Labor Markets: Demand, Supply, and Outsourcing

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Chapter 29

• Labor Markets Demand, Supply, and Outsourcing

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Things to understand

• Resource markets vs. product markets
• MPP (Marginal Physical Product), MRP (Marginal
  Revenue Product), MFC (Marginal Factor Cost)
• Determine MRP schedule
• Determining profit maximizing firm decides mix of
  resources to purchase
• Determinants of wage rates

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Things to understand cont.

• Why resource demand curve will shift
• Impact of input price elasticity of demand
• Why equilibrium wages might differ in different
  labor markets
• Determine least-cost combination of resources
• Rules for deciding how much resource to employ
  while minimizing cost and maximizing profit
• Labor outsourcing concept and impact

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Where does circular flow start?
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Primary and Derived Demand

• Think of circular flow. What comes first, the
  demand for resources or the demand for products?
• Primary demand is the demand for products in the
  product markets.
• The demand for inputs is derived from the demand
  for products. It is derived demand.
• If there was no demand for a product, there would
  be no demand for the inputs needed
  to produce the product.

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Primary Supply Derived Supply

• Think of circular flow model. What comes first,
  the supply of resources or the supply of
  products?
• Primary Supply is the supply of resources
  (inputs) to the resource markets.
• The supply of products is derived from the supply
  of resources. It is derived supply.
• If there were no supply of resources, there could
  not be a supply of product.

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Circular flow starts with households.
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Resource Markets vs Product Markets

• Resource market
• Demand firms, derived demand
• Supply households individuals, primary supply
• Product market
• Demand households individuals, primary demand
• Supply firms, derived supply

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Marginal Physical Product (MPP)

• Change in output resulting from the use of one
  more unit of an input.
• Another name for marginal product (MP). It
  eventually declines due to law of the diminishing
  returns.
• Computed in relation to a specific input.
• Formula Change in TP / Change in Q input

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Marginal Revenue Product (MRP)

• Change in total revenue when the additional
  output produced by the use of an additional unit
  is sold.
• TR after additional unit of input used minus TR
  before input added.
• Formula MRP MR x MP
• Computed in relation to a specific input

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Example of MRP of labor
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Marginal factor cost (MFC)

• Change in total costs when one more unit of an
  input is purchased.
• Formula MFC Change in TC / Change in Q input
• Computed in relation to a specific input.
• In perfectly competitive input market, MFC
  Price of input
• NOTE MFC is NOT MC
• MC change in TC when 1 more unit of output
  produced

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Formulae

• TR P x Q
• MP change in TP / change units input
• MR change in TR / change in Q output sold
• MRP MR x MP
• MFC Change in TC / Change in Q input

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How to profit when purchasing inputs?

• MRP is change in revenue from buying one more
  unit of input.
• MFC is change in cost from buying one more unit
  of input.
• Whether or not purchasing an additional input
  adds to profits depends on comparison of MRP and
  MFC.

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Rule for profit-maximizing firm

• Purchase each input so that MRP MFC for each
  input.
• MRPL MFCL and MRPC MFCC and MRPSL MFCSL
• When MRP MFC, then the extra revenue from
  buying using an extra unit of input is exactly
  equal to the extra cost of buying and using an
  extra unit of input.
• If MRP gt MFC, buying extra unit of input adds
  more to revenues (MRP) than to costs (MFC). It
  would increase firms profits to purchase/use
  additional input.
• If MRP lt MFC, buying extra unit of input adds
  more to costs (MFC) than to revenues (MRP). The
  firm should cut back on use of the input to
  increase its profits.
• In perfectly competitive labor market, MFC
  Input price, thus profit-maximizing input mix is
  to purchase inputs such that
• MRPL PL and MRPC PC and MRPSL PSL

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MRP Curve as input demand curve

• MRP is extra revenue possible from purchase/use
  of one more unit of an input.
• Maximum amount a firm would be willing to pay for
  an input is its MRP.
• MRP MR x MP
• MR constant (perfect competition) or falling
  (other market structures)
• MP rises and then falls
• Therefore MRP curve tends to have negative slope
  with MRP on vertical axis and units input on
  horizontal axis.
• MRP Curve for a resource becomes a firms demand
  curve for that resource because MRP is the
  maximum amount that a firm would be willing and
  able to pay for a unit of the resource.
• The demand for a resource in its resource market
  is the sum of the individual firm demands for it.

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Input demand curve is MRP curve

• 
  MRP
• 
  Q of input

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Determinants of Demand Elasticity for Inputs

• Price elasticity of demand for a variable input
  will be greater
• The greater the price elasticity of demand for
  the final product
• The easier it is to substitute another input for
  the particular variable input of focus
• The larger the proportion of total costs
  accounted for by the particular variable input of
  focus
• The longer the time period being considered

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Labor Market Example of Input Market

• Interaction of labor supply and labor demand.
• Many different labor markets for different
  skills/abilities
• Positive relationship between the wage rate and
  the quantity of workers supplied
• Negative relationship between wage rate and
  quantity of workers demanded
• NOTE Labor is being bought and sold, NOT jobs.
  Workers are supply of labor. Firms demand labor.

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Equilibrium Wage in Labor Market

• 
  Supply
• W
• 
  Demand
• 
  Quantity workers

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Influences on labor demand

• Changes in product demand
• Changes in labor productivity
• Changes in prices of substitute inputs
• Changes in prices of complementary inputs

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Influences on labor supply

• Changes in Labor-Leisure trade-off (preferences)
• Changes in wages of other markets
• Changes in working conditions in labor market
• Changes in other non-wage factors such as child
  care, retirement plan
• Costs of acquiring necessary skills

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Why income differences?

• Who does more for health of community doctor or
  garbage collector?
• Who does more for well-being of community
  sports superstar or elementary school teacher?
• Who contributes more to well-being in community
  illegal drug dealer or policeman?

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Cost Minimization

• To minimize total costs for a particular rate of
  production, the firm will hire factors of
  production up to the point at which the marginal
  physical product per last dollar spent on each
  factor is equalized.
• MPP of labor / price of labor MPP of capital /
  price of capital MPP of land / price of land
• Otherwise, adjustments in mix of inputs would
  allow same quantity to be produced at lower total
  cost

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Cost Minimizing Mix of Inputs

• To minimize total cost for given output level,
  firm should purchase inputs in mix such that MP
  per last dollar spent is equal for each input.
• MPL / PL MPC / PC MPSL / PSL
• Otherwise adjustments in input mix would allow
  same output quantity to be produced at lower
  total cost.

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Input Market Guideline Summary

• Cost minimization
• MPL / PL MPC / PC MPSL / PSL
• Profit maximization
• MRPL MFCL and MRPC MFCC and MRPSL MFCSL

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Labor Outsourcing

• Employment of labor outside country in which firm
  is located
• Reduces labor demand in firms country
• Increases labor demand in outside country
• Type of trade in input markets should be based
  on comparative advantage

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The end