Principles of Economics, Case and Fair,8e

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(No Transcript)
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Overview

• Input Markets
• Basic ConceptsDemand for Inputs A Derived
  Demand
• Labor MarketsA Firm Using Only One Variable
  Factor of Production LaborA Firm Employing
  Two Variable Factors of Production in the
  Short and/or Long Run
• Land Markets
• The Firms Profit-Maximization Condition Input
  Markets

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INPUT MARKETS BASIC CONCEPTS

• Decisions made by firms
• How much to supply?
• What type of technology to use?
• How much of each input to demand?
• In this chapter focus on how much of each input
  to demand.
• Inputs Raw Materials, Intermediate goods, Labor,
  Land, Capital

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INPUT MARKETS BASIC CONCEPTS

• Labor Markets
• Same results as any other type of factor market
  except when
• Inputs are in fixed supply (Land)
• Inputs last many periods of time (Capital)-Ch. 10

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INPUT MARKETS BASIC CONCEPTS

• A DERIVED DEMAND FOR INPUTS
• derived demand The demand for resources (inputs)
  that is dependent on the demand for the outputs
  those resources can be used to produce.

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INPUT MARKETS BASIC CONCEPTS

• A DERIVED DEMAND FOR INPUTS Points
• The value firms attach to inputs will in part be
  dependent on how much society values what the
  inputs produce
• Example
• Cashiers at fast food restaurant get paid low
  wages. In part this is due to the fact that
  society does not attach a high value to this type
  of food.
• Doctors are paid relatively high wages because
  what they produce is highly valued by society.

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INPUT MARKETS BASIC CONCEPTS

• A DERIVED DEMAND FOR INPUTS Points
• 2. The value firms attach to inputs will in part
  be dependent on the factors productivity (how
  much these inputs can produce)
• A firm would be willing to pay higher wages to
  workers that are much more productive.

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INPUT MARKETS BASIC CONCEPTS

• Equilibrium prices of inputs are determined by
  the intersection of Market Factor Supplies and
  Demands.
• First focus on Demand for labor by a particular
  firm.

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DERIVING THE DEMAND FOR LABOR

• Only one variable input (labor)
• At least one input fixed. This implies that at
  some point diminishing returns to labor will set
  in.
• In the short run, expect that at some point MPL
  will eventually start to decrease.

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DERIVING THE DEMAND FOR LABOR

• Marginal product of labor (MPL) The additional
  output produced by one additional unit of labor.
• Average Product of labor (APL) The amount of
  output produced per unit of labor
• Diminishing Returns If at least one input is
  fixed, eventually the MPL will start to fall as
  additional units of labor are employed.

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DERIVING THE DEMAND FOR LABOR

• Two additional terms
• Marginal revenue product (MRPL)
• MRPL MPLPrice of output
• Average revenue product (ARPL)
• ARPL APLPrice of output

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DERIVING THE DEMAND FOR LABOR

• Want to derive the firms demand for labor
  (quantity demanded for different wage rates)
• Use a cost-benefit analysis
• Hire an additional worker if the benefit from
  doing so exceeds the costs.
• What is the benefit from hiring an additional
  unit of labor?
• More output is produced
• More output can be sold increasing revenues
• What is the cost from hiring an additional unit
  of labor?
• Must pay worker

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DERIVING THE DEMAND FOR LABOR

• marginal revenue product (MRP)
• The additional revenue a firm earns by employing
  one additional unit of input, ceteris paribus.
• Additional costs from hiring one more unit of
  labor is the wage rate (w).

MRPL MPL x PX
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DERIVING THE DEMAND FOR LABOR

• A profit maximizing firm will want to hire
  another worker if the additional revenues
  generated exceed the additional costs. (hire more
  workers if MRPLgtW)
• A firm will want to fire the last worker if the
  decrease in costs exceeds the loss in revenues.
  (hire fewer workers if MRPLltW)
• A profit maximizing firm will hire the optimal
  amount of labor where the MRPL of the last worker
  equals the market wage rate.

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DERIVING THE DEMAND FOR LABOR

• Assume that labor is the only variable input.
• Recall,
• Joes Sandwich Shop has 1 grill which can
  accommodate 2 people comfortably. The shop itself
  is also relatively small.
• The following table describes the number of
  sandwiches that Joe can produce given the fixed
  size of his facility and the number of workers
  that he employs.

