Markets for Factor Inputs

Slide 2 Markets for factor inputs In some examination questions, one is asked to comment on factor market questions, such as wages This is not really covered in any detail in the textbook, although some major issues are discussed verbally To increase our understanding, let us look at some relevant models also.

Slide 3 Competitive Factor Markets Demand for factor inputs is a derived demand, as demand is derived from factor cost and output demand We will look at the simplest case possible, where factor markets are competitive and only one factor (labour) is variable and the other factor (capital) is fixed How much labour should be hired at the markets wage rate – w?

Slide 4 Competitive Factor Markets Measuring the Value of a Worker’s Output Marginal Revenue Product of Labor (MRP L ) MRP L = (MP L )(MR) Demand for a Factor Input When Only One Input Is Variable Demand for a Factor Input When Only One Input Is Variable

Slide 5 Competitive Factor Markets Assume perfect competition in the product market Then MR = P Demand for a Factor Input When Only One Input Is Variable Demand for a Factor Input When Only One Input Is Variable

Slide 6 Competitive Factor Markets Question What will happen to the value of MRP L when more workers are hired? Demand for a Factor Input When Only One Input Is Variable Demand for a Factor Input When Only One Input Is Variable

Slide 7 Marginal Revenue Product Hours of Work Wages ($ per hour) MRP L = MP L x P Competitive Output Market (P = MR) MRP L = MP L x MR Monopolistic Output Market (MR <P)

Slide 8 Competitive Factor Markets Choosing the profit-maximizing amount of labor If MRP L > w (the marginal cost of hiring a worker): hire the worker If MRP L < w: hire less labor If MRP L = w: profit maximizing amount of labor Demand for a Factor Input When Only One Input Is Variable Demand for a Factor Input When Only One Input Is Variable

Slide 9 w*SLSL In a competitive labor market, a firm faces a perfectly elastic supply of labor and can hire as many workers as it wants at w*. Hiring by a Firm in the Labor Market (with Capital Fixed) Quantity of Labor Price of Labor Why not hire fewer or more workers than L*. MRP L = D L L* The profit maximizing firm will hire L* units of labor at the point where the marginal revenue product of labor is equal to the wage rate.

Slide 10 Competitive Factor Markets If the market supply of labor increased relative to demand (baby boomers or female entry), a surplus of labor would exist and the wage rate would fall. Question How would this impact the quantity demanded for labor? Demand for a Factor Input When Only One Input Is Variable Demand for a Factor Input When Only One Input Is Variable

Slide 11 A Shift in the Supply of Labor Quantity of Labor Price of Labor w1w1 S1S1 MRP L = D L L1L1 w2w2 L2L2 S2S2

Slide 12 Competitive Factor Markets Comparing Input and Output Markets

Slide 13 Competitive Factor Markets Comparing Input and Output Markets In both markets, input and output choices occur where MR = MC  MR from the sale of the output  MC from the purchase of the input

Slide 14 S L = AE D L = MRP L P * MP L Labor Market Equilibrium Number of Workers Wage Competitive Output MarketMonopolistic Output Market wCwC LCLC wMwM LMLM vMvM A B

Slide 15 Labor Market Equilibrium Equilibrium in a Competitive Output Market D L (MRP L ) = S L w C = MRP L MRP L = (P)(MP L ) Markets are efficient Equilibrium in a Monopolistic Output Market Profits maximized Using less than the efficient level of input

Slide 16 Exam questions Essay 1, 2001