Extension Chapter 3 The pricing of economic resources Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Learning Objectives Understand the forces underlying the general level of wage rates in Australia. See how wage rates are determined in particular labour markets by presenting several representative labour market models. Analyse the impact of unions on the structure and level of wages. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Learning Objectives (cont.) Discuss the economic effects of minimum wages. Explain wage differentials. Provide an analysis of resource pricing that includes non-wage income: rent, interest and profits. Develop an understanding of the pattern of all income shares in Australia, including wages, and their current and historical significance. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Wages in Particular Labour Markets Wage rates are defined as: the price paid for the use of labour Earnings are defined as: wage rates and the number of hours or weeks of labour service supplied in the market. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Nominal vs Real Wages Nominal wages: Real wages the amount of money received by an individual or group during some period of time Real wages the mount of goods and services an individual or group can purchase with their nominal income during some period of time. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Wage Determination in Competitive Labour Market Many firms competing for labour. Many qualified workers acting as independent suppliers. Both firms and workers are ‘price takers’, i.e. ‘wage takers’. Market equilibrium intersection of labour demand and supply curves. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Wage Determination in Competitive Labour Market (cont.) MRC is constant and equal to resource price. An individual firm will find it profitable to hire up to the point at which the going wage rate is equal to MRP of labour. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Supply & Demand for Labour: Competitive Labour Market MRP curve qc D  dd ($6) ($6) Wage Rate (dollars) Wc S = MRC Wc Qc Quantity of Labour Quantity of Labour Individual Firm Market Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Wage Determination: Monopsony Model Monopsony is a market in which there is only one buyer of a resource. The firm dominates employment of a particular type of worker. The labour type is relatively immobile or inflexible. The firm is a ‘wage maker’. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Wage Determination: Monopsony Model (Cont.) Characteristics up-sloping labour supply curve MRC > wage rate Equilibrium up to point where MRC = MRP Results lower wages, employment levels and output. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Monopsonistic Labor Market MRC MRP S Qm b C Wage Rate (dollars) Wc Qc a Wm Q Quantity of labour Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Wage Determination: Monopsony Model (Cont.) Complication Monopoly power in product market Repressive firm: resource demand curve is depressed even lower wages, labour volumes Progressive firm: resource demand curve shifts to the right increases labour volumes. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Supply Imperfections: Some Union Models Unions basic objective: increase wage rates. How? Three alternative models increasing the demand for labour exclusive or craft unionism inclusive or industrial unionism Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Demand-Enhancement Union Model S D2 D Wage Rate (dollars) Q2 W2 W1 Q Q1 Quantity of Labour Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Exclusive or Craft Union Model Wage Rate (dollars) W2 W1 Q Q2 Q1 Quantity of Labour Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Inclusive Unionism Model Wage Rate (dollars) b a Wu Wc Q Qu Qc Quantity of Labour Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Wage Determination: Bilateral Monopoly Model A market in which there is a single seller and a single buyer of labour Big industry and big union Effect on wages is indeterminate and depends on the power of the respective parties Desirability Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Bilateral Monopoly Model MRC S Wage Rate (dollars) Wu MRC Wc Wm MRP Q Qu=Qm Qc Quantity of Labour Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Wage Differentials: Causes heterogeneity of workforce ability education training variety of attractiveness of jobs market imperfections non-competing groups investing in human capital: education and training Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Wage Differentials: Causes (cont.) compensating differences imperfection in labour market geographical immobilities institutional immobilities sociological immobilities in the form of discrimination. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Economic Rent Economic rent is a term used by economists. It is narrower than the common meaning of the term ‘rent’. Economic rent is the price paid for the use of land and other natural resources that are completely fixed in total supply. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Determination of Land Rent S D2 R2 R1 D3 R3 Land Rent (dollars) D1 D4 S Q Hectares of Land Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Land Rent Supply of land is perfectly inelastic Demand sole active determinant of land rent ‘derived demand’ down-sloping Law of diminishing returns Product price must be decreased to sell additional units Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Perfectly Inelastic Supply Why? No production costs associated with land. Economy has a finite supply of land. Variability in the usability of land is a very small fraction of the total amount of land. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Land Rent is a Surplus Does not serve as an incentive. A payment that is not necessary to ensure that land will be available to the economy as a whole. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Productivity Differences Different properties will differ in their productivities soil fertilities mineral wealth climatic factors environmental degradation Different grades of land can be represented by differing demand curves. Alternative uses and costs of land. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Interest The price paid for the use of money. Typically the amount that must be paid for the use of one dollar for one year. Measured as a percentage. Money is not a resource. Money is not in itself useful. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Interest Rate Determination The total demand for money has two components: transactions demand The demand for money as a medium of exchange. asset demand Demand for money as a financial asset, and store of wealth. Total demand for money is the horizontal summation of transaction and asset demand. The demand for money cure is down-sloping. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Interest Rate Determination Supply of money has three major components currency current deposits in banks non-current deposits in banks The money supply curve is a vertical line. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Interest Rate Determination Investment decision All projects whose expected rate of net profit exceeds the equilibrium interest rate will be undertaken. Nominal interest rate: current dollars Real interest rate: adjusted for inflation important in making investment decisions. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Interest Rate Determination Sm 10 8 6 4 2 Dm Rate of interest (per cent) Ie o 50 100 150 200 250 300 Amount of money demanded and supplied ($ billion) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Range of Interest Rates Commercial, mortgage rates, etc. Reasons for interest rate differentials risk maturity or length of loan size of loan Pure rate of interest overall interest rate in the economy best approximated by interest paid on Federal Government long-term bonds. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Role of Interest Rates Affect level of investment goods production Change in interest rates results in change in investment demand. Affect composition of investment goods production Interest rates allocate the available supply of money to those projects which are expected to result in the highest levels of profit. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Economic Profits Various terms economic profits or pure profits accounting profits explicit costs implicit costs. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Role of the Entrepreneur The role of the entrepreneur is to: take initiative to combine other resources in production make non-routine decisions introduce innovation take economic risks. Normal profit: The minimum return necessary to retain the entrepreneur in a production line. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Sources of Economic Profits are not a cost accrue to the entrepreneur potential sources are uninsured risks (dynamic and uncertain) innovations monopoly power and profits. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Functions of Profits Energises the economy. Stimulates innovation and output. Encourages investment. Allocates resources amongst alternatives. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Income Shares Largest share of national income accrue to labour. Labour’s relative share has increased over time in Australia. Labour’s share is around 70–75 per cent. Capitalist share about 25–30 per cent of national income. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal

Next Chapter: Aggregate expenditures model and multipliers Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal