ea session 20: august 23, 2007
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EA Session 20: August 23, 2007. Overview. Typology of Situations to be covered Equilibrium in Competitive Factor Markets Characteristics of Competitive Factor Markets Demand for Factor Input with Only One Variable Factor - PowerPoint PPT PresentationTRANSCRIPT
EA Session 20: EA Session 20: August 23, 2007August 23, 2007
Overview• Typology of Situations to be covered
• Equilibrium in Competitive Factor Markets– Characteristics of Competitive Factor Markets
– Demand for Factor Input with Only One Variable Factor
– Distinguishing between Marginal Revenue Product (MRPL) & Value of Marginal Product (VMPL) of Labor
– Comparing Input and Output Market Equilibrium Conditions
– Firm’s Demand Curve for Labor (with Variable Capital)
– Industry Demand for Labor
– A Firm’s Input Demand in a Competitive Factor Market
– Labor Market Equilibrium under Competition & Monopoly
– Economic Rent
Typology of Situations
Typology 1 2 3 4 5 6 7 8
Seller(Product) comp m’ply comp m’ply comp m’ply
comp m’ply
Buyer(Labor) comp comp m’sny m’sny comp comp
m’sny m’sny
Seller(Labor) comp comp comp comp m’ply m’ply
m’ply m’ply
Characteristics of Competitive Factor
Markets
1) Large number of buyers & sellers of the factor of production
2) The buyers and sellers of the factor of production are price takers
Demand for Factor Input with Only One Variable Factor
• Demand for factor inputs is a derived demand, derived from factor cost and output demand.
• Measuring the Value of a Worker’s Output– Marginal Revenue Product of Labor (MRPL)
– MRPL = (MPL)(MR)
• In a competitive product market – MR = P => VMPL=P.MPL
Marginal Revenue Product (MRPL) &
Value of Marginal Product (VMPL) of
Labor
Hours of Work
Wages($ perhour)
VMPL = MPLx P
Competitive Output Market (P = MR)
MRPL = MPL x MR
Monopolistic Output Market
(MR <P)
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
VMPL = 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.
Can we interpret this point of equilibrium as MR=MC?
A Shift in the Supply of Labor (e.g., due to baby boom/ female
entry)
Quantity of Labor
Price ofLabor
w1S1
VMPL = DL
L1
w2
L2
S2
Comparing Input and Output Market Equilibrium
Conditions
• Input market equilibrium condition:– Under monopoly: MRPL = MR.MPL = W => MR =
W/MPL = MC
– Under competition: VMPL = P. MPL = W => P = AR = MR = W/MPL = MC
• So, input market equilibrium condition is the same as the profit-maximization condition in the output market
VMPL1 VMPL2
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’sdemand for labor curve. When the wage rate falls to $15, the MRP curve shifts, generating a new point C on the firm’s demand for labor curve. Thus A and C are on the demand for labor curve, but B is not. Thus, demand curve for laboris more elastic in the presence of anothervariable factor, which opens up scope for substitution.DL
A
B
C
• Assuming all firms respond to a lower wage– All firms would hire more workers.– Market supply of output would increase.– The market price of output will fall. – The quantity demanded of labor by the
firm will be smaller, given lower output price.
– Thus, industry demand curve would be less elastic as compared to the curve w/o
any price fall.
Industry Demand for Labor
VMPL1
Derivation of the Industry Demand for
Labor
Labor(worker-hours)
Labor(worker-hours)
Wage($ perhour)
Wage($ perhour)
0
5
10
15
0
5
10
15
50 100 150 L0 L2
DL1
Horizontal sum ifproduct price
unchanged
120
VMPL2
L1
Industrydemand
curve withprice falling
DL2
Firm Industry
Step 1 Step 1More labor=>More output=>Less price=>VMPL shifts back
step2
Step 2
SMarket Supplyof fabric
A Firm’s Input Demand 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
VMP
Observations1) The firm is a price taker at $10.2) S = AE = ME = $103) ME = VMP @ 50 units
SL = AE
SL = AE
DL = VMPL DL = MRPL
VMPL =P *MPL
Labor Market Equilibrium (typology 1 & 2)
Number of Workers Number of Workers
Wage WageCompetitive Output Market Monopolistic Output Market
wC
LC
wM
LM
vM
AB
WC
LC
With monopoly, w↓, L ↓, Q ↓
(VM – WM) =‘exploitation of labor under monopoly
Labor Market Equilibrium
• Equilibrium in a Competitive Output Market– DL(VMPL) = SL
– wC = VMPL
– VMPL = (P)(MPL)– Markets are efficient
• Equilibrium in a Monopolistic Output Market– MR < P– MRP = (MR)(MPL)
– Hire LM at wage wM
– vM = marginal benefit to consumers
– wM = marginal cost to the firm
Labor Market Equilibrium
• Equilibrium in a Competitive Output Market– DL(VMPL) = SL
– wC = VMPL
– VMPL = (P)(MPL)– Markets are efficient
• Equilibrium in a Monopolistic Output Market– MR < P– MRP = (MR)(MPL)
– Hire LM at wage wM
– vM = marginal benefit to consumers
– wM = marginal cost to the firm
Total expenditure (wage) paidis rectangle 0w* AL*Economic Rent
Economic rent is ABW*
B
Economic Rent
Number of Workers
Wage
SL = AE
DL = VMPL
w*
L*
A
0
The economic rent associated with theemployment of labor is the excess of wages
paid above the minimum amount neededto hire workers.
How can rent toLabor disappear?
EconomicRent
s1
EconomicRent
s2
Land Rent
Number of Acres
Price($ peracre)
Supply of Land
D2
D1
Why is economic rentincreasing?