chapter 14 markets for factor inputs. chapter 14slide 2 topics to be discussed competitive factor...

Chapter 14

Markets for Factor InputsMarkets for

Factor Inputs

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

Chapter 14 Slide 3


Characteristics

1) Large number of sellers of the factor of production

2) Large number of buyers of the factor of production

3) The buyers and sellers of the factor of production are price takers

Chapter 14 Slide 4


Demand for a Factor Input When Only One Input Is VariableDemand for factor inputs is a derived

demand…derived from factor cost and output

demand

Chapter 14 Slide 5


AssumeTwo inputs: Capital (K) and Labor (L)Cost of K is r and the cost of labor is wK is fixed and L is variable

Demand for a Factor Input WhenOnly One Input Is Variable


Chapter 14 Slide 6


ProblemHow much labor to hire



Chapter 14 Slide 7


Measuring the Value of a Worker’s OutputMarginal Revenue Product of Labor

(MRPL)

MRPL = (MPL)(MR)



Chapter 14 Slide 8


Assume perfect competition in the product marketThen MR = P



Chapter 14 Slide 9


Question

What will happen to the value of MRPL when more workers are hired?



Chapter 14 Slide 10

Marginal Revenue Product

Hours of Work

Wages($ perhour)

MRPL = MPLx P

Competitive Output Market (P = MR)

MRPL = MPL x MR

Monopolistic Output Market

(P < MR)

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



Chapter 14 Slide 12

w* SL

In a competitive labor market, a firm faces a perfectly elastic supply of labor

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

Hiring by a Firm in theLabor Market (with Capital Fixed)

Quantity of Labor

Price ofLabor

Why not hire fewer or more workers than L*.

MRPL = DL

L*

The profit maximizing firm willhire L* units of labor at the point

where the marginal revenue productof labor is equal to the wage rate.

Chapter 14 Slide 13


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

QuestionHow would this impact the quantity

demanded for labor?



Chapter 14 Slide 14

A Shift in the Supply of Labor

Quantity of Labor

Price ofLabor

w1S1

MRPL = DL

L1

w2

L2

S2

Chapter 14 Slide 15


Comparing Input and Output Markets

production of MC MP

MP MR

MR))((MP

MRP workersofnumber

maximizingprofit at and

MR))(MP(MRP

L

L

L

L

LL

w

w

w

w

Chapter 14 Slide 16


Comparing Input and Output MarketsIn both markets, input and output choices

occur where MR = MCMR from the sale of the outputMC from the purchase of the input

Chapter 14 Slide 17


ScenarioProducing farm equipment with two

variable inputs:LaborAssembly-line machinery

Assume the wage rate falls

Demand for a Factor Input WhenSeveral Inputs Are Variable


Chapter 14 Slide 18


QuestionHow will the decrease in the wage rate

impact the demand for labor?



Chapter 14 Slide 19

MRPL1 MRPL2

When two or more inputs arevariable, a firm’s demand for one input

depends on the marginal revenue product of both inputs.

Firm’s Demand Curve for Labor(with Variable Capital)

Hours of Work

Wages($ perhour)

0

5

10

15

20

40 80 120 160

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, theMRP curve shifts, generating a new

point C on the firm’s demand forlabor curve. Thus A and C are

on the demand for labor curve, butB is not.

DL

A

B

C

Chapter 14 Slide 20

Assume that all firms respond to a lower wageAll 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 LaborIndustry Demand for Labor

MRPL1

The Industry Demand for Labor

Labor(worker-hours)

Labor(worker-hours)

Wage($ perhour)

Wage($ perhour)

0

5

10

15

0

5

10

15

50 100 150 L0 L2

DL1

Horizontal sum ifproduct price

unchanged

120

MRPL2

L1

IndustryDemandCurve DL2

Firm Industry

Chapter 14 Slide 22

The Industry Demand for Labor

QuestionHow would a change to a non-competitive

market impact the derivation of the market demand for labor?

Chapter 14 Slide 23

The Demand for Jet Fuel

ObservationsJet fuel is a factor (input) costCost 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

Chapter 14 Slide 24


ObservationsAirlines responded to higher prices in the

1970’s by reducing the quantity of jet fuel used

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

Chapter 14 Slide 25


ObservationsThe demand for jet fuel impacts the airlines

and refineries alikeThe short-run price elasticity of demand for

jet-fuel is very inelastic

Chapter 14 Slide 26

Short-run Price Elasticityof Demand for Jet Fuel

American -.06 Delta -.15

Continental -.09 TWA -.10

Northwest -.07 United -.10

Airline Elasticity Airline Elasticity

Chapter 14 Slide 27


QuestionHow would the long-run price elasticity of

demand compare to the short-run?

