Chapter 14
Chapter 13.Pricing and Employment of Inputs
Topics to be Discussed
Competitive Factor Markets
Factor Markets with Monopsony Power
Factor Markets with Monopoly Power
Competitive Factor Markets
Characteristics
Large number of sellers and buyers of the factor of production
2) The buyers and sellers of the factor of production are price takers
We will illustrate the demand for a factor input and assume only one input is variable
Demand for factor inputs is a derived demand
Depends on output demand
The Decision to Hire or Fire
Assume
Two inputs are needed to produce output : Capital (K) and Labor (L)
Cost of K is r and the cost of labor is w
K is fixed and L is variable
Problem
How much labor to hire
Measuring the Value of a Worker’s Output
The owner of donut shop wants to know whether it is profitable to hire an additional worker.
It will be profitable if the additional revenue from an additional worker is greater than its cost. (i.e., MRPL > wage )
Marginal Revenue Produce (MRPL)
MRPL = (MR) (MPL)
Assume perfect competition in the product market
Then MR = P
MRPL = (P) (MPL)
Competitive Factor Markets
Question
When more workers are hired, what will happen to the value of MRPL?
[pic]
MRPL is downward sloping because MPL decreases due to diminishing marginal returns.
Question
Why is the MRPL for the monopoly output market below the MRPL for the competitive output market?
In a competitive output market, MR=P.
In a monopolistic output market, MR < P
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
Hiring by a Firm in the Labor Market (with Capital Fixed)
The profit maximizing firm will hire L* units of labor at the point where the marginal revenue product of labor is equal to the wage rate.
[pic]
Competitive Factor Markets
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.
Question
How would this impact the quantity demanded for labor?
Competitive Factor Markets
Comparing Input and Output Markets
[pic]
Competitive Factor Markets
Comparing Input and Output Markets
In both, input and output choices occur where MR = MC
MR from the sale of the output
MC from the purchase of the input
Competitive Factor Markets
The Supply of Inputs to a Firm
Determining how much of an input to purchase
Assume a perfectly competitive factor market
[pic]
Observations
The firm is a price taker at $10.
S = AE = ME = $10
ME = MRP @ 50 units
Question
Why is 50 units the profit maximizing quantity?
Competitive Factor Market
A competitive factor market is in equilibrium when the price of the input equates the quantity demanded to the quantity supplied.
Labor Market Equilibrium
[pic]
Equilibrium in a Competitive Output Market
DL(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 society
wM = marginal cost to the firm
Profits maximized
Using less than the efficient level of input
Equilibrium in a Competitive Factor Market
Economic Rent
For 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.
[pic]
Economic Rent
Question
What would be the economic rent if SL is perfectly inelastic?
Land: A Perfectly Inelastic Supply
With land inelastically supplied, its price is determined entirely by demand, at least in the short run.
Factor Markets with Monopsony Power
Assume
The output market is perfectly competitive.
Input market is pure monopsony.
Marginal and Average Expenditure
[pic]
Factor Markets with Monopsony Power
Examples of Monopsony Power
Government
Soldiers, Missiles, B2 Bombers
NASA
Astronauts
Factor Markets with Monopoly Power
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.
Objectives of the Union Leader.
1. To maximize the number of workers hired
: L* at wage w*.
2. To maximize the economic rent that employees earn
: L1 at wage w1.
3. To maximize total wages paid to workers
: L2
at a wage rate of w2
4.
[pic]
Bilateral Monopoly Marketsr
Bilateral Monopoly
Market in which a monopolist sells to a monopsonist.
[pic]
Observations
Hiring 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
Bilateral Monopoly
Who Will Win? : Depending on the bargaining power
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.
Minimum Wage above higher market-wage: Explained already.
Issue :
30 how many jobs are lost due to the minimum wage.
31 Isn’t there any side-effects in imposing minimum wage.
32 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.
When factor markets are competitive, the buyer of an input assumes that its purchase will have no effect on the price of the input.
Economic rent is the difference between the payments to factors of production and the minimum payment that would be needed to employ those factors.
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.
When a monopolistic union bargains with a monopsonistic employer, the wage rate depends on the nature of the bargaining process.
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