Unit 6: The FACTOR MARKET (aka: The Resource Market … or Input Market) 1

Unit 6: The Factor Market Length: 5-6 Lessons Chapters: 12 & 13 in textbook Good News: Only two Graphs to learn (PC vs. Monopsony – for factor market) Many concepts are just the application of things we have already learned. Basically just Supply and Demand 2

Producers Supply Households Demand Product Market 3

Producers Demand Households Supply Resource Market 4

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 Workers are wage takers Firms can hire as many workers as they want at a wage set by the industry 5 Perfect Competition Monopsony Resource Markets

Perfectly Competitive Labor Market and Firm SLSL DLDL ? Wage Q Q 5000 $10 Industry Firm

DERIVED DEMAND Example 1: If there was a significant increase in the demand for pizza, how would this affect the demand for cheese? Cows? Milking Machines? Veterinarians? Vet Schools? Etc. Example 2: An increase in the demand for cars increases the demand for… Derived Demand - The demand for resources is determined (derived) by the products they help produce. 7

Continue to hire until… MRP = MFC How do you know how many resources (workers) to employ? 8 Remember the Paper Chain Activity

Push-Up Machine 9

I am the inventor of a new generator that converts human push ups into safe and clean electrical energy. Each push up generative $1 worth of energy. Supply and demand in the labor market has resulted in a equilibrium wage of $10 (MRC = $10). The supply curve for the firm is perfectly elastic at $10…how much will you work for? Assuming identical skills, hire the first worker (do push ups in a 4ft x 7ft box). Let’s start hiring workers (Each worker must make sound effects) 10 The Push-Up Machine

The additional cost of an additional worker (or resource). In a perfectly competitive labor market the MFC equals the WAGE set by the market and is constant. Ex: The MFC of an unskilled worker is $8.75. Another way to calculate MFC is: Marginal Factor Cost = Change in Total Cost Change in Inputs 11 Marginal Factor Cost (MFC)

The additional revenue generated by an additional worker (resource). In perfectly competitive product markets the MRP equals the marginal product of the resource times the price of the product. Ex: If the Marginal Product of the 3 rd worker is 5 and the price of the good is constant at $20 the MRP is……. $100 Another way to calculate MRP is: Marginal Revenue Product = Change in Total Revenue Change in Inputs 12 Marginal Revenue Product (MRP)

Calculate MP and MRP The Push-Up Machine Quantity Labor Total ProductMarginal Product $1 Price

Supply Supply and demand in the INDUSTRY GRAPH has resulted in a equilibrium wage of $10. How much MUST each worker work for? Why not ask for more? Why not less? Demand If each push up generates $1 worth of energy what is the MRP for each worker? How much is each worker worth to the firm? The Push-Up Machine

Why does the MRP eventually fall? Diminishing Marginal Returns. Fixed resources means each worker will eventually add less than the previous workers. The MRP determines the demand for labor The firm is willing and able to pay each worker up to the amount they generate. Each worker is worth the amount of money they generate for the firm. The Push-Up Machine

Perfectly Competitive Labor Market and Firm DLDL ? Wage Q Q QEQE WEWE IndustryFirm SLSL

SLSL DLDL Wage Q Q IndustryFirm QEQE WEWE QeQe D L =MRP S L =MFC Side-by-side graph showing Market and Firm

Industry Graph 18

DEMAND RE-DEFINED 19

Where do you get the Market Demand? Q McDonalds WageQ L Dem $121 $102 $83 $65 $47 Burger KingOther Firms WageQ L Dem $120 $101 $82 $63 $45 WageQ L Dem $129 $1017 $825 $642 $468 WageQ L Dem $1210 $1020 $830 $650 $480 3 P Q 2 P Q 25 P Q 30 P $8 DDDD

Who demands labor? FIRMS demand labor. Demand for labor shows the quantities of workers that firms will hire at different wage rates. Market Demand for Labor is the sum of each firm’s MRP. DL Quantity of Workers Wage As wage falls, Qd increases. As wage increases, Qd falls. 21

Who supplies labor? Individuals supply labor. Supply of labor is the number of workers that are willing to work at different wage rates. Higher wages give workers incentive to leave other industries or give up leisure activities. Quantity of Workers Wage As wage increases, Qs increases. As wage decreases, Qs decreases. Labor Supply 22

Market Equilibrium Wage (the price of labor) is set by the market. EX: Supply and Demand for Carpenters Quantity of Workers Wage Labor Supply = MFC Labor Demand = MRP $30hr 23

Individual Firms 24 Wage Q QeQe D L = MRP S L = MFC

25 Example: You hire workers to mow lawns. The wage for each worker is set at $100 a day. Each lawn mowed earns your firm $50. If you hire one worker, he can mow 4 lawns per day. If you hire two workers, they can mow 5 lawns per day together. 1.What is the MFC for each worker? 2.What is the first worker’s MRP? 3.What is the second worker’s MRP? 4.How many workers will you hire? 5.How much are you willing to pay the first worker? 6.How much will you actually pay the first worker? 7.What must happen to the wage in the market for you to hire the second worker?

