Part 7 © 2006 Thomson Learning/South-Western Further Topics

Chapter 15 © 2006 Thomson Learning/South-Western Pricing in Input Markets

3 Profit-Maximizing Behavior and the Hiring of Inputs A profit-maximizing firm will hire additional units of any input up to the point at which the additional revenue from hiring one more unit is exactly equal to the cost of hiring that unit. Let ME K and ME L denote the marginal expense of hiring capital and labor, respectively.

4 Profit-Maximizing Behavior and the Hiring of Inputs Let MR K and MR L be the extra revenue that hiring more units of capital and labor allows the firm to bring in. Profit maximizing behavior requires:

5 Price-Taking Behavior If the firm is a price taker in the capital and labor market then it can always hire an extra unit of capital at the prevailing rate (v) and an extra unit of labor at the wage rate (w).

6 Marginal Revenue Product Marginal product is how much output the additional input can produce. Marginal revenue (MR) is the extra revenue obtained from selling an additional unit of output. Thus, the profit maximizing rules are:

7 A Special Case--Marginal Value Product If the firm is also a price taking in the goods market, marginal revenue equals the price (P) at which the output sells. The profit maximizing conditions become

8 Marginal Value Product The marginal value product (MVP) of capital and labor, respectively, are special cases of marginal revenue product in which the firm is a price taker for its output.

9 Responses to Changes in Input Prices: Single Variable input Case Assume the firm has fixed capital and can only vary its labor input in the short run. Labor will exhibit diminishing marginal physical productivity so labor’s MVP will decline as more labor is hired. In Figure 15-1, the profit maximizing firm will hire L 1 labor hours when the wage rate is w 1.

10 MVP Wage MVP L w1w1 Labor hours 0L1L1 L2L2 w2w2 FIGURE 15-1: Change in Labor Input When Wage Falls: Single Variable Case

11 Responses to Changes in Input Prices: Single Variable input Case If the wage rate falls to w 2 the firm hires increased labor to L 2. If the firm continued to hire L 1 it would not be maximizing profit since labor would be capable of producing more in additional revenue than hiring additional labor would cost. With one variable input, diminishing marginal productivity results in a downward sloping demand curve.

12 TABLE 15-1: Hamburger Heaven’s Profit- Maximizing Hiring Decision

13 The Substitution Effect The substitution effect, in the theory of production, is the substitution of one input for another while holding output constant in response to a change in the input’s price. In Figure 15-2(a), a fall in w will cause the firm to change from input combination A to B to equate RTS to the new w/v. Diminishing RTS leads to more labor hired.

14 Capital per week MC K1K1 K2K2 A q1q1 B Labor hours per week 0L1L1 L2L2 (a) Input Choice Price P Output per week 0q1q1 (b) Output Decision FIGURE 15-2: Substitution and Output Effects of A Decrease in Price of Labor

15 The Output Effect The output effect is the effect of an input price change on the amount of the input that the firm hires that results from a change in the firm;s output level. In Figure 15-2(b), the lower w causes the marginal cost curve to shift to MC’. The profit maximizing output raises to q 2 resulting in more labor hired.

16 Capital per week MC’ MC K1K1 K2K2 A C q2q2 q1q1 B Labor hours per week 0L1L1 L2L2 (a) Input Choice Price P Output per week 0q1q1 q2q2 (b) Output Decision FIGURE 15-2: Substitution and Output Effects of A Decrease in Price of Labor

17 Responsiveness of Input Demand to Price Changes Ease of Substitution The size of the substitution effect will depend upon how easy it is to substitute other factors of production for labor. The size of the substitution effect will also depend upon the length of time as it becomes easier to find substitutes in a longer period of time.

18 Costs and the Output Effect The size of the output effect will depend upon How large the increase in marginal costs brought about by the wage rate increase is, and How much quantity demanded will be reduced by a rising price. The first depend upon how important labor is in production while the latter depends upon the price elasticity of demand for the final product.

19 Input Supply Resources come from three major sources: Labor is provided by individuals. Capital equipment is produced which other firms can buy outright or rent. Natural resources are extracted from land and can be used outright or sold to other firms. As shown in earlier chapters, capital and natural resources have upward sloping supply curves.

20 Labor Supply and Wages Wages represent the opportunity cost of not working at a paying job for individuals. For purposes of this analysis, wages should be interpreted to include all forms of compensation. Individuals will balance the monetary rewards from working against the psychic benefits of other, nonpaid activities.

21 Labor Supply and Wages Labor supply curves will differ based upon individual preferences. Noneconomic factors such as pleasant working conditions will affect the location of the supply curve. It is likely that an increase in the wage will result in more labor supplied to the market. Graphically, the market labor supply curve is likely to be positively sloped.