Chapter 14 Slide 28

The Short- and Long-RunDemand for Jet Fuel

Quantity of Jet Fuel

Price

MRPLRMRPSR

Chapter 14 Slide 29


The Supply of Inputs to a FirmDetermining how much of an input to

purchaseAssume a perfectly competitive factor

market

SMarket Supplyof fabric

A Firm’s Input Supply in aCompetitive Factor Market

Yards ofFabric (thousands)

Yards ofFabric (thousands)

Price($ peryard)

Price($ peryard)

D

Market Demandfor fabric

100

ME = AE10 10

Supply ofFabric Facing Firm

50

Demand for Fabric

MRP

Observations1) The firm is a price taker at $10.2) S = AE = ME = $103) ME = MRP @ 50 units

Chapter 14 Slide 31


The Market Supply of InputsThe market supply for physical inputs is

upward slopingExamples: jet fuel, fabric, steel

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

Chapter 14 Slide 32


The Supply of LaborThe 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

Chapter 14 Slide 33


The Supply of LaborHigher 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)

Chapter 14 Slide 34


The Supply of LaborIf the income effect exceeds the

substitution effect the supply curve is backward bending

Chapter 14 Slide 35

Income Effect <Substitution Effect

Income Effect >Substitution Effect

Backward-Bending Supply of Labor

Hours of Work per Day

Wage($ perhour) Supply of Labor

12

C

Worker chooses point A:•16 hours leisure, 8 hour work•Income = $80

16Q

P

A

w = $10

Substitution and IncomeEffects of a Wage Increase

Hours of Leisure

Income($ per

day)

0

240

8 24

480

20

B

w = $20

Suppose wages increase to $20

Substitution effect

Income effect

Increase wage to $20 worker chooses: 20 hour leisure, 4 hours work income = $80

Chapter 14 Slide 37

Labor Supply for One- andTwo-Earner Households

Female Percent of Labor Force1950 -- 29%

1999 -- 60%

Elasticities of Labor Supply (Hours Worked)

Head’s Hours Spouse’s Hours Head’s Hourswith Respect to with Respect to with Respect to

Group Head’s Wage Spouse’s Wage Spouse’s Wage

Unmarried males .026(no children)Unmarried females .106(with children)Unmarried females .011(no children)One-earner family -.078(with children)One-earner family .007(no children)Two-earner family -.002 -.086 -.004(with children)Two-earner family -.107 -.028 -.059(no children)

Chapter 14 Slide 39

Equilibrium in aCompetitive Factor Market

A competitive factor market is in equilibrium when the price of the input equates the quantity demanded to the quantity supplied.

SL = AE

SL = AE

DL = MRPL DL = MRPL

P * MPL

Labor Market Equilibrium

Number of Workers Number of Workers

Wage WageCompetitive Output Market Monopolistic Output Market

wC

LC

wM

LM

vM

AB

Chapter 14 Slide 41


Equilibrium in a Competitive Output MarketDL(MRPL) = SL

wC = MRPL

MRPL = (P)(MPL)

Markets are efficient

Equilibrium in a Monopolistic Output Market MR < P

MRP = (MR)(MPL)

Hire LM at wage wM

vM = marginal benefit to consumers

wM = marginal cost to the firm

Chapter 14 Slide 42


Equilibrium in a Competitive Output MarketDL(MRPL) = SL

wC = MRPL

MRPL = (P)(MPL)

Markets are efficient

Equilibrium in a Monopolistic Output MarketProfits maximized

Using less than the efficient level of input

Chapter 14 Slide 43

Economic RentFor 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.


Chapter 14 Slide 44

Total expenditure (wage) paidis 0w* x AL*Economic Rent

Economic rent is ABW*

B

Economic Rent

Number of Workers

Wage

SL = AE

DL = MRPL

w*

L*

A

0

The economic rent associated with theemployment of labor is the excess of wages

paid above the minimum amount neededto hire workers.

Chapter 14 Slide 45

Economic Rent

Question

What would be the economic rent if SL is perfectly elastic or perfectly inelastic?

Chapter 14 Slide 46

Land: A Perfectly Inelastic SupplyWith land inelastically supplied, its price is

determined entirely by demand, at least in the short run.


Chapter 14 Slide 47

EconomicRent

s1

EconomicRent

s2

Land Rent

Number of Acres

Price($ peracre)

Supply of Land

D2

D1

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.

Chapter 14 Slide 49

Pay in the Military

Shortages of skilled personnel has occurred? Why?Hint: If there is a shortage, the wage must

be below the…?

Chapter 14 Slide 50

The Shortage ofSkilled Military Personnel

Number of Skilled Workers

WageSL

DL = MRPL

w*

w0

Shortage

Chapter 14 Slide 51

Pay in the Military

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.

Chapter 14 Slide 52

Pay in the Military

SolutionSelective reenlistment bonuses

Base pay on MRP

Chapter 14 Slide 53


AssumeThe output market is perfectly competitive.

Input market is pure monopsony.

Chapter 14 Slide 54

SL = Average Expenditure (AE)

MarginalExpenditure (ME)

Why is marginal expendituregreater than SL?

