© 2009 pearson education canada 11/1 chapter 11 input markets and the allocation of resources

© 2009 Pearson Education Canada11/1

Chapter 11Chapter 11

Input Markets and the Input Markets and the Allocation of ResourcesAllocation of Resources


Perfectly Competitive Input MarketsPerfectly Competitive Input Markets

There are two types of There are two types of input marketsinput markets::1.1. Primary inputPrimary input markets markets include include

resources that have not been processed resources that have not been processed by other firms, such as land, oil and by other firms, such as land, oil and labour.labour.

2.2. Intermediate inputIntermediate input markets markets are the are the processed output from other firms, such processed output from other firms, such as iron ingots, hog bellies and rolled as iron ingots, hog bellies and rolled steel.steel.


Assumptions of Perfectly Assumptions of Perfectly Competitive Input MarketsCompetitive Input Markets

1.1. Large NumbersLarge Numbers-There are a large number of input -There are a large number of input demanders/suppliers and no individual buys (sells) a demanders/suppliers and no individual buys (sells) a significant portion of total quantity traded.significant portion of total quantity traded.

2.2. Perfect Information-Perfect Information-Demanders/suppliers have Demanders/suppliers have perfect knowledge of prices and all firms have perfect perfect knowledge of prices and all firms have perfect information of production functions.information of production functions.

3.3. Input HomogeneityInput Homogeneity-In any input market, all units of -In any input market, all units of the input are identical.the input are identical.

4.4. Perfect Mobility of ResourcesPerfect Mobility of Resources-All inputs are -All inputs are perfectly mobile.perfectly mobile.


The Supply of Non-Labour InputsThe Supply of Non-Labour Inputs

Renewable resourcesRenewable resources, such as land, can , such as land, can be used over and over again.be used over and over again.

Non-Renewable resourcesNon-Renewable resources, like oil, once , like oil, once it is used it is gone.it is used it is gone.

In the analysis that follows, it is assumed In the analysis that follows, it is assumed that the supply of non-labour inputs is that the supply of non-labour inputs is perfectly price-elastic. perfectly price-elastic.


The Supply of LabourThe Supply of Labour An individual faces two constraints:An individual faces two constraints:1.1. The The time constrainttime constraint says says that total that total

time available time available (T)(T) equals work time equals work time (h)(h) plus leisure time plus leisure time (x(x11): h+x): h+x11=T=T

2.2. The The income constraintincome constraint says that a says that a person’s income person’s income (x(x22)) is the sum of work is the sum of work income (wage x income (wage x hh) and non-work income ) and non-work income (A): x(A): x22=wh+A=wh+A


The Leisure-Income ConstraintThe Leisure-Income Constraint The The leisure income constraintleisure income constraint: :

wxwx11+x+x22=A+=A+wwTT The wage The wage (w)(w) is the price of leisure and is the price of leisure and

the slope of the budget constraint.the slope of the budget constraint. A+wTA+wT is full (all work) income. is full (all work) income. The utility maximizing bundle of The utility maximizing bundle of

leisure/labour is where the indifference leisure/labour is where the indifference curve is tangent to the leisure-income curve is tangent to the leisure-income constraint in Figure 11.1constraint in Figure 11.1


Figure 11.1 The demand for Figure 11.1 The demand for leisure and the supply of labourleisure and the supply of labour


Figure 11.2 Leisure as a normal goodFigure 11.2 Leisure as a normal good


Figure 11.3 Income and substitution Figure 11.3 Income and substitution effects for a wage changeeffects for a wage change


Response to a Change in Wage RateResponse to a Change in Wage Rate

When leisure is a normal good, the hours of When leisure is a normal good, the hours of work may increase or decrease in response to a work may increase or decrease in response to a wage increase, depending upon whether the wage increase, depending upon whether the income effect is greater than or less than the income effect is greater than or less than the income effect. income effect.

When leisure is an inferior good, an increase in When leisure is an inferior good, an increase in wage rate invariably leads to a decrease in wage rate invariably leads to a decrease in leisure hours and an increase in work hours.leisure hours and an increase in work hours.


Figure 11.4 (a & b) The demand for Figure 11.4 (a & b) The demand for leisure and the supply of labourleisure and the supply of labour


Firm’s Demand for One Variable InputFirm’s Demand for One Variable Input

The The short-run demand functionshort-run demand function relates to a scenario where only one relates to a scenario where only one input is variable.input is variable.


