UNIT 5: FACTOR MARKETS Why does a coach get paid $6 million?

In this section we will examine: Unit 4.1: Monopoly Define derived demand Define & graph Demand for Labor (DL) & Supply for Labor (SL) Define & graph Marginal Revenue Product (MRP) and Marginal Resource Cost (MRC) Effects of shifts in the market supply or demand for resources Define & graph a perfectly competitive labor markets Review & graph imperfectly competitive labor markets AP Micro

Basic Graphing in Factor Markets & MRP = MRC Rule

Factor Market Overview Basic view of the market for resource is a mirrored image of the product market. SProduct SLabor Wage Price $10 $10 DLabor DP QProduct 5000 QResource/Labor 5000 Industry Industry

Vocab: Derived Demand The demand for a factor of production is a derived demand. It is derived from the demand for the goods and services the factor of production is used to produce. In other words, if the demand for a good such as wheat increases, then the productivity increases, which leads to an increase in labor.

Vocab: Marginal Revenue Product Value of Marginal Product (VMP) is the additional revenue that results from the additional product produced when more inputs are added. The value of marginal product is simply: Marginal product x the price for those additional units. Value of Marginal Product = Change in Marginal Product Price of those additional units x

Vocab: Marginal Revenue Product Marginal Revenue Product (MRP) is the change in revenue that results from the addition of one extra unit when all other resources are kept equal. The MRP is often used to calculate the affect of adding employees, as companies want to add employees up to the point at which additional labor won't bring in enough revenue to cover costs.

Marginal Revenue Product (MRP) The additional revenue generated by an additional worker (resource). Another way to calculate MRP is: Marginal Revenue Product = Change in Total Revenue Inputs Marginal Revenue Product = Marginal Revenue Marginal Product x How much are those unit of labor worth in term of additional revenue?

Marginal Revenue Product (MRP) Assumes $3 per wash. Marginal Revenue Product

Factor Market: Vocab Marginal Revenue Product: DL=MRP Also called the marginal revenue product curve. The orange line is the firm’s value of the marginal revenue product of labor curve. Thus the demand for labor is the marginal revenue product curve. Assumes $3 per wash. DL=MRP

= Vocab: Marginal Resource Cost (MRC) Marginal Resource Cost The additional cost of an additional resource. Another way to calculate MRC is: Marginal Resource Cost = Change in Total Cost Inputs How much extra does each resource cost me? Materials Technology Labor

= Vocab: Marginal Resource Cost (MRC) Marginal Cost Labor Marginal Cost Labor (MCL): The additional cost of an additional worker. Another way to calculate MCL is: Marginal Cost Labor = Change in Total Cost Labor How much extra does each laborer cost me? Labor

Basic View of MRP & MRC Firm MRC = SResource $10 MRP = DResource Cost of Resource Most beneficial amount of inputs to employ. $10 MRP = DResource It is almost a mirrored image of the product market graph. QResource 5000 Firm

Supply and Demand For Surgeons Supply and Demand For Gardeners Basic View of MRP & MRC Use supply and demand analysis to explain why surgeons earn an average salary of $137,050 and gardeners earn $13,560. Supply and Demand For Surgeons Supply and Demand For Gardeners SL Wage Rate Wage Rate SL DL DL Quantity of Workers Quantity of Workers

MRP = MRC Continue to hire until… MRP = MRC RULE How do you know how many resources (workers) to employ? Continue to hire until… MRP = MRC This is similar to the MC = MR rule in the product market

How do you know how many resources (workers) to employ? MRP = MRC RULE How do you know how many resources (workers) to employ? This example assumes a perfectly competitive labor market. More on this later This example assumes a perfectly competitive product market PIZZA (only 1 Oven) Wage = $20 Price = $10 Total Product (Pizzas) Marginal Revenue Product Marginal Resource Cost Quantity of Workers Marginal Product - - 1 2 2 7 3 10 4 12 5 13 6 13 7 10

How do you know how many resources (workers) to employ? MRP = MRC RULE How do you know how many resources (workers) to employ? PIZZA (only 1 Oven) Wage = $20 Price = $10 Total Product (Pizzas) Marginal Revenue Product Marginal Resource Cost Quantity of Workers Marginal Product - - 20 1 2 2 20 50 20 2 7 5 The firm should NOT hire more than 4 workers. (MRP = MRC) Thus this logic applies to all inputs. 20 3 10 3 30 4 12 2 20 20 10 20 5 13 1 20 6 13 20 7 10 -3 -30

As long as MRP > MRC the firm will continue to hire inputs MRP = MRC RULE Note: One would not stop hiring here since there is additional marginal revenue per unit of product to achieve. The firm will stop hiring inputs at the 4th worker since any more workers (given current other fixed inputs) will result in diminished returns on the marginal unit produced. As long as MRP > MRC the firm will continue to hire inputs LABOR MARKET FIRM Wage SL Wage $20 $20 SL=MRC DL DL=MRP 100 4 Quantity of Labor Quantity of Labor

SHIFTERS OF RESOURCE DEMAND

Shifters of Resource Demand 1.) Changes in the Demand for the Product Price increase of the product increases MRP and demand for the resource. 3.) Changes in Price of Other Resources Substitute Resources Ex: What happens to the demand for assembly line workers if price of robots falls? Complementary Resources Ex: What happens to the demand for nails if the price of lumber increases significantly? 2.) Changes in Productivity Technological advances increase Marginal Product and therefore MRP/Demand.