22 Equilibrium Input Price Determination In Figure 15-3, the market demand for labor is labeled D, and the market supply of labor is labeled S. The equilibrium wage and quantity is where quantity demanded equals quantity supplied, [w *, L * ]. Other things equal, this equilibrium will tend to persist from period to period.

23 Wage D S w* Labor hours per week 0 L* FIGURE 15-3: Equilibrium in an Input Market

24 Shifts in Demand and Supply Any factor that shifts the firms’ underlying production function will shift its input demand curve. Demand for an input is derived from the demand for the output, changes in the prices of the output will shift input demand curves

25 Shifts in Demand and Supply In Figure 15-3, the demand curve shifts to D’ which reduces equilibrium wages from w* to w’ and equilibrium employment from L* to L’. The various factors that shift input demand and supply curves are summarized in Table 15-2.

26 Wage D’ D S w’ w* Labor hours per week 0 L’L* FIGURE 15-3: Equilibrium in an Input Market

27 TABLE 15-2: Factors That Shift Input Demand and Supply Curves

28 An Overview of Labor Market Science is built up with facts, as a house is with stones. But a collection of facts is no more a science than a heap of stones is a house. -Jules Henri Poincar’e- Labor Force: All those over 15 years of age who are either employed, actively seeking work, or awaiting recall from a layoff. (The age may vary in different countries. For example, it is 16 years of age for the U.S.) Labor Force Participation Rate: The ratio of the labor force to those of age over 15.

29 Unemployment: Those in the labor force who are not employed (for pay). Unemployment Rate: The ratio of those unemployed to those in the labor force. This is the most widely cited measure of labor market condition. An Overview of Labor Market

30 Wage Rate: The price of labor per working hour. Wage rate × Units of time worked = Earnings. Earnings + Fringe benefit = Compensation. Compensation + Unearned income (interest, dividends, transfer payments etc.) = Income An Overview of Labor Market

31 Population (Age 15 and over) Labor Force (Employed plus Unemployed) Not in Labor Force New Entrants Reentrants Dropouts Retirements Employed Unemployed (Not employed, but looking for work or awaiting recall) Layoffs Quits New Hire Recalls FIGURE 15-4

32 FIGURE 15-5: Demand for Labor Product demand Wages, amount of K Choice of technologies Determines number of workers employed Wage Changes: (1) Scale Effect (2) Substitution Effect A demand curve for labor tells us how the desired level of employment varies with changes in the price of labor when the other factors affecting demand are held constant. Wages # of workers D

33 Market Supply: The supply of labor to a particular market is positively related to the wage rate prevailing in that market holding other wages constant. Wages # of workers S S2S2 S1S1 FIGURE 15-6: Market Supply

34 Supply to Firms: The supply to a firm would be a horizontal line since each firm is a price taker in the competitive labor market. Wages # of workers W* FIGURE 15-7: Supply to Firms

35 FIGURE 15-8: Determination of the Wages Wages # of workers Demand Supply W2W2 W* W1W1 W 1 ： demand exceeds supply W 2 ： supply exceeds demand W* ： Market-Clearing Wage

36 FIGURE 15-9: Wage rates are determined by the market and announced to individual firm. Wages # of workers Demand Supply W* Wages # of workers DADA W* SASA Market A Typical Firm

37 表 15-3: 重要人力指標 項目別總計男性女性 年度年度 經濟 成長 率 (%) 勞動力 ( 千人 ) 就業者 ( 千人 ) 失業者 ( 千人 ) 勞動力 參與率 (%) 勞動力 ( 千人 ) 就業者 ( 千人 ) 失業者 ( 千人 ) 勞動力 參與率 (%) 勞動力 ( 千人 ) 就業者 ( 千人 ) 失業者 ( 千人 ) 勞動力 參與率 (%) 資料來源：行政院主計處

38 表 15-3: 重要人力指標 ( 續 ) 項目別總計男性女性 年度年度 經濟 成長 率 (%) 勞動力 ( 千人 ) 就業者 ( 千人 ) 失業者 ( 千人 ) 勞動力 參與率 (%) 勞動力 ( 千人 ) 就業者 ( 千人 ) 失業者 ( 千人 ) 勞動力 參與率 (%) 勞動力 ( 千人 ) 就業者 ( 千人 ) 失業者 ( 千人 ) 勞動力 參與率 (%) 資料來源：行政院主計處

39 表 15-3: 重要人力指標 ( 續 ) 項目別總計男性女性 年度年度 經濟 成長 率 (%) 勞動力 ( 千人 ) 就業者 ( 千人 ) 失業者 ( 千人 ) 勞動力 參與率 (%) 勞動力 ( 千人 ) 就業者 ( 千人 ) 失業者 ( 千人 ) 勞動力 參與率 (%) 勞動力 ( 千人 ) 就業者 ( 千人 ) 失業者 ( 千人 ) 勞動力 參與率 (%) 資料來源：行政院主計處

