Input Demand: Labor and Land Markets

1
Input Demand Labor and Land Markets
2
Demand for Inputs A Derived Demand

• Derived demand is demand for resources (inputs)
  that is dependent on the demand for the outputs
  those resources can be used to produce.
• Inputs are demanded by a firm if, and only if,
  households demand the good or service produced by
  that firm
• ? this means that firms will layoff employees
  when the demand for its product falls and will
  hire fewer workers when the price of labor
  (wages) increases.

3
Inputs Complementary and Substitutable

• The productivity of an input is the amount of
  output produced per unit of that input.
• Labor Productivity Q/L (output per hour of
  labor)
• Inputs can be complementary or substitutable.
  This means that a firms input demands are
  tightly linked together.
• Complements as the firm hires more workers, it
  will need to employ more machinery (computers,
  etc.) for labor to use.
• Substitutes as labor becomes more costly firms
  will automate by buying machinery that can do
  what labor does.

4
Marginal Product and Marginal Revenue Product

• Faced with a capacity constraint in the
  short-run, a firm that decides to increase output
  will eventually encounter diminishing marginal
  product.
• Marginal product of labor (MPL) is the additional
  output produced by one additional unit of labor.
• Marginal Revenue Product of Labor (MRPL) is the
  additional revenue a firm earns by employing one
  additional unit of labor, holding all else
  constant.
• Suppose Px is the price of output ? MRPL Px
  MPL

5
Marginal Revenue Product Per Hour of Labor in
Sandwich Production (One Grill)
(1)TOTAL LABOR UNITS (EMPLOYEES) (2)TOTALPRODUCT (SANDWICHES PER HOUR) (2)TOTALPRODUCT (SANDWICHES PER HOUR) (2)TOTALPRODUCT (SANDWICHES PER HOUR) (3)MARGINAL PRODUCT OF LABOR (MPL) (SANDWICHES PER HOUR) (3)MARGINAL PRODUCT OF LABOR (MPL) (SANDWICHES PER HOUR) (3)MARGINAL PRODUCT OF LABOR (MPL) (SANDWICHES PER HOUR) (4)PRICE (PX) (VALUE ADDED PER SANDWICH)a (4)PRICE (PX) (VALUE ADDED PER SANDWICH)a (4)PRICE (PX) (VALUE ADDED PER SANDWICH)a (5)MARGINAL REVENUEPRODUCT (MPL X PX)(PER HOUR) (5)MARGINAL REVENUEPRODUCT (MPL X PX)(PER HOUR) (5)MARGINAL REVENUEPRODUCT (MPL X PX)(PER HOUR) (5)MARGINAL REVENUEPRODUCT (MPL X PX)(PER HOUR)
0 0 - - -
1 10 10 .50 5.00
2 25 15 .50 7.50
3 35 10 .50 5.00
4 40 5 .50 2.50
5 42 2 .50 1.00
6 42 0 .50 0
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6
Marginal Revenue Product Per Hour of Labor in
Sandwich Production (One Grill)
MRPL PxMPL

• When output price is constant, the behavior of
  MRPL depends only on the behavior of MPL.
• Under diminishing returns, both MPL and MRPL
  eventually decline.

7
Determining the Profit-Max Level of Labor What
is the Firms Demand for Labor?

• A competitive firm using only one variable factor
  of production will use that factor as long as its
  marginal revenue product exceeds its unit cost.
• If the firm uses only labor, then it will hire
  labor as long as MRPL is greater than the going
  wage, W.
• Suppose W 2.50 ?

8
In General
Labor Market
Representative Firm
S
W
D
MRPL
labor
L
Labor
When a firm uses only one variable factor of
production, that factors marginal revenue
product curve is the firms demand curve for that
factor in the short run.
Profit-max rule hire L where MRPL W
9
Comparing Marginal Revenue and Marginal Cost to
Maximize Profits

• We have 2 profit-maximizing rules
• The output rule choose q where MR MC
• The input rule choose L where MRPL W
• These two rules should be consistent the L
  from the input rule should be capable of
  producing the q units from the output rule.
• Assuming that labor is the only variable input,
  if society values a good more than it costs firms
  to hire the workers to produce that good, the
  good will be produced.
• Firms weigh the value of outputs as reflected in
  output price against the value of inputs as
  reflected in marginal costs.

10
The Two Profit-Maximizing Conditions

• The two profit-maximizing conditions are simply
  two views of the same choice process.

11
Many Labor Markets

• If labor markets are competitive, the wages in
  those markets are determined by the interaction
  of supply and demand.
• Firms will hire workers only as long as the
  value of their product exceeds the relevant
  market wage. This is true in all competitive
  labor markets.
• Examples

12
Land Markets

• Unlike labor and capital, the total supply of
  land is strictly fixed (perfectly inelastic).

13
Demand Determined Price

• The price of a good that is in fixed supply is
  demand determined.
• Because land is fixed in supply, its price is
  determined exclusively by what households and
  firms are willing to pay for it.

The return to any factor of production in fixed
supply is called pure rent.
14
Land in a Given Use Versus Land of a Given Quality

• The supply of land in a given use may not be
  perfectly inelastic or fixed.

• The supply of land of a given quality at a given
  location is truly fixed in supply.

15
Rent and the Value of OutputProduced on Land

• A firm will pay for and use land as long as the
  revenue earned from selling the output produced
  on that land is sufficient to cover the price of
  the land.
• The firm will use land (A) up to the point at
  which

MRPA PA
Where MRPA is defined as PxMPA
16
The Firms Profit-Maximization Condition in Input
Markets

• Profit-maximizing conditions for the perfectly
  competitive firm with 3 types of variable inputs
  are

PL MRPL PxMPL PA MRPA PxMPA PK MRPK
PxMPK
where L is labor, K is capital, A is land
(acres), X is output, and PX is the price of that
output.
17
The Firms Profit-Maximization Condition in Input
Markets

• Profit-maximizing condition for the perfectly
  competitive firm, written another way is

• In words, the marginal product of the last dollar
  spent on labor must be equal to the marginal
  product of the last dollar spent on capital,
  which must be equal to the marginal product of
  the last dollar spent on land, and so forth.

18
Input Demand Curves
MRPLPXMPL

• If product demand increases (Px ?), product
  price will rise and marginal revenue product will
  increase
• ? The Firms demand for inputs increases.

19
Input Demand Curves
MRPLPXMPL

• If the productivity of labor increases (due to
  more, better machinery/computers), marginal
  product increases causing marginal revenue
  product will increase
• ? The firms demand for labor will increase.

20
Impact of Technological Change

• Technological change refers to the introduction
  of new methods of production or new products
  intended to increase the productivity of existing
  inputs or to raise marginal products.
• Technological change can, and does, have a
  powerful influence on factor demands.
• When we aggregate up all the firms higher demand
  curves for labor, we see the entire demand curve
  for labor shift right, pushing up wages.