chapter 15 factor markets and vertical integration

Chapter 15

Factor Markets and Vertical Integration

© 2004 Pearson Addison-Wesley. All rights reserved 15-2

Factor markets

• For completeness - firms hire labour from workers/consumers

• Consumers use income to buy from firms

• Workers make labour supply decisions

• Firms make decisions on how much to produce and sell


Questions

• How do firms decide how much labour (and other inputs) to hire?

• Related questions:– why do some jobs pay more than others?– what determines the distribution of (earned)

income?– what is the effect of trade unions?– why do men earn more than women?


How much labour to hire?

• Where to start?

• Keep it simple, look at one input at a time

• Hence look at the demand for labour, holding capital (and any other inputs) constant

• Hence this is the short run

• Relax this assumption later


The usual assumptions...

• Firms try to maximise profits

• The firm will only hire an additional worker if she generates extra profit– marginal revenue from labour > marginal cost

of labour

• Marginal revenue from labour = extra output price of output

• Marginal cost of labour = wage


Marginal product of labour

• The additional output of the worker is the marginal product of labour - MPL

• Price of output = marginal revenue - MR

• The additional revenue the worker generates is the marginal revenue product of labour - MRPL = MR MPL

• For the competitive firm, MR = P, so we refer to the value marginal product of labour - VMPL = P MPL


Table 15.1 Marginal Product of Labor, Marginal Revenue Product of Labor, and Marginal Cost

Should be VMPL, but never mind!


Maximising profit

• As long as MRPL > w, the firm should continue hiring more workers

• The optimum is therefore...– MRPL = w

• At the margin, workers are paid what they are worth. David Beckham is worth £70,000 (or whatever!) per week.

• (No exploitation, etc. This is a competitive economy.)


Diagrams

L

Q

L

LMP

AP

L

MP

MP ,

L

APL

APL

L

Production function Marginal and averageproducts


MRPL curveVMPL = p MPLMRPL = MR MPL

w

L

w,VMP

LM LC


Labour demand and supply - same as previous diagram


Re-interpretation - MC = MR

• w = MR MPL

• Re-write as w/MPL = MR

• Note the LHS is the firm’s MC:– if w = 10, MPL = 2...

– MC of one unit of output is 10/2 = 5.

• Hence firm is setting MC = MR


Wages change... obvious effect

Think aboutthe minimumwage...


The long run... capital not fixed

• What difference does it make?

• Wage falls labour demand increases, with capital fixed

• But... this is an inefficient way to expand, surely the firm would change capital too?

• MC falls, but not as much as it could, if capital can vary too.


• If K can vary too, MC falls by more, so output increases by more, so demand for labour increases by more.

• Hence, the long run demand curve for labour is flatter (more elastic) than the short run curve

• Firms may take time to fully adjust to changing wage levels.


Figure 15.3 Labor Demand of a Thread Mill


Market demand for labour

• Above we examined the demand of a single firm. What about the market demand for labour?

• We do not horizontally sum the firms’ labour demand curves

• Why not...


• Wage falls...

• Each firm’s labour demand rises...

• Each firm produces more output...

• So the market price of output falls...

• Hence, MPL falls...

• The moderates the rise in labour demand. It is less than the sum of the firms’ effects in isolation.


Figure 15.4a Market Demand for Labor

Wage falls from$25 to $10.Firm’s labour demand rises from 50 to 90. But, price fallstoo...


Figure 15.4b Market Demand for Labor

Market demandcurve


Market imperfections

• Labour/input markets are not always competitive

• We examine monopsony

Buyer/employer Many One Seller/ Many PC, monopoly monopsony workers One monopoly

union Bilateral monopoly


Monopsony

• A single buyer faces multiple sellers, the reverse of monopoly.– Big employer in a small, isolated town– NHS and nurses/doctors– BBC buying football programmes– Tesco buying food from farmers

• How do we analyse monopsony?


Adapt the monopoly analysis

• Market power is held by the buyer, not the seller

• Hence it is the reverse of monopoly

• Rather than the seller facing a downward sloping demand curve...

• The buyer faces an upward sloping supply (e.g. of labour) curve.


Figure 15.9a Monopsony

Hint: it’s the monopoly diagramupside down!

The wage (price ofinput) is reduced


Monopsony in buying televised football

Year Length of contract

B'caster Live matches per

season

Annual rights fee

£m per live match

1983 2 years BBC/ITV 10 2.6 0.26 1985 6 months BBC/ITV 6 1.3 0.22 1986 2 years BBC/ITV 14 3.1 0.22 1988 4 years ITV 18 11.0 0.61 1992 5 years BBC/Sky 60 42.8 0.71 1996 5 years Sky 60 170.0 2.83 Source: Baimbridge et al, Satellite TV and the Demand for Football: a Whole New Ball Game? SJPE, 43 (3) 1996


Implications of monopsony

• Nurses and doctors are paid less because of the NHS (though doctors can do private work and nurses are beginning to use agencies)

• Sky is the best thing that happened for (top) football clubs

• Farmers are worse off because of the power of Tesco, etc. (though they have the CAP!)


The minimum wage again

wM

wMW

LM LMW

demand

supply

MEDemand for labour increases


Summary and conclusions

• Factor demand is an extension of what we have done before.

• Maximising agents - look at the results

• Wages reflect marginal products, in perfect markets

• Imperfect markets can alter our predictions


Things to think about

• Why are wages in Third World countries so low?

• Should football league clubs be allowed to sell their own TV rights?

chapter 15 factor markets and vertical integration

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