The other side of the circular flow model Factor Markets The other side of the circular flow model

In the Factor Market…. Businesses demand resources Households supply the resources Four Factors of Production Land-resources provided by nature Labor-work done by human beings Capital – 2 kinds (new) Physical Capital – “capital”, manufactured resources Human Capital – improvement in labor created by education & knowledge Entrepreneurship – risk taking activities that bring resources together to produce and innovate

Derived Demand Demand for factors (resources) is driven by the demand for the product that the firm produces Ex: People want more bottled watered then the need for plastics, labor, water, etc. by firms increases.

Marginal Analysis – Yet again Marginal Revenue Product (MRP) Change in total revenue from adding an extra unit of labor MRP=ΔTR/ΔL If product market is perfectly competitive MRP=(MP)(P)

Marginal Analysis – Continued Marginal Resource Cost (MRC) Change in total cost from adding an extra unit of labor MRC=ΔTC/ΔL If labor market is perfectly competitive you can use MRC=wage

Profit-Maximizing To maximize profit, firms will hire additional units of a resource up to the point where marginal revenue product (MRP) is equal to marginal resource cost (MRC). MRP=MRC Similar to the MR=MC rule used to determine profit-maximizing output Activity 4-1 part A

Firm’s MRP Curve The downward sloping portion of the firm’s MRP curve is its demand curve for labor IF the labor market is perfectly competitive In a perfectly competitive market, MRC=wage Optimal amount of labor is where the horizontal supply curve, S=MRC intersects the MRP curve Downward sloping because if firm stops hiring at a point on the upward-sloping portion, it will miss some labor units that have MRP>MRC Activity 4-1, part B & C

Cost-Minimizing Input Combinations In LR, firm must decide the combination of resources Want to maximize profits Needs to minimize costs Two resources: Labor and Capital Economically efficient Produce given output at lowest total cost Produce the most possible given total cost Requires resource combinations where marginal product per dollar is the same for all resources To maximize profit, MRP=MRC for each input Economic efficiency is necessary but not sufficient condition for profit maximization Activity 4-2

A Monopolist firm in the Labor Market Still hires in a perfectly competitive labor market. Hire all the workers it wants at the market wage rate Marginal Revenue Product (MRP) curve is demand for Labor In order to sell more product, a monopolist has to ……. MR  as it hires more labor Extra workers are less valuable Activity 4-3 and 4-4 Lower its price. Remember the wedge shape and downward sloping demand curve?

Recap: S & D for Labor in a Competitive Labor Market Firm that is hiring is a wage-taker Wage is determined by the market and is where S and D curves intersect Market labor demand curve slopes downward. Why? Market labor supply curve slopes upward. Why? D curve = MRP (marginal revenue product) for market and individual firm Firm labor supply curve is horizontal. Why? Firm labor supply curve is also it MRC (marginal resource cost) curve. S=MRC Visual 4-4 Market demand for labor decreases as wages go up. Demand for labor increases as wages go down. Market supply of labor increases as wages go up. Supply of labor decreases as wages go down. Firm can hire as many workers as it wants at the market wage. There is not need to pay more than the market wage to attract more workers.

Imperfectly Competitive Labor Markets (Ch. 15 – Add on) Monopsony – factor market structure which only has a single buyer Labor Market Monopsony Characteristics Single buyer of particular type of labor Workers have few employment options other than working for monopsony Firm is a wage-maker. Varies directly with the # of workers employed Varying degrees of monopsony One firm Few firms Few employment options due to geographic location (small town) and can’t relocate. Finding other employment would mean having to learn new skill set.

Graphing a Monopsony Upward sloping S Curve Firm must pay higher wages if it wants to hire additional workers Higher than the wage rate S Curve = Average Cost of Labor Curve MRC Curve Higher than the S Curve because if it wants to hire more workers it must raise wages and pay everyone more MRC=new higher wage + wage increase for those workers hired at a lower wage

Profit-Maximizing Q of Labor Profit maximizing quantity of labor MRP = MRC Optimal wage comes from labor supply curve at that quantity of labor Draw line down from MRP = MRC to S curve Monopsonist maximizes profit by Hiring smaller # of workers Paying less-than-competitive wage rate Society loses output and workers receive a wage rate that is less than their MRP Activity 4-5 Activity 4-6

Economic Rent Economic Rent is different than how “rent” is usually thought of Economic Rent – the amount by which the price of a resource exceeds the minimum price necessary to make a resource available