D = MRPL

Marginal and Average Expenditure

Units of Input

Price(per unitof input)

0 1 2 3 4 65

5

10

15

20

w* = 13

L*

wc

Lc

C

Chapter 14 Slide 55


Examples of Monopsony PowerGovernment

SoldiersMissilesB2 Bombers

NASAAstronauts

Company town

Chapter 14 Slide 56

Monopsony Power inthe Market for Baseball Players

Baseball owners created a monopsonistic cartelReserve 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

Chapter 14 Slide 57

Baseball owners created a monopolistic cartel1975 salaries were 25% of team

expenditures

1980 salaries were 40% of team expenditures

Monopsony Power inthe Market for Baseball Players

Chapter 14 Slide 58

Teenage Labor Marketsand 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.

Chapter 14 Slide 59

ExplanationsReduction in fringe benefits

Lower pay for more productive workers

Monopsony market


Chapter 14 Slide 60

FindingsNone of the explanations are validated by

the survey results

Indicates of the need for further study


Chapter 14 Slide 61


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.

Chapter 14 Slide 62

SL

DL

MR

When a labor union is a monopolist, it chooses among points on the buyer’s

demand for labor curve.

Monopoly Power of Sellers of Labor

Number of Workers

Wageper

worker

A

L*

w*

The seller can maximize the number of workershired, at L*, by agreeing that workers will

work at wage w*.

Chapter 14 Slide 63

EconomicRent

w1

L1

The quantity of labor L1 that maximizesthe rent that employees earn is determinedby the intersection of the marginal revenueand supply or labor curves; union members

receive a wage rate of w1.

SL

DL

MR

Monopoly Power of Sellers of Labor

Number of Workers

Wageper

worker

A

L2

w2

Finally, if the union wishes to maximize totalwages paid to workers, it should allow L2

union members to be employed at a wagerate of w2 because the marginal revenue

to the union will then be zero.

L*

w*

Chapter 14 Slide 64

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


Chapter 14 Slide 65

A Two-Sector Model of Labor EmploymentUnion monopoly power impacts the

nonunionized part of the economy.


Chapter 14 Slide 66

Wage Determination inUnionized and Nonunionized Sectors

Number of Workers

Wageper

worker

DUDNU DL

SL

w*

UL

wU

When a monopolistic unionraises the wage rate in the

unionized sector of theeconomy from w* to wU,

employment in that sector falls.

For the total supply of labor toremain unchanged, the wage in

the nonunionized sectormust fall from w* to wNU..

MUL

wNU

Chapter 14 Slide 67

Bilateral MonopolyMarket in which a monopolist sells to a

monopsonist.


Chapter 14 Slide 68

Bilateral Monopoly

Numberof Workers

Wageper

worker

DL = MRPL

MR

5

10

15

20

25

10 20 40

SL = AE

ME

25

19

WagePossibilities

wC

Chapter 14 Slide 69

Bilateral Monopoly

Numberof Workers

Wageper

worker

DL = MRPL

MR5

10

15

20

25

10 20 40

SL = (AE)

ME

25

19wC

ObservationsHiring without union

monopoly power MRP = ME at 20

workers and w = $10/hr

Union’s objective MR = MC at 25

workers and w = $19/hr

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 wc.

Chapter 14 Slide 71

The Decline of Private Sector Unionism

ObservationsUnion membership and monopoly power

has been declining.

Initially, during the 1970’s, union wages relative to nonunion wages fell.

Chapter 14 Slide 72

ObservationsIn the 1980’s union wages stabilized

relative to non-union wages.

In the 1990’s membership has been falling and wage differential has remained stable.


Chapter 14 Slide 73

ExplanationThe unions have been attempting to

maximize the individual wage rate instead 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.


Chapter 14 Slide 74

Wage Inequality--HaveComputers Changed the Labor Market?

1950 - 1980Relative wage of college graduates to high-

school graduates hardly changed

1980-1995The relative wage grew rapidly

Chapter 14 Slide 75


In 1984, 25.1% of all workers used computers

1993 -- 46.6%

1999 -- nearly 60%

Chapter 14 Slide 76


Percent change in use of computers College degrees

1984 - 1993 -- 42 to 70%

Less than high school degree5 to 10%

With high school degree19 to 35%

Chapter 14 Slide 77


Growth in wages -- 1983 - 1994College graduates using computers - 11%

Non-computer users -- less than 4%

Chapter 14 Slide 78


1993 - 1997High school dropouts out of school less

than 10 years earned 29% less than high school graduates

1963 -- The differential was only 19%

Chapter 14 Slide 79


1993 - 1997Average weekly wage for college

graduates (out of school less than 10 years) was 96% higher than high school graduates.

College graduation premium has more than doubled.

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.

Chapter 14 Slide 81

Summary

The market demand for an input is the horizontal sum of the industry demands for the input.

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

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.

Chapter 14 Slide 83

Summary

When a buyer of an input has monopsony power, the marginal expenditure curve lies above the average expenditure curve.

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.

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.

End of Chapter 14

Markets for Factor InputsMarkets for

Factor Inputs

chapter 14 markets for factor inputs. chapter 14slide 2 topics to be discussed competitive factor...

Documents

variable slide

factor inputs

factor of production

labor demand

variable demand

output demand slide

competitive labor market

monopsony power factor