1 Markets for Factors of Production Factors of Production -Land -Labour -Physical Capital -Human Capital -Other These factors are bought and sold in a

1

Markets for Factors of ProductionMarkets for Factors of Production

Factors of Production

-Land

-Labour

-Physical Capital

-Human Capital

-Other

These factors are bought and sold in a factor market with supply and demand curves similar to the goods market

2

Markets for Factors of ProductionMarkets for Factors of Production

These markets are important because:

• money incomes are primarily determined by the prices set in these markets.

–distribution of income

• production costs determine which factors are used and in what quantities

–resource allocation

3

Government

ProductMarket

ResourceMarket

BusinessFirms

HouseholdsResourceOwners

ProductsProducts

Resources

Resou

rces

Products &Services

Products &Services

CIRCULAR FLOW

LAND LABORCAPITAL

$ Taxes$ Taxes

$ Costs$ Income

$ Spending $ Revenue

PRO

DUCT

S

$SPE

NDI N

G$S

PEND

I NG

RESO

URCE

S

4

(a) The Market for Apples (b) The Market for Apple PickersPr

ic e o

f Ap p

les

Wag

e of

App

le P

icker

s

W

00 0 LQ

P

Quantity ofApples

Quantity ofApple Pickers

Supply Supply

DemandDemand

The Versatility of Supply & Demand

5

• Factors other than Wage that affect Labour Demand – 1) Changes in demand for the product– 2) Changes in labour productivity (technology,

etc)– 3) Change in the price of other factors (land,

human capital, etc.)

Shifters of Labor DemandShifters of Labor Demand

6

Shifters of Labour SupplyShifters of Labour Supply• Examples of Factors

other than Wage which affect Labour Supply:

• 1) Income, wealth• 2) Lifestyle• 3) The wage of

competing jobs

• 4) Expectations–Future wages–Income–Job availability

• 5) Population (workforce)

Essentially, all factors affecting demand Essentially, all factors affecting demand have a parallel affecting have a parallel affecting

labour supplylabour supply

7

Labour Market:Labour Market:Perfect CompetitionPerfect Competition

• 1. many firms competing with one another in hiring a specific type of labour.

• 2. numerous qualified workers with identical skills independently supplying this type of labour service.

• 3. neither firms nor workers can exert control over the market wage rate.

• price takers.

8

Wag

e

Labour Input (workers per week)

Wag

e

Labour Market: Perfect CompetitionLabour Market: Perfect Competition


D

S

Industry LabourMarket

The Firm: on the demand side is a

price taker

w1SL

L1

w1

9


• There are many households selling to many firms, and no one household or firm has any power to influence the price.

Demand for Labour Demand for Labour • Assume that the firm on the demand side of the

market is –buying (hiring) apple pickers in a perfectly

competitive labour market, and–selling apples in a perfectly competitive goods

market.

10

Labour Market: Perfect Competition: Labour Market: Perfect Competition: Demand for Labour.Demand for Labour.

• The firm, on the DemandDemand side of the market, is a “price taker”.

• It has to decide: –how many apple pickers to hire

• given the price of apples ( goods market)

• given the wage rate for apple pickers (factor market)

– in order to maximize profit

11

Marginal ReviewMarginal Review

Marginal Product of Labour• Additional production of last worker hired• MPL=Q /L

Marginal Revenue Product• Additional revenue of last worker hired• MRP=P x MPL• MRP= TR / L

12

The Competitive Firm Decides How Much The Competitive Firm Decides How Much Labour to Hire: Price of Apples=$10/bu. Labour to Hire: Price of Apples=$10/bu. Wage Rate=$500/weekWage Rate=$500/week

Labor (# of workers)

(L)0

1

2

3

4

5

Output

(Bushels/

Week)

(Q)

0

100

180

240

280

300

Marginal

Product of

Labour

(MPL=Q /L)

100

80

60

40

20

of Labour

(MRP=PxMPL)

$1000

800

600

400

200

TR Total

revenue

$1000

1800

2400

2800

3000

MRP marginal revenue product

MRP marginal revenue product

of Labour (TR / L)

$1000

800

600

400

200

13

The Demand for Labour: The Demand for Labour: The Profit Max Hiring DecisionThe Profit Max Hiring Decision

• In order to find the MR of the Profit Maximizing decision: The firm must consider :– 1. the production function - how the size of the work force

affects the amount produced by each worker, MPL

– 2. the contribution to revenue, MRPL, and to the profit equation that each worker makes

– MRP = TR / # of workers.– MRP = Product Price x MPL.

» When MP MRP .

14

Profit Maximizing Hiring DecisionProfit Maximizing Hiring Decision

• In order to find the MC of the profit maximizing decision; the firm must find– 3 The Marginal Factor Cost (MFC)

= wage rate in perfect competition = additional cost of hiring one more unit of labour in all types of

markets

• hire workers up to the point where:

MRP Wage (MFC)

(MR) (MC)

15

Demand for Labour:Demand for Labour:• The quantity of labour a firm will hire at any given

wage, cet. par.

To maximize profit the firm hires the quantity of labour where the

MRP = MFC (W in P.C.)

