an Output Market

Monopoly

 For a monopoly, price is not constant: Price is a function of output

which is a function of the quantities of inputs employed

 Input prices are still constant

 The firm should use an input up to the point where the input’s marginal value product equals its price

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Input Demand by Competitive and

Monopoly Firms

(continued)

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