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DERIVING THE DEMAND FOR LABOR
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DERIVING THE DEMAND FOR LABOR
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DERIVING THE DEMAND FOR LABOR
FIGURE 10.2 Deriving a MarginalRevenue Product
Curvefrom Marginal Product
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DERIVING THE DEMAND FOR LABOR
MRP, WAGE
7.5 5 2.5 1
1 2 3 4 5 6
MRPL
L
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DERIVING THE DEMAND FOR LABOR

• The profit maximizing firm chooses the quantity
  of labor where the MRPL of the last worker hired
  exactly equals the wage rate.
• Will a firm always demand a positive amount of
  labor? What if the wage rate is really large?
• In other words, what is the shut-down point when
  the firm finds it more profitable to shut-down
  and produce q0?

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DERIVING THE DEMAND FOR LABOR

• A firm will shut-down if the profits from doing
  so exceed the profits from continuing to operate.
• Shut down if PltAVC
• Here there is only one variable input (labor) so
  the only variable costs are labor costs (wL),
  such that AVCwL/q
• Shut down if
• P lt wL/q
• Pq/L lt w
• PAPLlt w
• ARPLlt w
• A firm should shut-down if the wage exceeds the
  ARPL .

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DERIVING THE DEMAND FOR LABOR
MRP, WAGE
ARPL
7.5 5 2.5 1
1 2 3 4 5 6
MRPL
L
The firms short run demand for labor is given by
the part of the MRPL curve below the ARPL
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DERIVING THE DEMAND FOR LABOR
A representative firm
The Labor Market

w
w
S
ARPL
w
MRPL
D
Units of Labor
Units of Labor
l
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DERIVE THE DEMAND FOR LABOR

• The firms short run demand for labor is given by
  the part of the MRPL curve below the ARPL
• MRPLMPLPrice of output
• Notice
• If the price of output increases or if labor
  became more productive, the firms demand for
  labor would increase. (would shift the MRPL curve
  upward)
• When there is at least one fixed input,
  diminishing returns guarantees that the demand
  for labor is downward sloping.

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THE DEMAND FOR LABOR WITH MORE THAN ONE VARIABLE
FACTOR

• There may be more than one variable factor in the
  short run and all factors are variable in the
  long run.
• Firms employing just one variable factor of
  production, a change in the price of that factor
  affects only the demand for the factor itself.
• When more than one factor can vary, however, a
  change in one factor price will affect the demand
  for other factors as well.

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THE DEMAND FOR LABOR WITH MORE THAN ONE VARIABLE
FACTOR

• 2 effects when the price of one factor changes
• factor substitution effect The tendency of firms
  to substitute away from a factor whose price has
  risen and towards the other factor.
• output effect of a factor price change When a
  factor price increases, this increases costs and
  consequently decreases the supply of output. As a
  result, the firm will produce less and demand
  fewer of both factors.

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THE DEMAND FOR LABOR WITH MORE THAN ONE VARIABLE
FACTOR

• Example 1
• Suppose there are two variable inputs labor and
  capital, employed to produce a good. The price of
  labor increases.
• Substitution effect capital use should increase
• labor use should
  decrease
• Output effect less output will be produced so
  both capital and labor use should decrease.
• Net effect on capital use is ambiguous, the net
  effect on labor is negative.

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THE DEMAND FOR LABOR WITH MORE THAN ONE VARIABLE
FACTOR

• Example 2
• Suppose there are two variable inputs labor and
  capital, employed to produce a good. The price of
  capital decreases. What are the substitution,
  output, and net effects on the quantity demanded
  of labor and capital?

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LAND MARKETS

• The supply of land of a given quality at a given
  location is truly fixed in supply.
• If there are no alternative uses of the land,
  then the owner will have a perfectly inelastic
  supply curve.
• The price will then be determined by the demand
  (how much consumers are willing to pay)
• demand determined price The price of a good that
  is in fixed supply it is determined exclusively
  by what firms and households are willing to pay
  for the good.

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LAND MARKETS
FIGURE 10.6 The Rent on Land Is Demand Determined
The supply of land of a given quality at a given
location is truly fixed in supply. Its value is
determined exclusively by the amount that the
highest bidder is willing to pay for it.
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LAND MARKETS

• Implications
• The price of land will be determined by the
  demand for its use.
• The demand for land is a derived demand. Depends
  on how productive is the land for its use and the
  price of the good that the land would be used to
  produce. (MRP of Land)
• For example More agricultural or even desert
  land will be developed when there is an increase
  in the demand for housing because land is a key
  input used in the production of housing.

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THE FIRMS PROFIT-MAXIMIZATION CONDITION IN INPUT
MARKETS
Profit-maximizing condition for the perfectly
competitive firm for any input is to choose the
quantity of the factor where the factors price
exactly equals the marginal revenue product of
the last unit hired. PL MRPL (MPL x PX) PK
MRPK (MPK x PX) PA MRPA (MPA x
PX) where L is labor, K is capital, A is land
(acres), X is output, and PX is the price of
that output.