PERFECTLY COMPETITIVE LABOR MARKET We are stuck making the same wage as everyone else in this labor market!

Types of Factor Markets Perfectly Competitive Labor Market Competition Monopsony Perfectly Competitive Labor Market Characteristics: Many small firms are hiring workers No one firm is large enough to manipulate the market. Many workers with identical skills Wage is constant: firms are wage takers Firms can hire as many workers as they want at a wage set by the industry

Types of Factor Markets Perfectly Competitive Labor Market Competition Monopsony Perfectly Competitive Labor Market MRC = Wage same as MCL = Wage

Perfectly Competitive Labor Market Generally this condition is found in low skilled labor markets. SL Wage Wage WE SL=MRC DL DL=MRP Q Qe Q QE Industry Firm

Perfectly Competitive Labor Market What happens to the wage and quantity in the market and firm if new workers enter the industry? SL Wage Wage SL1 WE SL=MRC W1 SL1=MRC1 DL DL=MRP Q Qe Q1 Q QE Q1 Industry Firm

Perfectly Competitive Labor Market I am stuck making the same wage as everyone else! Suxs to be a Wage Taker In perfectly competitive labor markets there is sometimes the pressure to unionize workers in an effort to increase the wage above the market equilibrium wage. United Auto Workers

Practice: What should the firm do – hire more, hire less, or stay put? 1. MRPL = $15; PL = $6 2. MRPL = $10; PL = $10 2. MRPL = $5; PL = $10 4. MRPL = $10; PL = $15 3. MRPL = $25; PL = $20 6. MRPL = $15; PL = $15 4. MRPL = $12; PL = $12 8. MRPL = $50; PL = $40 MORE STAY PUT LESS LESS MORE STAY PUT STAY PUT MORE

IMPERFECT LABOR MARKET Monopsony

Types of Factor Markets Monopsony Labor Market Perfect Competition Monopsony Monopsony Labor Market Monopsonist (Greek: mono”single” - opsonia”purchase”) Characteristics: Few large firms are hiring workers One firm is large enough to manipulate the labor market. Wage is NOT constant: firms are wage makers If the monopsonist wants to increase the number of workers that it hires, it must increase the wage that it pays to all of its workers, including those whom it currently employs.

Imperfect Labor Market Monopsonist (Greek: mono”single” - opsonia”purchase”) An employer is said to be a monopsonist if the employer must increase the wage offered to workers in order to attract additional workers. There are two types of monopsonists: A non-discriminating monopsonist is an employer who must increase the wage offered to workers in order to attract more workers. A discriminating monopsonist is one that pays the higher wage only to the extra worker for whom the employer raised the wage. Could be illegal!!

Imperfect Labor Market Monopsonist Non-discriminating monopsonist: true cost to the firm of adding an extra worker (MRC) will be greater than the wage paid to that worker. [MRC > Wage] MRC doesn’t equal wage MRC = MRP

Imperfect Labor Market Monopsonist Non-discriminating monopsonist: true cost to the firm of adding an extra worker (MRC) will be greater than the wage paid to that worker. [MRC > Wage] MRC MRC

“Glass Ceilings”

The Labor Market: Minimum Wage Laws & Unions Unit 5: Resource Market How can raising minimum wage cause higher unemployment? AP Micro

Perfectly Competitive Labor Market Generally this condition is found in low skilled labor markets. If viewed to be too low. The government attempts to adjust the wage. SL Wage Wage Surplus of Labor $10 Minimum Wage Wminimum WE SL=MRC DL DL=MRP QDL QSL Q QE Qmin Qe Q Industry

Unionized Labor Market A labor union restricts the supply of labor and the supply of labor curve shifts leftward to LS1. The wage rate rises to $15 an hour, but employment decreases to 200 workers. Jobs are traded off for a higher wage rate.

Unionized Labor Market If union action increases labor productivity, the demand for union labor increases and the demand for labor curve shifts rightward to LD1. The wage rate rises to $20 an hour and employment increases to 250 workers.

LEAST COST RULE Up to this point we have analyzed the use of only one resource. What about when a firm wants to combine different resources? MPx = MPy Px Py

If you only have $35, the best combination is 2 robots and 3 workers Least Cost Rule How much additional output does each resource generate per dollar spent? $10 $5 Robots MP (Robots) MP/PR (PriceR =$10) Workers MP (Workers) MP/PW (PriceW =$5) 1 30 3 20 4 2 15 10 5 .50 If you only have $35, the best combination is 2 robots and 3 workers

If you only have $35, the best combination is 2 robots and 3 workers Least Cost Rule MPx = MPy $10 $5 Px Py Robots MP (Robots) MP/PR (PriceR =$10) Workers MP (Workers) MP/PW (PriceW =$5) 1 30 3 20 4 2 15 10 5 .50 If you only have $35, the best combination is 2 robots and 3 workers

Profit Maximizing Rule for a Combining Resources MRPx MRPy 1 = = MRCx MRCy This means that the firm is employing resources where MRP = MRC for each resource.

2010 Practice FRQ 3 apples and 2 oranges 42