Chapter 9

THE MARKET FOR FACTORS OF PRODUCTION 1. Perfect markets Supply of Labour Demand for labour Distribution of Income when Markets are competitive Imperfect competition in factor markets 1. Perfect markets Supply of Labour Demand for labour Distribution of Income when Markets are competitive Imperfect competition in factor markets

The circular flow of incomes and expenditure FIRMS (suppliers of goods and services, demanders of factor services) HOUSEHOLDS (demanders of goods and services, suppliers of factor services)

P Q £ £ (1) Goods demand demand O D1D1 The circular flow of incomes and expenditure

P Q £ £ Goods (1) Goods demand demand (2) Goods supply supply O D1D1 S The circular flow of incomes and expenditure

P Q £ £ Goods (1) Goods demand demand (2) Goods supply supply P1P1 O Q1Q1 D1D1 S The circular flow of incomes and expenditure

P Q P Q £ £ ££ Goods (1) Goods demand demand (3) Factor demand demand (2) Goods supply supply P1P1 O OQ1Q1 D1D1 S The circular flow of incomes and expenditure D1D1

P Q P Q £ £ ££ Factor services Goods Factor services (1) Goods demand demand (4) Factor supply supply (3) Factor demand demand (2) Goods supply supply P1P1 O Q1Q1 O D1D1 S S The circular flow of incomes and expenditure D1D1

P Q P Q £ £ ££ Factor services Goods Factor services (1) Goods demand demand (4) Factor supply supply (3) Factor demand demand (2) Goods supply supply P1P1 Q1Q1 O PF1PF1 QF1QF1 O D1D1 S S The circular flow of incomes and expenditure D1D1

P Q P Q £ £ ££ Factor services Goods Factor services S S D1D1 D1D1 (1) Goods demand demand (4) Factor supply supply (3) Factor demand demand (2) Goods supply supply P1P1 Q1Q1 O O PF1PF1 QF1QF1 D2D2 The circular flow of incomes and expenditure

P Q P Q £ £ ££ Factor services Goods Factor services S S D1D1 D1D1 (1) Goods demand demand (4) Factor supply supply (3) Factor demand demand (2) Goods supply supply P1P1 Q1Q1 O O P2P2 Q2Q2 PF1PF1 QF1QF1 D2D2 The circular flow of incomes and expenditure

P Q P Q £ £ ££ Factor services Goods Factor services S S D1D1 D1D1 (1) Goods demand demand (4) Factor supply supply (3) Factor demand demand (2) Goods supply supply P1P1 Q1Q1 O O P2P2 Q2Q2 PF1PF1 QF1QF1 D2D2 D2D2 The circular flow of incomes and expenditure

P Q P Q £ £ ££ Factor services Goods Factor services S S D1D1 D1D1 (1) Goods demand demand (4) Factor supply supply (3) Factor demand demand (2) Goods supply supply P1P1 Q1Q1 O O D2D2 P2P2 Q2Q2 D2D2 PF1PF1 QF1QF1 PF2PF2 QF2QF2 The circular flow of incomes and expenditure

THE MARKET FOR FACTORS OF PRODUCTION Perfectly competitive factor markets Everyone is a price taker, worker, firm, and suppliers of capital and land. Freedom of Entry and Exit Factors are homogeneous – –Same level of skill and motivation Perfect Knowledge – –Know the contract, conditions and alternatives – –How good is your worker Perfectly competitive factor markets Everyone is a price taker, worker, firm, and suppliers of capital and land. Freedom of Entry and Exit Factors are homogeneous – –Same level of skill and motivation Perfect Knowledge – –Know the contract, conditions and alternatives – –How good is your worker

THE MARKET FOR FACTORS OF PRODUCTION Perfectly Competitive Labour markets – –assumptions of a perfect factor market – –determination of factor prices Perfectly Competitive Labour markets – –assumptions of a perfect factor market – –determination of factor prices

A labour market: Whole market O Labour hours Hourly wage S all workers in the market D all firms in the market

O Labour hours Hourly wage WmWm S all workers in the market D all firms in the market A labour market: Whole market

A labour market: Individual employer O Labour hours Hourly wage WmWm S labour

A labour market: Individual employer O Labour hours Hourly wage WmWm S labour D individual employer

O Labour hours Hourly wage Q1Q1 WmWm S labour D individual employer A labour market: Individual employer

A labour market: Individual worker O Labour hours Hourly wage WmWm D labour

A labour market: Individual worker O Labour hours Hourly wage WmWm S individual worker D labour

O Labour hours Hourly wage Q2Q2 WmWm S individual worker D labour A labour market: Individual worker

WAGE DETERMINATION UNDER PERFECT COMPETITION The supply of labour – –the supply of hours by an individual worker The supply of labour – –the supply of hours by an individual worker

Units of CONSUMPTION I1I1 Consumption Versus Work a Like Consumption Dont like work What are our indifference curves shaped like? Hours worked

Units of CONSUMPTION I1I1 Consumption Versus Work a Any point to the North west is better and any point to the South East is worse. C Up Work down C down Work Up Consider point a Hours worked

Units of CONSUMPTION I1I1 Consumption Versus Work a So any indifference curve must lie to the North East or South West BETTER WORSE Hours worked

