microeconomics: theory & applications chapter 17 wages, rent, interest, and profit by edgar k....

MICROECONOMICS: Theory & Applications

Chapter 17 Wages, Rent, Interest, and Profit

By Edgar K. Browning & Mark A. ZupanJohn Wiley & Sons, Inc.9th Edition, copyright 2006PowerPoint prepared by Della L. Sue, Marist College

Copyright 2006John Wiley & Sons, Inc.17-2

Learning Objectives

Investigate a worker’s decision concerning how many work hours to supply.

Examine the income and substitution effects of a higher wage rate and whether the net result of a wage increase involves a worker supplying more work hours.

Analyze the general level of wage rates and why wages differ among jobs.

Define when economists mean by the term “rent”.(Continued)


Learning Objectives (continued)

Explore selling or monopoly power in input markets and show how unions attempt to exercise such power in labor markets.

Explain how the interest rate is determined through the interplay of the supply of and demand for capital.

Overview why interest rates differ across specific credit markets.


The Income-Leisure Choice of the Worker

Leisure – the portion of a worker’s time when he or she is not receiving compensation from an employer

Figure 17.1


Is the Income-Leisure Model Plausible?

Common objection: workers do not really have the ability to vary their work hours.

Justifications:– Options to workers that give them control over how much

they work: overtime, vacation leave, leave without pay, moonlighting, sick leave, early retirement

– The model is fundamentally correct analytically.– The model provides a basis for analyzing work effort

decisions involving groups of workers, not necessarily one specific worker.


The Supply of Hours of Work

Question: Does a higher wage always lead a workers to work more?

Substitution effect - a higher wage rate encourages more work

Income effect – a higher wage rate encourages less work

The total effect is the sum of the effects: if larger effect will determine whether there is an increase or a decrease in work hours.


Worker’s Response to a Change in the Wage Rate [Figure 17.2]


Is a Backward-Bending Labor Supply Curve Possible?

A supply curve of work hours can be backward-bending beyond some wage rate if the normal income effect of a higher wage rate exceeds the substitution effect.

Figure 17.3


The Market Supply Curve

A market supply curve of work hours is obtained by horizontally summing the individual supply curves of all workers competing in a given labor market.

Like the individual supply curve, the market supply curve can slope upward, bend backward, or show a combination of the two.

The elasticity of the supply curve of labor to a specific job or industry depends upon how the number of workers varies with wage rates in those occupations.


The General Level of Wage Rates

The aggregate demand curve for labor reflects the marginal productivity of labor to the economy as a whole.

Real wages are higher in developed countries than in less developed countries because of the factors determining the position of the demand curve: capital, technology, and skills.

Figure 17.4


Why Wages Differ

Assumptions behind the equalization of wage rates across firms or industries:

– Workers are identical.– Workers evaluate the

desirability of jobs only in terms of money wage rates.

Figure 17.5


Factors Attributable to Equilibrium Difference in Wage Rates

Compensating wage differentials – differences in wages paid that are created by the forces of supply and demand when workers view some jobs as intrinsically more attractive than others

Human capital investment – the process by which people augment their earning capacity

Differences in ability


Economic Rent

Economic rent – that portion of the payment to an input supplier in excess of the minimum amount necessary to retain the input in its present use

Figure 17.6


Economic Rent with an Upward-Sloping Supply Curve [Figure 17.7]


Monopoly Power in Input Markets: The Case of Unions [Figure 17.8]


Some Alternative Views of Unions and an Assessment of the Impact of Unions on Worker Productivity

Unions protect workers’ rights and wages, counteracting the monopsony power possessed by input-buying firms.

Unions set up effective grievance procedures. Unions give workers a “voice” with their

employers.


Borrowing, Lending, and the Interest Rate

Interest rate– The price paid by

borrowers for the use of funds

– The rate of return earned by capital as an input in the production process

Figure 17.9


Investment and the Marginal Productivity of Capital

Gross marginal productivity – the total addition to productivity that capital investment contributes

Net marginal productivity – the total addition to productivity that capital investment contributes, less the cost of capital


The Investment Demand Curve

Investment demand curve – the relationship between the rate of return generated and various levels of investment

Figure 17.10


Saving, Investment, and the Interest Rate [Figure 17.11]


The Level of Investment and Productive Capacity [Figure 17.12]


Equalization of Rates of Return

Tendency: capital is allocated across firms and industries so that the rate of return is equal

Why? Owners of capital have an incentive to shift their investments to industries where the return is higher => output in that industry will expand and price falls until the industry earns a normal profit. Adjustments occur until all industries earn a normal profit.


Why Interest Rates Differ

Reasons:– Difference in risk– Differences in the duration of the loan– Cost of administering loans– Differences in tax treatment


Copyright 2006 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in section 117 of the 1976 United States Copyright Act without express permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information herein.

microeconomics: theory & applications chapter 17 wages, rent, interest, and profit by edgar k....

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