CRC Microeconomics1

10/22/2014CRC Microeconomics2 What did you study last time?  what is meant by an oligopoly?  what is meant by a duopoly?  how game theory is applied to oligopoly?  how governments deal with oligopoly?

CRC Microeconomics3 Do you know …  what determines your wages and salaries?  what determines the rent paid to landowners?  what determines the interest paid to capital owners?

CRC Microeconomics4 A. What determines your wages and salaries? Your wages and salaries are determined in the market for your labor service.  The demand for labor  The supply of labor  The equilibrium in the labor market

CRC Microeconomics5 1. The demand for labor  The demand for labor is a derived demand. A firm’s demand for labor (a factor of production) is derived from its decision to supply a good in another market.  Labor is the most important factor of production, for workers receive most of the total income earned in the U.S. economy.

CRC Microeconomics6 1. The demand for labor a.A derived demand b.Assumptions c.The production function and marginal product of labor (MP L ) d.The value of marginal product (VMP) and the demand for labor (D L ) e.Output supply (Q*) and input demand (L*) f.What causes the labor demand curve to shift?

CRC Microeconomics7 a. A derived demand The market for apples (an output market) Q apples The market for apple pickers (an input market) P apples D S P Q D S P Q Q apple pickers W apple pickers The demand for apple pickers depends on (is derived from) the supply of apples. FromTo

CRC Microeconomics8 b. Assumptions  The firm is competitive (i.e. a price taker) in both the output market and the input market.  The firm is profit-maximizing.

CRC Microeconomics9 c. Production function and MP L L Labor Q Output MP L Marginal product of labor ? ? ? ? ? VMP L Value of marginal product W Wage $500 MM Marginal profit VMP-W ? ? ? ? ? $500 ? ? ? ? ? Replace the ?’s with correct values. Assume that P = $ $1,000 $800 $600 $400 $200 $500 $300 $100 -$100 -$300 Decision Yes/No ? ? ? ? ? Yes No What are the firm’s profit-maximizing output and labor input levels? Q* = 240 at L* = 3, where VMP L >= W

CRC Microeconomics10 c. Production function and MP L  The production function is the relationship between the quantity of inputs used to make a good and the quantity of output of that good.  Q = f (L, l, K) where L = labor, l = land, and K = capital  In the short run: Q = f (L), l & K are fixed

CRC Microeconomics11 c. Production function and MP L  As the quantity of input increases, the production function gets flatter, reflecting the property of diminishing marginal product.  MP L is the increase in the amount of output from an additional unit of labor. MP L =  Q /  L

CRC Microeconomics12 Graph Q L Production function 0 The production function becomes flatter as L increases, reflecting diminishing MP L. (MP L is the slope of the production function.)

CRC Microeconomics13 d. VMP L & the demand for labor D L  The value of marginal product, VMP, is the marginal product of an input times the price of the output.  VMP = MP x P  For a competitive firm, the VMP is also the firm’s demand for labor used to produce that product.  i.e. VMP L = D L.

CRC Microeconomics14 Graph VMP L L 0 Market wage W VMP L = D L L* Profit-maximizing quantity of L A competitive, profit-maximizing firm hires workers up to the point where VMP L = W

CRC Microeconomics15 e. Output supply (Q*) & input demand (L*)  A competitive firm produces its profit-maximizing Q* in the output market where: (P = AR) = MR = MC or P = MC =  TVC /  Q(1)  Multiplying both sides of (1) by MP L = (  Q /  L) P x MP L = MC x MP L = (  TVC /  Q) x (  Q /  L) =  TVC /  L =  (W x L) /  L

CRC Microeconomics16 e. Output supply (Q*) & input demand (L*)  In a competitive labor (input) market W is fixed. So VMP L = MP L x P =  TVC /  L = W Or VMP L = W (2)  P = MR = MC (in a competitive output market) is the same as VMP L = W (in a competitive labor market)

CRC Microeconomics17 e. Output supply (Q*) & input demand (L*)  The profit-maximizing output Q* is determined where MR = MC.  The profit-maximizing input L* is determined where VMP L = W.  They are just two sides of the same coin.