MRP schedule is the Demand for Labour, for a competitive profit maximizing firm

16


Wag

eProfit Max: MRP=W(MFC): Profit Max: MRP=W(MFC): The MRP is the Demand for LabourThe MRP is the Demand for Labour

D=MRP

0

•MRP = P x MPL

(the value of the worker’s output)•MFC = W (the cost of hiring a worker)•Optimal number of employeesoccurs where MFC = MRP

•Labour Demand is down sloping

Q2

W2 MFC

MFCW1

Q1

MFCW3

Q3Market demand for labour in perfect competition

17

““Shifters of Labour Demand”Shifters of Labour Demand”

• labour does not satisfy wants directly:

demand for resources is a demand for resources is a “Derived” Demand“Derived” Demand

and therefore depends on

1. How productive (MP) labour isNon labour inputs, technological progress,

labour quality, prices of other resources2.Price of the product3.Price of other inputs

18

Market Supply of LabourMarket Supply of Labour

• To attract workers, the wage rate paid must cover – the opportunity costs of alternative uses of time

spent,• in other labour markets, • in house-hold activities • in leisure.

• Higher wages attract people whose opportunity costs are not covered at lower wages: therefore the Supply of labour to any labour market is upward sloping.

19

Supply ShiftersSupply Shifters

• The supply of labour changes and the supply curve shifts if– The adult population changes

– Technology and capital in the home change

– Preferences change

20

Equilibrium Wage Rate:Equilibrium Wage Rate:Perfectly Competitive Labour MarketPerfectly Competitive Labour Market

Quantity of Labour

Wag

e R

ate

per

Wor

ker

per

Wee

k ($

)

D

S

00

498

Q1

Surplus

Shortage

The wage adjusts so Qn.D=Qn.SShifts of demand or supply will change the equilibrium wage and the MRPL by the same amount since they are always equal

The wage adjusts so Qn.D=Qn.SShifts of demand or supply will change the equilibrium wage and the MRPL by the same amount since they are always equal

21

Wag

e


Wag

e



D

S

Industry LabourMarket

The Firm: on the demand side is a

price taker

w1SL

L1

w1

22

MonopsonyMonopsonyMonopsonyMonopsony

• A monopsonist faces the Market Supply of Labour To hire more labour, a higher wage must be paid: marginal cost of labour (MFC) curve is upward sloping.

A monopsony is a market in which there is a single buyer.

A monopsony is a market in which there is a single buyer.

To maximize profit the monopsonist hires until the marginal cost of labour , that is , the marginal factor cost , is equal to the marginal revenue product.

To maximize profit the monopsonist hires until the marginal cost of labour , that is , the marginal factor cost , is equal to the marginal revenue product.

23

Supply of labour: monopsony in the hire of labourSupply of labour: monopsony in the hire of labour Supply of labour: monopsony in the hire of labourSupply of labour: monopsony in the hire of labour (1)

Units of labor

0

1

2

3

4

5

6

(2)

Wage rate

$5

6

7

8

9

10

11

(3)

Total labor cost (wage bill)

$0

6

14

24

36

50

66

(4)

Marginal factor(labour) cost

TFactorC/QL

$6

8

10

12

14

16

•the cost of an extra worker : MFC the wage rate by the amount needed to bring the wage rate of all workers currently employed up to the new wage.

•the cost of an extra worker : MFC the wage rate by the amount needed to bring the wage rate of all workers currently employed up to the new wage.

24

Marginal Factor Cost :Marginal Factor Cost : Monopsonist: Profit Max Employment Monopsonist: Profit Max EmploymentMarginal Factor Cost :Marginal Factor Cost : Monopsonist: Profit Max Employment Monopsonist: Profit Max Employment

Labour Input (worker-weeks)

MF

C a

nd M

RP

per

Wor

ker-

Wee

k ($

)

S

MFC

MRP

We

Qe

Wm

Qm

E

Hire Qm whereMFC = MRP andpay Wm

Hire Qm whereMFC = MRP andpay Wm

MRP > WMRP > W

•Monopsony decreases the level of employment and the wage rate, compared to perfect competition

25

Monopsony ResultsMonopsony ResultsMonopsony ResultsMonopsony Results

• Provides rationale for regulation of monopsony’s

A monopsony reduces employment and wages when compared to PC

A monopsony reduces employment and wages when compared to PC

Monopsonistic exploitation – workers are paid a wage rate less than the monopsonist’s revenues

Monopsonistic exploitation – workers are paid a wage rate less than the monopsonist’s revenues

• Programs such as work camps, free housing, and after-education work contracts can benefit the producers more than the workers

26

Minimum Wage in MonopsonyMinimum Wage in Monopsony

• The supply now becomes perfectly elastic at the minimum wage

• MFC follows suit

• To maximize profit, MFC =MRP monopsony hires 75 hours at $7.50 an hour.

Labour (hours per day)

Wag

e ra

te (

dolla

rs p

er h

our)

50

5.00

7.50

10.00

0 75

MRP = D

MFCL

SS

Minimum wage

Increase in employment

• The minimum wage has increased the wage rate by $2.50 an hour and the amount of labour employed by 25 hours a day.