Input Demand in a One-Good EconomyInput Demand in a One-Good Economy

For any wage less than the maximum For any wage less than the maximum value of the average product, the firm’s value of the average product, the firm’s demand function is the downward sloping demand function is the downward sloping portion of the marginal product curve.portion of the marginal product curve.

For any wage rate greater than the For any wage rate greater than the maximum value of the average product, maximum value of the average product, the firm maximizes profits by hiring no the firm maximizes profits by hiring no labour.labour.


Figure 11.5 Input demand in a one-good economyFigure 11.5 Input demand in a one-good economy


Transforming the Product Curves Transforming the Product Curves into Revenue Curvesinto Revenue Curves

Marginal Revenue ProductMarginal Revenue Product is the is the marginal product from an additional unit marginal product from an additional unit of labour times the marginal revenue of labour times the marginal revenue when the additional output is sold:when the additional output is sold:

MRP(z)=MR(y)MP(z)MRP(z)=MR(y)MP(z) Similarly, Similarly, Average Revenue ProductAverage Revenue Product

equals the price of the output times equals the price of the output times average product of the variable input:average product of the variable input:

ARP(z)=pAP(z)ARP(z)=pAP(z)


Figure 11.6 The firm’s demand forFigure 11.6 The firm’s demand forone variable inputone variable input


The Firm’s Demand Curve for One The Firm’s Demand Curve for One Variable InputVariable Input

For input prices less than the maximum values For input prices less than the maximum values of ARP, the firm’s demand function is the of ARP, the firm’s demand function is the downward-sloping portion of MRP.downward-sloping portion of MRP.

For input prices greater than the maximum For input prices greater than the maximum value of ARP, the firm will demand none of the value of ARP, the firm will demand none of the variable input.variable input.

Given an initial positive quantity of the input Given an initial positive quantity of the input demanded, an increase in the price of an input, demanded, an increase in the price of an input, will cause the firm to reduce the quantity will cause the firm to reduce the quantity demanded of that input.demanded of that input.


The Firm’s Demand Curve for One The Firm’s Demand Curve for One Variable InputVariable Input

The The value of the marginal productvalue of the marginal product (VMP) (VMP) of the variable input of the variable input (VMP(VMPzz)) is is output price time marginal product: output price time marginal product: VMPVMPzz=pMP(z).=pMP(z).

For a perfect competitor, For a perfect competitor, VMP =MRPVMP =MRP (since (since p=MRp=MR).).

For a monopoly, For a monopoly, MRP<VMPMRP<VMP since since MR<PMR<P..


Input Demand with Many Variable InputsInput Demand with Many Variable Inputs

In the long run all inputs are variable.In the long run all inputs are variable. In the long run, the firm’s response to In the long run, the firm’s response to

an input price change will, via both the an input price change will, via both the substitution effectsubstitution effect and the and the output output effecteffect, produce a downward sloping , produce a downward sloping input demand curve.input demand curve.


Figure 11.7 The substitution effect Figure 11.7 The substitution effect of an input price changeof an input price change


Figure 11.8 Comparing long-run and Figure 11.8 Comparing long-run and short-run input demand functionsshort-run input demand functions


Elasticity Rules for Elasticity Rules for Derived DemandDerived Demand

The response to an input price The response to an input price change, in both the short and long change, in both the short and long run, is to demand more (less) of an run, is to demand more (less) of an input as its price falls (rises).input as its price falls (rises).

The response to a input price change The response to a input price change is greater in the long run than in the is greater in the long run than in the short run.short run.


Equilibrium in a Competitive MarketEquilibrium in a Competitive Market In the long run, a firm that is a perfect In the long run, a firm that is a perfect

competitor in both its output and input market competitor in both its output and input market will chose an input bundle such that for each will chose an input bundle such that for each input:input: wwe=MRP(ze=MRP(z)=pMP(z)=VMP(z))=pMP(z)=VMP(z)

In long-run equilibrium, a firm that is a perfect In long-run equilibrium, a firm that is a perfect competitor in its input markets but a competitor in its input markets but a monopolist in its output market, will choose an monopolist in its output market, will choose an input bundle such that for each input: input bundle such that for each input:

wwee=MRP(z)=MR(y)MP(z)<pMP(z)=VMP(z)=MRP(z)=MR(y)MP(z)<pMP(z)=VMP(z)


Figure 11.9 Equilibrium in a Figure 11.9 Equilibrium in a competitive input marketcompetitive input market


MonopsonyMonopsony in Input Markets in Input Markets A A monopsonistmonopsonist has significant has significant

control over what it pays for an control over what it pays for an input.input.