Units of CONSUMPTION I1I1 Consumption Versus Work U0U0 U1U1 U2U2 C Up, Work down, U rising Hours worked

Units of CONSUMPTION Constraint & Optimum Hours worked 24 Hours =£12 U0U0 U1U1 U2U2 W 24=C max Budget Constraint: C=W L 24 hours

Units of CONSUMPTION Hours worked Suppose now wages rise 24 Hours =£24 U0U0 U1U1 U2U2 U3U3

The supply of hours worked O Hours worked Hourly wage S L0L0 L1L1 w0w0 w1w1

Backward-bending supply curve of labour S WIWI Hourly wage Hours O

WAGE DETERMINATION UNDER PERFECT COMPETITION The supply of labour – –the supply of hours by an individual worker marginal disutility of work the shape of the individuals supply curve of labour – –the supply of labour to an individual employer Elastic from the perspective of the employer – –the market supply of a given type of labour Generally upward sloping The supply of labour – –the supply of hours by an individual worker marginal disutility of work the shape of the individuals supply curve of labour – –the supply of labour to an individual employer Elastic from the perspective of the employer – –the market supply of a given type of labour Generally upward sloping

WAGE DETERMINATION UNDER PERFECT COMPETITION The demand for labour: marginal productivity theory – –the marginal revenue product of labour ( MRP L ) What is the additional output a firm can get from hiring one more worker? How much will they get for that output The demand for labour: marginal productivity theory – –the marginal revenue product of labour ( MRP L ) What is the additional output a firm can get from hiring one more worker? How much will they get for that output

The marginal revenue product of labour ( MRP L ) What is the additional output a firm can get from hiring one more worker? How much will they get for that output What is the additional output a firm can get from hiring one more worker? How much will they get for that output

The marginal revenue product of labour ( MRP L ) What is the additional output a firm can get from hiring one more worker? How much will they get for that output UNDER PERFERCT COMPETTITON

The marginal revenue product of labour ( MRP L ) How much will they get for that output How much does it cost them to hire that worker? W Therefore hire workers until:

Marginal physical product of labour curve O Output MPP L Q of labour

O Output MPP L x Marginal physical product of labour curve

The profit-maximising level of employment O £ MRP L x Q of labour

O £ MRP L x WmWm MC L = W Q of labour The profit-maximising level of employment

O £ MRP L x WmWm MC L = W QeQe Q of labour The profit-maximising level of employment

WAGE DETERMINATION UNDER PERFECT COMPETITION The demand for labour: marginal productivity theory – –the marginal revenue product of labour ( MRP L ) – –derivation of the firm's demand curve for labour The demand for labour: marginal productivity theory – –the marginal revenue product of labour ( MRP L ) – –derivation of the firm's demand curve for labour

Deriving the firms demand curve for labour O Q of labour £ MRP L W1W1 MC L 1 Q1Q1 a

O Q of labour £ W1W1 MC L 1 Q1Q1 MC L 2 W2W2 Q2Q2 a b MRP L Deriving the firms demand curve for labour

O Q of labour £ W1W1 MC L 1 Q1Q1 MC L 2 MC L 3 W2W2 W3W3 Q2Q2 Q3Q3 a b c MRP L Deriving the firms demand curve for labour So Firms demand Curve is the MRP L = L D

WAGE DETERMINATION IN IMPERFECT MARKETS Factor market power: Monopsony A firm which is a monopoly purchaser of a factor – –E.g. Single Employer in a Town – –Government A Monopolist restricts Quantity sold to keep price up A Monopsonist restricts quantity purchased to keep price down!!!….WHY? Factor market power: Monopsony A firm which is a monopoly purchaser of a factor – –E.g. Single Employer in a Town – –Government A Monopolist restricts Quantity sold to keep price up A Monopsonist restricts quantity purchased to keep price down!!!….WHY?

Monopsony O Q of labour £ MRP L AC L W (supply curve)

O Q of labour £ MRP L AC L W (supply curve) MC LMonopsony

WAGE DETERMINATION IN IMPERFECT MARKETS Firms with monopsony power in employing labour – –MC L > W (where MC L is equal to MRP L ) Under Perf. Competition, workers get their MRP L. With a monopsony, they are being paid less… – –effects on wages and employment Firms with monopsony power in employing labour – –MC L > W (where MC L is equal to MRP L ) Under Perf. Competition, workers get their MRP L. With a monopsony, they are being paid less… – –effects on wages and employment

O Q of labour £ MRP L AC L W (supply curve) Q1Q1 MC LMonopsony

O Q of labour £ MRP L W1W1 AC L W (supply curve) Q1Q1 MC LMonopsony

O Q of labour £ MRP L W1W1 AC L W (supply curve) Q1Q1 Q2Q2 W2W2 MC LMonopsony

WAGE DETERMINATION IN IMPERFECT MARKETS Firms with monopsony power in employing labour – –MC L > W – –effects on wages and employment Monopsony implies Wages and Employment Down compared to a perfectly competitive labour market. Firms with monopsony power in employing labour – –MC L > W – –effects on wages and employment Monopsony implies Wages and Employment Down compared to a perfectly competitive labour market.