Factor markets --Factor markets --Labor marketsLabor markets

Dr. D. Foster – ECO 284

& General & General EquilibriumEquilibrium

Factor MarketsFactor Markets

Look at perfectly competitive factor markets. Focus on labor market.

Results applicable to other factor markets.

Consider in the context of competitive output markets.

Omit the following:Omit the following: C26: Case 2 (481-482), Case 4 (485-487), Factors affecting the C26: Case 2 (481-482), Case 4 (485-487), Factors affecting the

elasticity of derived demand (483-484).elasticity of derived demand (483-484). C27: Unions (507-512).C27: Unions (507-512).

Factor MarketsFactor Markets

Look at perfectly competitive factor markets. Focus on labor market.

Results applicable to other factor markets.

Consider in the context of competitive output markets.

ResultsResults: Wages are equal.: Wages are equal.

Why do wages differ?Why do wages differ?

Factor MarketsFactor Markets Role reversal:

Demand – comes from firms. Supply – comes from us (labor).

Demand = derivedderived from the demand for output produced by the factor.

What would be the profit maximizing rule?What would be the profit maximizing rule?

LaborL*

Wage

D

S

w*

Hire until the marginal benefit equals marginal cost:

Marginal Revenue Product = Marginal Factor CostMarginal Revenue Product = Marginal Factor Cost

Factor MarketsFactor MarketsMarginal Revenue Product (MRP) is …Marginal Revenue Product (MRP) is …

revenue generated by this unit of labor

= MPMPLLx PPe e or = MPPLxPe$

L

MRP

Actually, this is MPActually, this is MPLL··MR, not MR, not

the price MPthe price MPLL··PPee..

But, in a perfectly competitive But, in a perfectly competitive output market, the MR = P.output market, the MR = P.

We will content ourselves with We will content ourselves with this simple case.this simple case.

Factor MarketsFactor MarketsMarginal Factor Cost (MFC) = Wage Rate (w)Marginal Factor Cost (MFC) = Wage Rate (w)

If a firm hires If a firm hires too fewtoo few workers, they are giving workers, they are giving up profitable production.up profitable production.

If they hire If they hire too manytoo many, they , they are losing profit on the are losing profit on the

last unit(s) of labor.last unit(s) of labor.

$

L

MRP

MFCw*

ℓ*

Factor MarketsFactor MarketsWhat would change the equilibrium level of

workers hired (l*)? A change in the equilibrium wage (w*)A change in the equilibrium wage (w*)

Due to a change in the Supply of labor. Due to a change in the Demand for labor.

A change in the equilibrium output price (PA change in the equilibrium output price (Pee)) The price affects the profitability of each worker.

A change in the productivity of labor (MPA change in the productivity of labor (MPLL)) Changes in skills, education, experience. Changes in the amount of capital Changes in the price of other (substitutable) factors.

Perfectly Competitive Labor Perfectly Competitive Labor MarketsMarkets Everyone is a price takerprice taker. There are no barriersno barriers to entry/exit. Labor is mobilemobile . . .

in use. in location.

All labor is the samethe same. All job environments are the samethe same.

Result: In the LR, all wages are the same!Result: In the LR, all wages are the same!

Perfectly Competitive Labor Perfectly Competitive Labor MarketsMarkets Why do wage rates differ?Why do wage rates differ?

All labor is notnot the same. Skills differdiffer – education differsdiffers – experience differsdiffers

Labor is not mobilenot mobile in use. Labor is not perfectly mobile in location. Job environments differdiffer.

Result: Even with P.C. wages will differ!Result: Even with P.C. wages will differ!

Factor Markets – Work Factor Markets – Work ProblemProblem

Derive and plot MRP & MFC:i. when P=$4 & w=$24

ii. when P=$2 & w=$24

iii. when P=$4 & w=$8

Find the optimal level of labor.

Labor Quantity

0 0

1 15

2 27

3 37

4 45

5 51

6 55

7 57

8 58

General EquilibriumGeneral EquilibriumPutting Output & Factor Markets Putting Output & Factor Markets TogetherTogether

Factor market assumptionsFactor market assumptions – competitive; wage differentials reflect job environments; labor is mobile; capital is abundant; when wages change, equilibrium is disrupted in SR; LR equilibrium restored when differences reflect

values placed on differing environments.

General EquilibriumGeneral EquilibriumPutting Output & Factor Markets Putting Output & Factor Markets TogetherTogether Output market assumptionsOutput market assumptions –

competitive; long-run constant costs; there are only two goods – coal and wheat; all income is spent;

Current (long run equilibrium) conditionCurrent (long run equilibrium) condition – Wages: wheat workers $5; coal miners $8. Prices: wheat is $3/bushel; coal is $10/ton.

Draw these market curves for our next class.

Factor markets --Factor markets --Labor marketsLabor markets

Dr. D. Foster – ECO 284

& General & General EquilibriumEquilibrium