markets for factor of production

Markets for factor of productionMicroeconomic FoundationAlaleh Mani2011

Factors of production and it’s price1. Labor wage2. Land rental rate3. Capital interest rate4. Entrepreneurship normal profit

Demand and Supply in factor of production Market

erived Demand

Exceptional

Income ≈ Demand elasticity

Marginal Revenue Product Change in Revenue ,MR, hiring one

more labor. Every employed labor produce a MP Every Product has a MR (reading 17- output and cost)

MP*MR=MPREvery Labor make MPR revenue

MRP is diminishingCompetition Market: MR=d=p= Cte MP diminishingMP*MR=MRP diminishing

MP

Rest Market Structure:MR diminishingMP diminishingMP*MR=MRP diminishing

Labor Individual Demand Curve=MRPMPR=Demand??Firm wants to maximize its profit

MR=MC in firm:MC=Wage rate/q(MP)MR*MP=MRPMR=MRP/MP

MRP/MP=wage rate/MPMRP=wage rate=demand

Change in individual Demand of labor(cfa 2007) 1. Price of output

∆P ∆ MR ∆ MRP ∆ D (increase in short run, decrease in long run)

2.Price of other factors (long run effect)

∆P of Factor of production that substitute(+) or complement (-)the labor force ∆ D

3.Technology and Capital that substitute(+) or complement (-)the labor force (long run effect)

Technology and capital ∆ MP ∆ MRP ∆ D

Market Demand of Labor Summation of individual derived

demand curve would depict market demand which is still derived from production demand

Elasticity of Demand for labor depends on:

Responsiveness of labor demand to wage rate change reflect the labor income changes when supply change:

1.Labor Intensity: labor intensive production is a one that use a lot of labor and a little capital which has a elastic demand for labor If wages ↑ firm cost ↑ decrease the labor

2.Elasticity of demand for good produced:If production demand is elastic labor demand would be elastic If wages ↑ MC ↑ Supply ↓ P ↑ demand of goods↓↓

(elastic)labor demand↓↓ decrease the labor3.Substituability of capital for Market (long run)Exp : robot is a good substitute for worker(elastic) but not for

news reporter, teacher, bank officer (inelastic

Supply of Labor

People time

Reservation wage= Minimum wage people are willing to work at

If wage > reservation wage labor supply > leisure

Leisure

Labor supply

Quantity of labor supply depend on: 1.Substitution effect wage rate= opportunity cost of leisureIf wage↑cost of leisure↑work substitute leisure

labor supply ↑2.Income EffectIf wage↑ income ↑ demand for leisure↑ labor

supply ↓ 3.Backward bending of supply curve: at low wage rate substitute works at higher wage rate income effect works

Backward Bending Supply curve

Reservation wage

Change in supply and demand Population growth lead to labor supply rise Technology and capital create more job than

destroy and save time for household to supply labor more on average

Pace of labor supply < Pace of labor demand Exceptions about skilled worker: 1.Demand for their services decrease 2.The production of low skilled worker are sold in

competition market and make low revenue for firms that lead them to demand for low skilled labor less.

Labor unions

A group of worker who have been organized to increase the wages and make the job condition better

UnionCrafts : Smallest Union, Same skill worker in different industry

Industrial: Largest Union, different skill worker in same industry

Union Terms Collective Bargaining: a process of

negotiation between employee and worker Strike: worker weapon to refuse prevailing

condition Lockout: Employer main weapon to employ Binding Arbitrage: a third part or arbitrator

makes the last decision

Union’s Objectives and Constrain

Objectives

Constrain

Increase compensation

Improve condition

Expand Job opportunity

Supply Side: nonunion and union members can not be recognize

Demand Side: firms decrease labors after wage rise

Union activity in Labor Market

Increase the wage rate

Restrict Supply of union member (UM)

Stimulate the demand

Decrease job available

Inelastic supply of limited labor force

Union control the demand 1. make it less elastic less effective 2. increase the demand for unionized labor:

Increase the marginal product of UM: OTJ training( apprenticeship)

Import restriction: Lobby to restrict Encourage people to buy local goods

Support minimum wage law Substitute high skilled worker for low skilled

Immigration restriction Decrease foreign supply

Increase demand for local good Demand for labor derived from demand for goods

Monopsony in Labor Market A Market with single buyer; Only one employer exist to hire at

lowest wage rateMonopsony control the wage MCL>S

= ATC of labor

=MCL

Equilibrium wage= =Demand

minimum wage a labor willing to work at

The more elastic the supply the less wage is cut

Bilateral Monopoly If Union act like Monopoly and There is

monopsony in labor Market, bilateral monopoly occur.

Monopoly union wage

Monopsony wage

Bargaining

Strike

Lockout

Monopsony and minimum wage (reading 15 market in action): Reminding: every minimum wage above

equilibrium increase unemployment but here min wage increase employement

Minimum wageMonopoly wag

Wages Equilibrium wage Monopsony wage Minimum wage Efficiency wage : a wage above

equilibrium to attract productive worker and make shirker to work harder not to lose this good payment job

Capital Market Goods have value named price Capital has value named Investment that come from saving Physical capital is stock of (an object that is deplete or

replenish): tools Instrument Machines Buildings Inventory:

1. Raw material2. Semi finished material3. finished material

To buy physical capital (investment),firms need financial resources (financial capital)which gained through capital Market.

Price of capital

Quantity of Financial Capital

Demand for Capital

People compare present expenditure with future income

firms borrow financial capital pay interest buy physical capital produce MRPC

Planned Investment

• Firm decide to borrow money in given time • Firm decide to buy physical capital (investment)

Firm maximize its

profit

• Marginal revenue Product of capital(future)=expenditure on capital (present)

• Interest rate≈1/ borrowing and investment

Supply of Capital It derives from people decision on saving that

affected from:1. Income: influence on current(spend) and

future(save) consumption2. Expected future Income :

if future income >current income people save less spend more exp: young people if future income<current income people save more spend less exp: old people

3. Interest rate : the bigger the interest rate the more the opportunity cost of spending the more the interest of saving

Fluctuation in interest rate Population and technology increase the

demand and supply of capital not equally but continually.

As the effect timing of population growth and technology on demand and supply is different the interest rate fluctuate over time but amount of capital always grow

Natural resource Market Nonrenewable natural resource supply:Gas, coal, oil, hydrocarbon fuels

1. Stock : Quantity existence in given time.2. KNOWN STOCK : AMOUNT OF DISCOVERED RESOURCES3. FLOW SUPPLY: AMOUNT OF RESOURCE SUPPLIED USE FOR

PRODUCTION =Perfectly elastic Direct Influence on Price

Exp: Saudi Arabia choose to sell or keep the inventory of oil:

P≤E(p)/(1+r) Saudi Arabia sells oil otherwise keeps it

Renewable(replenished by nature) natural resource supply:Rain, river, lakes, wind, sunshine, land

INDIRECT INFLUENCE ON PRICE

Price and hotelling principal Hotteling principal: Nonrenewable natural

resource Price rise at the rate of interest rate Actual price=PV(E(Pf)) The reason why actual price does not follow

the hotteling principal is : Unexpected change of technology that leads

to discover more of resources .or use resources more efficient price falls continually

Economic rent, tax, opportunity cost Economic rent=producer surplus for

factor of production

If s=elastic all income=opportunity cost=tax burden by consumerLike low skilled worker that have not rent

If s=inelastic all income=Economic rent=tax burden by supplier=efficientLike land that have not other opportunity cost

Producer surpluswage

Quantity of factor of production