CRC Microeconomics18 f. What shifts D L ?  VMP L = MP L x P = D L  So VMP L = D L shifts due to changes in: P (the output price), MP L (marginal product of labor), as a result of technological change, and the supply of other factors

CRC Microeconomics19 2. The supply of labor  The tradeoff between work and leisure  What causes the labor supply curve to shift?

CRC Microeconomics20 Graph W/hr Hrs/day 0 $300 $ $200 $400 $550 $900 $1,000 $1,100 Suppose that your wage is initially $100/hr, and you work 8 hours a day.Do you work more if your wage goes up to $200? $400? $550? $900? $1,100? This section of the labor supply curve is upward-sloping. Workers work more when their wages increase. This section of the labor supply curve is backward-bending. Workers work less when their wages increase.

CRC Microeconomics21 a. The tradeoff between work and leisure  The labor supply curve reflects how workers decide about the labor-leisure tradeoff.  An increase in wages increases the opportunity cost of leisure, (i.e. leisure time becomes more expensive.)

CRC Microeconomics22 a. The tradeoff between work and leisure  If workers respond by enjoying: less leisure, they work more, the supply of labor slopes upward. more leisure, they work less, the supply of labor slopes downward. It is backward- bending.

CRC Microeconomics23 a. The tradeoff between work and leisure  For now, assume that the labor supply curve is upward sloping.

CRC Microeconomics24 b. What shifts S L ?  S L shifts due to changes in: tastes or attitudes toward work/leisure, alternative opportunities in other labor markets, and immigration/emigration.

CRC Microeconomics25 3. Equilibrium in the labor market  Key facts  Equilibrium in the labor market  Shifts in S L  Shifts in D L

CRC Microeconomics26 a. Key facts  The market wage adjusts to balance the supply of labor S L and demand for labor D L.  At equilibrium in the labor market: W = VMP L  Any event that changes S L or D L must change W and VMP by the same amount, because they must always be equal.

CRC Microeconomics27 b. Equilibrium in the labor market W QLQL 0 We DLDL E SLSL At equilibrium workers receive the value of their marginal contribution to the production of G&S (VMP). Qe PLPL

CRC Microeconomics28 c. Shifts in S L W QLQL 0 W1W1 DLDL E1E1 S1S1 The diagram shows the original situation in a labor market. Q1Q1 S2S2 E2E2 Q2Q2 W2W2 1. An increase in S L 2. reduces the wage.. 3. and raise employment.

CRC Microeconomics29 c. Shifts in D L W QLQL 0 W1W1 D1D1 E1E1 S1S1 Q1Q1 E2E2 Q2Q2 W2W2 1. An increase in D L 2. raises the wage.. 3. and raise employment. D2D2 The diagram shows the original situation in a labor market.

CRC Microeconomics30 B. Other factor markets  The market for land  The market for capital  Linkages among factors of production

CRC Microeconomics31 a. The market for land Rent QlQl 0 Pe DlDl E SlSl Supply and demand determine the compensation paid to the owners of land. The demand for land depends on the VMP of land. Qe PlPl

CRC Microeconomics32 a. The market for capital Rent QKQK 0 Pe DKDK E SKSK Supply and demand determine the compensation paid to the owners of capital. The demand for capital depends on the VMP of capital. Qe PKPK

CRC Microeconomics33 c. Linkages among factors  Because of diminishing MP, a factor in abundant supply has a low MP and thus a low price. a factor in scarce supply has a high MP and thus a high price.  When the supply of a factor falls, its equilibrium price rises.

CRC Microeconomics34 c. Linkages among factors  An event that changes the supply of any one factor can alter the earnings of all the factors.  The change in earnings of any factor can be found by analyzing the impact of the event on the VMP of that factor.

CRC Microeconomics35 Conclusion The neoclassical theory of distribution  The amount earned by a factor depends on supply and demand.  The demand for a factor depends on its marginal productivity.  In equilibrium, each factor earns the value of its marginal product.

CRC Microeconomics36 Now you know …  what determines your wages and salaries.  what determines the rent paid to landowners.  what determines the interest paid to capital owners.

CRC Microeconomics37 What will you study next?  Why do people’s earnings differ?  What is discrimination?

CRC Microeconomics38