40 圖 15-10: 年台灣地區趨勢圖

41 圖 15-11: 勞動參與率

42 表 15-4: 歷年五月台灣地區有偶婦女勞動 參與率 項目 年 總平均 女性 平均 有偶婦女 平均 子女均在６歲 以上有偶婦女 有未滿 6 歲子女 有偶婦女 尚無子女 有偶婦女

43 表 15-4: 歷年五月台灣地區有偶婦女勞動 參與率 ( 續 ) 項目 年 總平均 女性 平均 有偶婦女 平均 子女均在６歲 以上有偶婦女 有未滿 6 歲子女 有偶婦女 尚無子女 有偶婦女

44 圖 15-12: 歷年子女年齡別有偶婦女勞動力 參與率

45 Monopsony If the firm is not a price taker in the input market, it may have to offer a higher wage to attract more employees. A monopsony is the condition in which one firm is the only hirer in a particular input market. If the firm is a monopsony, it faces the entire market supply curve for the input.

46 Marginal Expense The marginal expense of an input is the cost of hiring one more unit of an input. The firm has to offer a higher wage to the hired worker and to the workers already employed. The marginal expense of labor (ME L ) will exceed the price of the input if the firm faces an upward-sloping supply curve for the input.

47 A Numerical Illustration Suppose the Yellowstone Park Company is the only hirer of bear wardens. The number of people willing to take this job (L) is given by This relationship is shown in Table 15-3

48 TABLE 15-5: Labor Costs of Hiring Bear Wardens in Yellowstone Park

49 A Numerical Illustration Total labor costs (w·L) is shown in the third column and the marginal expense of hiring each warden is shown in the fourth column. Since the new warden and the existing wardens receive the wage increase, the marginal expense exceeds the wage rate.

50 A Numerical Illustration Figure 15-4 shows the supply curve (S) for wardens. If Yellowstone wishes to hire three wardens it must pay $6 per hour with total outlays of $18 (point A on the graph). The wage must be increased to $8 to get a fourth warden (point B) which results in total outlays of $32.

51 Hourly wage S A B 6 $8 Bear wardens per hour 034 FIGURE 15-13: Marginal Expense of Hiring Bear Wardens

52 A Numerical Illustration The marginal expense of the fourth warden, $14 is reflected in the graph. The hourly wage ($8) is shown in gray. The extra outlay to the three previous workers ($8 per hour versus $6 per hour previously) is shown in color. Total outlays exceed the amount for three wardens by the sum of these two areas.

53 Hourly wage S A B 6 $8 Bear wardens per hour 034 FIGURE 15-13: Marginal Expense of Hiring Bear Wardens

54 Monopsonists and Resource Allocation: A Graphical Demonstration The demand curve in Figure 15-5 is D. Since marginal expense (ME L ) exceeds the wage, the marginal expense curve is above the supply curve (S). L 1 is the profit maximizing choice while the marginal value product is MVP 1 and the wage is w 1.

55 Wage S D ME MVP 1 w1w1 Labor hours per week 0 L1L1 FIGURE 15-14: Pricing in a Monopsonistic Labor Market

56 A Graphical Demonstration L 1 is less than L *, the amount hired with perfect competition. As with a monopoly, the “demand curve” for a monopolist actually consists of the single point given by L 1, w 1.

57 Wage S D ME w* MVP 1 w1w1 Labor hours per week 0 L*L1L1 FIGURE 15-14: Pricing in a Monopsonistic Labor Market

58 Monopsonists and Resource Allocation Since the monopsonist restrict its input use, it pays an input less than its marginal value product (w 1 < MVP 1 ). Total output could be increased by drawing more labor into the market. The more inelastic the labor supply, the more the monopsonists can benefit from this profit opportunity.

59 Bilateral Monopoly A bilateral monopoly is a market in which both suppliers and demanders have monopoly power. In Figure 15-6, “supply” and “demand” intersect at P *, Q *, but this is not equilibrium since neither player is a price taker. The monopoly supplier will operate on its marginal revenue curve (MR) and prefer price- quantity combination P 1, Q 1.

60 Bilateral Monopoly The monopoly supplier will operate on its marginal revenue curve (MR) and prefer price-quantity combination P 1, Q 1. The monopsonistic will operate on its marginal expense curve (ME) and prefer combination P 2, Q 2.

61 Bilateral Monopoly The monopoly supplier will operate on its marginal revenue curve (MR) and prefer price-quantity combination P 1, Q 1. The monopsonistic will operate on its marginal expense curve (ME) and prefer combination P 2, Q 2. The final outcome, after bargaining, will lie between these two combinations.

62 Input price S D ME MR P* P1P1 P2P2 Quantity per period 0 Q*Q1Q1 Q2Q2 FIGURE 15-15: Bilateral Monopoly