UNIT 5: FACTOR MARKETS Why does a coach get paid $6 million?

UNIT 5:FACTOR MARKETS

Why does a coach get paid $6 million?

1. Define derived demand2. Define & graph Demand for Labor (DL)

& Supply for Labor (SL)

3. Define & graph Marginal Revenue Product (MRP) and Marginal Resource Cost (MRC)

4. Effects of shifts in the market supply or demand for resources

5. Define & graph a perfectly competitive labor markets

6. Review & graph imperfectly competitive labor markets

In this section we will examine:

Basic Graphing in Factor Markets

&MRP = MRC Rule

Factor Market Overview

Basic view of the market for resource is a mirrored image of the product market.

SProduct

DP

Pric

e

QProduct5000

$10

Industry

SLabor

DLabor

Wag

e

QResource/Labor5000

$10

Industry

Vocab: Derived Demand

The demand for a factor of production is a derived demand.

It is derived from the demand for the goods and services the factor of production is used to produce.

In other words, if the demand for a good such as wheat increases, then the productivity increases, which leads to an increase in labor.

Vocab: Marginal Revenue Product

Value of Marginal Product (VMP) is the additional revenue that results from the additional product produced when more inputs are added.

The value of marginal product is simply: Marginal product x the price for those

additional units.

Value of MarginalProduct

=Change inMarginal Product

Price of those

additional units

x

Vocab: Marginal Revenue Product

Marginal Revenue Product (MRP) is the change in revenue that results from the addition of one extra unit when all other resources are kept equal.

The MRP is often used to calculate the affect of adding employees, as companies want to add employees up to the point at which additional labor won't bring in enough revenue to cover costs.

Marginal Revenue Product (MRP)

The additional revenue generated by an additional worker (resource).

Another way to calculate MRP is:

Marginal Revenue Product (MRP):

MarginalRevenueProduct =

Change inTotal Revenue

Change inInputs

How much are those unit of labor worth in term of

additional revenue?

MarginalRevenueProduct = Marginal Revenue Marginal Productx

Marginal Revenue Product (MRP)

Marginal Revenue Product:

Assumes $3 per wash.

MarginalRevenueProduct

Also called the marginal revenue product curve.

DL=MRP

Factor Market: Vocab

The orange line is the firm’s value of the marginal revenue product of labor curve.

Thus the demand for labor is the marginal revenue product curve.

Marginal Revenue Product:

Assumes $3 per wash.

Vocab: Marginal Resource Cost (MRC)

Marginal Resource Cost (MRC):The additional cost of an additional resource.

Another way to calculate MRC is:

MarginalResource

Cost=

Change inTotal Cost

Change inInputs

How much extra does each resource

cost me?

Materials

Technology Labor

Vocab: Marginal Resource Cost (MRC)

Marginal Cost Labor (MCL):The additional cost of an additional worker.

Another way to calculate MCL is:

MarginalCost Labor =

Change inTotal Cost

Change inLabor

How much extra does each laborer

cost me?

Labor

Basic View of MRP & MRC

MRC = SResource

MRP = DResource

Cost of R

esource

QResource5000

$10

Firm

It is almost a mirrored image of the product market graph.

Most beneficial amount of inputs to employ.

Basic View of MRP & MRC

Use supply and demand analysis to explain why surgeons earn an average salary of $137,050 and gardeners earn $13,560.

Quantity of Workers

Wag

e Rate

SL

DL

Supply and Demand For Surgeons Supply and Demand For Gardeners

Quantity of Workers

Wag

e Rate

SL

DL

MRP = MRC RULE

Continue to hire until…

MRP = MRC

How do you know how many resources (workers) to employ?

This is similar to the MC = MR

rule in the product market

MRP = MRC RULE


0

1

2

3

4

5

6

7

PIZZA (only 1 Oven)

0

2

7

10

12

13

13

10

-

Quantity of Workers

Total Product(Pizzas)

Marginal Product

Wage = $20 Price = $10

Marginal Revenue Product

-

Marginal Resource

Cost

This example assumes a perfectly

competitive product market

This example assumes a perfectly

competitive labor market. More on this

later

MRP = MRC RULE

0

1

2

3

4

5

6

7

PIZZA (only 1 Oven)

0

2

7

10

12

13

13

10

- 2

5

3

2

1

0

-3

Quantity of Workers

Total Product(Pizzas)

Marginal Product

Wage = $20 Price = $10

Marginal Revenue Product

- 20

50

30

20

10

0 -30

Marginal Resource

Cost

20

20

20

20 20

20

20


The firm should NOT hire more than 4 workers.

(MRP = MRC)Thus this logic applies to all

inputs.

MRP = MRC RULE

Quantity of Labor

$20

100 4

SL=MRC

As long as MRP > MRC the firm will

continue to hire inputsWageLABOR MARKET

Quantity of Labor

WageFIRM

$20

SL

DL DL=MRP

The firm will stop hiring inputs at the 4th worker since any more workers (given

current other fixed inputs) will result in diminished returns on the marginal unit

produced.

Note: One would not stop hiring here since there is additional marginal

revenue per unit of product to achieve.

SHIFTERS OF RESOURCE DEMAND

Shifters of Resource Demand

1.) Changes in the Demand for the Product • Price increase of the product increases MRP and

demand for the resource.

3.) Changes in Price of Other Resources• Substitute Resources

Ex: What happens to the demand for assembly line workers if price of robots falls?

• Complementary ResourcesEx: What happens to the demand for nails if

the price of lumber increases significantly?

2.) Changes in Productivity• Technological advances increase

Marginal Product and therefore MRP/Demand.