27

2) Unions: Monopoly on the Supply 2) Unions: Monopoly on the Supply Side of the Labour MarketSide of the Labour Market

• In some markets, workers collectively “sell” their labour through unions.

• Labour unions are worker/employee organizations

• Engage in collective bargaining to establish a contract which sets out

• Wages,fringe benefits, maximum work days, working conditions

Imperfect Competition

28

Unions: Goal, Increase WagesUnions: Goal, Increase Wages

• Suppose a union is formed in an otherwise competitive market,

the union is bargaining with a large number of employers.

• Assume the major goalgoal is to increase wagesincrease wages

• A variety of ways to achieve thisA variety of ways to achieve this

29

Unions: Increase WagesUnions: Increase Wages

• 1) Increase Increase Demand for Labor.Demand for Labor.– increase demand for

the product - union label.

– Decrease demand for alternatives

• Often self-fulfilling, as higher wages lead to higher quality

– increase productivity

Quantity of Labour per Time Period

Wag

e R

ate

per

Hou

r

Qe

We E

S

D

D`

W1

Q1

Wage increases and Wage increases and more labour is hiredmore labour is hired

30

Unions: Increase WagesUnions: Increase Wages

• 2) Restrict Labour Supply

• exclusive or craft union: – union that

comprises workers of a given skill.

– occupational licensing. S1

Number of Workers per Time Period

Wag

e R

ate

per

Hou

r ($

)

D2

D1

Q2

E315

Q1

14 E1

If union membership is limited to Q1, wages increase to $16 instead of $15 when demand increases

16 E2

S2

31

Unions: Increase Wages Unions: Increase Wages

• 2) Restrict Labour Supply.

• inclusive/ industrial union: – union that seeks as

members all unskilled, semi skilled & skilled workers in a given industry.

SL

D=MRP

Wag

e R

ate

per

Hou

r ($

)


Wc

Qc

Supply becomes horizontal at the union wage rate: MFC=Wu.

SuWu

Qu

MRP=MFC

32

Unions: Goal, Increase WagesUnions: Goal, Increase Wages

• Contracts for higher wages can be negotiated via the THREAT of reduced labour supply (ie: a strike)

• Control over the supply side of the labour market is required here

33

Unions: Employ workersUnions: Employ workers

• 2) A union may want to employ more workers than at equilibrium. This requires, however a reduction in wage from W1 to W2

S1


Wag

e R

ate

per

Hou

r ($

)

D2

Q2

E3W2

This union goal is less common due to the decrease in wages for employed workersW1 E2

Q1

34

3.) Bilateral Monopoly3.) Bilateral Monopoly• In communities with a single major

employer, there is typically also a union.

A bilateral monopoly exists when a union (monopoly seller) faces a monopsony buyer.

Wages are determined by bargaining.

35

3.) Bilateral Monopoly3.) Bilateral Monopoly

• The monopsony hires 50 hours and pays $5/hour.

• The union may agree to work 50 hours, but seeks the highest wage rate the employer can be forced to pay — $10/hour=MRPL


Wag

e ra

te (

dolla

rs p

er h

our)

50

5.00

7.50

10.00

0 75

MRP

MCL

S

36

3.) Bilateral Monopoly3.) Bilateral Monopoly

• It is unlikely the union will get $10/hour or that the firm can keep wages at $5.00/hr.

• The monopsony firm and union bargain over the wage rate

• It will settle between $5 and $10/hour (depending upon who is stronger).


Wag

e ra

te (

dolla

rs p

er h

our)

50

5.00

7.50

10.00

0 75

MRP

MCL

S

37

Wage DifferentialsWage Differentials

• Wages & earnings typically exhibit wide variations:– 1) Labour Market Imperfections

– workers are not always mobile– institutional restrictions – unions..– discrimination – hiring practices - another

model of labour market imperfection

• If all labour was homogeneous and all jobs were equally attractive, and all labour markets were perfectly competitive, then all wages would be the same……..

38

Wage DifferentialsWage Differentials

– 2) Compensating Differences

–jobs vary in attractiveness

– 3) Non-competing Occupational Groups

–workers aren’t homogeneous, they have different ability, different education and training.

39

Union BenefitsUnion Benefits

– 1) Allows for increased productivity, skill and efficiency

– 2) Reduce wage inequality

– 3) Reduce profits (transfer surplus to workers)

– 4) Provide a voice for workers

– 5) Increase workforce stability (and job security)

40

Union DrawbacksUnion Drawbacks

– 1) Job security can lead to reduced productivity. Free-riding = expecting others to work hard

Featherbedding = forcing employers to use more workers than needed

– 2) Increase wage inequality between union and non-union workers

– 3) Cause businesses with little economic profit to fold, resulting in unemployment

– 4) Generally causes unemployment– 5) Often prevents natural market mechanisms to

take place (ie: raises to hard workers, fire others)

Documents

1 Markets for Factors of Production Factors of Production -Land -Labour -Physical Capital -Human Capital -Other These factors are bought and sold in a