The relationship between input price The relationship between input price (w)(w) and quantity of the input and quantity of the input (z)(z) is is determined by the market supply determined by the market supply function for the input: function for the input: w=S(w).w=S(w).


Monopsony in Input MarketsMonopsony in Input Markets The monopsonist buys all units of an The monopsonist buys all units of an

input at the same price (input at the same price (average average factor costfactor cost or or AFCAFC).).

Total factor costTotal factor cost (TFC)(TFC) is quantity is quantity (z)(z) times times AFCAFC or price or price S(z):S(z):

TFC(z)=zS(z)TFC(z)=zS(z)


Monopsony in Input MarketsMonopsony in Input Markets The The marginal factor costmarginal factor cost (MFC)(MFC) is the is the

rate at which rate at which TFCTFC changes as the changes as the quantity of output quantity of output (z)(z) changes. changes.

When a monopsonist buys a positive When a monopsonist buys a positive quantity of the input, the quantity of the input, the MFCMFC exceeds exceeds price price (w)(w) or or average factor costaverage factor cost..

The The MFC=w+zMFC=w+z(slope of supply curve):(slope of supply curve):


Figure 11.11 A monopsonist’s Figure 11.11 A monopsonist’s profit-maximizing decisionprofit-maximizing decision


Profit Maximizing Input DecisionsProfit Maximizing Input Decisions

The general profit-maximizing rule in an The general profit-maximizing rule in an input market is to buy an input up to the input market is to buy an input up to the point where point where marginal factor costmarginal factor cost is is equal to equal to marginal revenue productmarginal revenue product..

For a competitive input market:For a competitive input market:MRP(z*)=MFC(z*)=w*MRP(z*)=MFC(z*)=w*

For a monopsonist:For a monopsonist:MRP(z*)=MFC(z*)>w*MRP(z*)=MFC(z*)>w*


Figure 11.13 The inefficiency of monopsonyFigure 11.13 The inefficiency of monopsony


Figure 11.15 Resource allocation summarizedFigure 11.15 Resource allocation summarized


The Firm’s Demand for Capital InputsThe Firm’s Demand for Capital Inputs

Since capital is durable, the sum of present Since capital is durable, the sum of present values of values of MRPMRP through time is: through time is:ΣΣMRP=MRPMRP=MRP00++[MRP[MRP11/(1+i)]+…+[MRP/(1+i)]+…+[MRP11/(1+i/(1+i)D-1)D-1]]

The optimal quantity of The optimal quantity of capital inputcapital input is the is the quantity where the present value of the quantity where the present value of the marginal revenue products over its life is equal marginal revenue products over its life is equal to the present value of all costs of this input to the present value of all costs of this input (p= (p= ΣΣMRP).MRP).

The The ΣΣMRPMRP is the firm’s demand curve for is the firm’s demand curve for gadgets.gadgets.


Figure 11.16 The demand for a capital inputFigure 11.16 The demand for a capital input


Human Capital Decisions Over TimeHuman Capital Decisions Over Time

Human capital Human capital - investments in - investments in education and training.education and training.

Human capital production functionHuman capital production function::R=F(H)R=F(H)

Which says additional income (return on Which says additional income (return on human capital investment) human capital investment) (R),(R), is a is a diminishing function of the quantity of diminishing function of the quantity of human capital human capital (H).(H).


Figure 11.17 Investing in human capitalFigure 11.17 Investing in human capital


From Figure 11.17 From Figure 11.17 Invest in an additional dollar of human Invest in an additional dollar of human

capital if the marginal product capital if the marginal product (MP)(MP) exceeds the rate at which current exceeds the rate at which current foregone consumption can generate foregone consumption can generate future consumption future consumption (1+i).(1+i).

To maximize the present value of net To maximize the present value of net income, invest in human capital up to the income, invest in human capital up to the point where point where MP=(1+i).MP=(1+i).


Figure 11.18 Another perspective on Figure 11.18 Another perspective on the human capital investmentthe human capital investment


Figure 11.19 The life-cycle choiceFigure 11.19 The life-cycle choice

© 2009 pearson education canada 11/1 chapter 11 input markets and the allocation of resources

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