PERFECTLY COMPETITIVE LABOR MARKET

We are stuck making the same wage as

everyone else in this labor market!

Types of Factor MarketsPerfect

Competition Monopsony

Perfectly Competitive Labor Market

Characteristics: Many small firms are hiring workers

No one firm is large enough to manipulate the market.

Many workers with identical skills Wage is constant: firms are wage takers

Firms can hire as many workers as they want at a wage set by the industry



Perfectly Competitive Labor MarketNumber of

Workers Wanted Wage that Must Be Paid

To Attract an Extra Worker Marginal Cost of Labor

(MCL) 1 $4.00 +$4.00 2 $4.00 +$4.00 3 $4.00 +$4.00 4 $4.00 +$4.00

MRC = Wagesame as

MCL = Wage

Wage

Q

Wage

Q

Industry FirmQE

WE

Qe


Generally this condition is found in low skilled labor markets.

SL

DLDL=MRP

SL=MRC

Wage

Q

Wage

Q

Industry FirmQE

Qe

What happens to the wage and quantity in the market and firm if new workers enter the industry?

W1

Q1Q1


SL

SL1

DLDL=MRP

SL=MRC

SL1=MRC1

WE


Suxs to be a

Wage Taker

I am stuck making the

same wage as everyone else!

In perfectly competitive labor markets there is sometimes the pressure to unionize workers in an effort to increase the wage above the market equilibrium wage.United

Auto Workers

Practice: What should the firm do – hire more, hire less, or stay put?

1. MRPL = $15; PL = $6 2. MRPL = $10; PL = $10

2. MRPL = $5; PL = $10 4. MRPL = $10; PL = $15

3. MRPL = $25; PL = $20 6. MRPL = $15; PL = $15

4. MRPL = $12; PL = $12 8. MRPL = $50; PL = $40

MORE

LESS

STAY PUT

MORE

MORE

STAY PUT

STAY PUT

LESS

IMPERFECT LABOR MARKET

Monopsony



Monopsony Labor Market

Characteristics: Few large firms are hiring workers

One firm is large enough to manipulate the labor market.

Wage is NOT constant: firms are wage makers If the monopsonist wants to increase the number of

workers that it hires, it must increase the wage that it pays to all of its workers, including those whom it currently employs.

Monopsonist (Greek: mono”single” - opsonia”purchase”)

Imperfect Labor Market

Monopsonist (Greek: mono”single” - opsonia”purchase”)

An employer is said to be a monopsonist if the employer must increase the wage offered to workers in order to attract additional workers.

1. A non-discriminating monopsonist is an employer who must increase the wage offered to workers in order to attract more workers.

2. A discriminating monopsonist is one that pays the higher wage only to the extra worker for whom the employer raised the wage. Could be illegal!!

There are two types of monopsonists:


MonopsonistNon-discriminating monopsonist: true cost to the firm of adding an extra worker (MRC) will be greater than the wage paid to that worker. [MRC > Wage]

MRC = MRP

MRC doesn’t equal wage


MonopsonistNon-discriminating monopsonist: true cost to the firm of adding an extra worker (MRC) will be greater than the wage paid to that worker. [MRC > Wage]

Number of Workers Wanted

Wage that Must Be Paid To Attract an Extra Worker

Marginal Cost of Labor (MCL)

1 $4.00 +$4.00 2 $4.10 +$4.20 3 $4.20 +$4.40 4 $4.30 +$4.60

MRC

MRC

“Glass Ceilings”

The Labor Market:Minimum Wage Laws &

Unions

How can raising

minimum wage cause higher

unemployment?

Wage

Q

Wage

Q

IndustryQE

WE

Qe


Generally this condition is found in low skilled labor markets.

If viewed to be too low. The government attempts to

adjust the wage.SL

DLDL=MRP

SL=MRC

$10Minimum

Wage

Qmin

Wminimum

Surplus of Labor

QDL QSL

Unionized Labor Market

1. A labor union restricts the supply of labor and the supply of labor curve shifts leftward to LS1.

2. The wage rate rises to $15 an hour, but employment decreases to 200 workers.

3. Jobs are traded off for a higher wage rate.

Unionized Labor Market

4. If union action increases labor productivity, the demand for union labor increases and the demand for labor curve shifts rightward to LD1.

5. The wage rate rises to $20 an hour and employment increases to 250 workers.

LEAST COST RULE

Up to this point we have analyzed the use of only one resource.

What about when a firm wants to combine different resources?

MPx = MPyPx Py

If you only have $35, the best combination is 2 robots and 3 workers

Robots MP(Robots)

MP/PR(PriceR =$10)

Workers MP (Workers)

MP/PW(PriceW =$5)

1 30 3 1 20 4

2 20 2 2 15 3

3 10 1 3 10 2

4 5 .50 4 5 1

$10 $5

Least Cost Rule

How much additional output does each resource generate per dollar spent?

If you only have $35, the best combination is 2 robots and 3 workers

Robots MP(Robots)

MP/PR(PriceR =$10)

Workers MP (Workers)

MP/PW(PriceW =$5)

1 30 3 1 20 4

2 20 2 2 15 3

3 10 1 3 10 2

4 5 .50 4 5 1

$10MPx = MPy

Px Py $5

Least Cost Rule

Profit Maximizing Rule for a Combining Resources

MRPx MRPy MRCx MRCy 1

This means that the firm is employing resources where

MRP = MRC for each resource.

= =

2010 Practice FRQ

42

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UNIT 5: FACTOR MARKETS Why does a coach get paid $6 million?