You’re the Boss You own a business. Assume the you are selling the goods in a perfectly competitive PRODUCT market so the price is constant at $10. Assume that you are hiring workers in a perfectly competitive FACTOR market so the wage is constant at $20. Also assume the wage is the ONLY cost. Given the table (next slide) To maximize profit how many workers should you hire? 26

Workers Total Product (Output) Use the following data: *Hint* How much is each worker worth? Wage = $20Price = $10 27

Units of Labor Total Product (Output) Use the following data: What is happening to Total Product? 2.Why does this occur? 3.Where are the three stages? Wage = $20Price = $10 28

Units of Labor Total Product (Output) Use the following data: Wage = $20Price = $10 Marginal Product (MP) This shows the PRODUCTIVITY of each worker. Why does productivity decrease? 29

Units of Labor Total Product (Output) Use the following data: Wage = $20Price = $10 Marginal Product (MP) Product Price 0 10 Price constant because we are in a perfectly competitive market. 30

Units of Labor Total Product (Output) Use the following data: Wage = $20Price = $10 Marginal Product (MP) Product Price 0 10 Marginal Revenue Product This shows how much each worker is worth 31

Units of Labor Total Product (Output) Use the following data: Wage = $20Price = $10 Marginal Product (MP) Product Price Marginal Factor Cost 0 20 How many workers should you hire? 32 Marginal Revenue Product

Factor Markets (Part 2) Drawing the Factor Demand Curve 33

P.Q. 1.Give an example of Derived Demand. 2.Define MRP. 3.Explain the difference between MRP and MR. 4.Why does the MRP fall as more workers are hired? 5.Identify the two ways to calculate MRP. 6.Define MFC. 7.Explain the difference between MFC and MC. 8.How does a firm decide how many workers to hire? 34

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Why do people with only high school degrees make less money on average? Employers assume they have low productivity and will generate less additional revenue. 36

Real Life Application Top 5 Fastest Growing Jobs ( ) 1.Computer Software Engineers, Applications 2.Computer Support Specialists 3.Computer Software Engineers, Systems 4.Computer Systems Administrators 5.Data Communications Analyst Top 5 Fastest Declining Jobs 1.Railroad Switch Operators 2.Shoe Machine Operators 3.Telephone Operators 4.Radio Mechanics 5.Loan Interviewers WHY? “You’ve got to learn technology!” 37

Real Life Application 38

Adjusting for Inflation Wage – The price of labor defined as currency per unit of labor worked. –NOMINAL Wage – The price of labor not adjusted for inflation. –REAL wage – The price of labor adjusted for inflation; Economists use the CPI to adjust numbers from prices/wages from different times into a consistent unit of measure (ie. “2010 dollars”)

Average Wage ( )

Wage Trends Other US labor market trends: 1)Workers with higher skills are paid more than unskilled workers. This gap is increasing. 2)College graduates earn more than high school graduates and the gap has been increasing. 3)Women, on average, are paid lower than men, although the gap has become more narrow over the years.

The MRP of a resource equals the Demand. 42

Drawing the Demand Curve for Resources 43

Units of Labor Total Product (Output) Yesterday's Activity Wage = $20Price = $10 Marginal Product (MP) Product Price 0 10 MRP Shows how many workers a firm is willing and able to hire at different wages. 44

Units of Labor Total Product (Output) Use the following data: Wage = $20Price = $10 Marginal Product (MP) Product Price 0 10 MRP Demand for this resource Plotting the D=MRP curve 45

Wage Rate Q $ D = MRP Quantity of Workers Demand=MRP Why is it downward sloping? Because of the law of diminishing marginal returns 46 Each additional resource is less productive and therefore is worth less than the previous one

Wage Rate Q $ D = MRP Quantity of Workers Demand=MRP This model applies to land, labor, and capital Notice the inverse relationship between wage and quantity of resources demand

Wage Rate Q $ D = MRP Quantity of Workers What happens if demand for the product increases? MRP increases causing demand to shift right 48 D 1 = MRP 1

3 Shifters of Factor Demand 1.) Derived Demand: Changes in the Demand for the Product Price increase of the product increases MRP and demand for the resource. 2.) Changes in Productivity Technological Advances increase Marginal Product and therefore MRP… Demand. 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 nails if the price of lumber increases significantly? 49

Drawing the Demand Curve for Resources 50

Units of Labor Total Product (Output) Use the following data: Wage = $20Price = $10 Marginal Product (MP) Product Price 0 10 Additional Revenue per worker Additional Cost per worker 0 20 How would this change if the demand for the good increased significantly? 1.Price of the good would increase. 2.Value of each worker would increase. 51

Units of Labor Total Product (Output) Use the following data: Wage = $20Price = $100 Marginal Product (MP) Product Price Additional Revenue per worker 52

Units of Labor Total Product (Output) Use the following data: Wage = $20Price = $100 Marginal Product (MP) Product Price Additional Revenue per worker Each worker is worth more!! THIS IS DERIVED DEMAND. 53

Units of Labor Total Product (Output) Use the following data: Wage = $20Price = $10 Marginal Product (MP) Product Price 0 10 Additional Revenue per worker Additional Cost per worker 0 20 How would this change if the productivity of each worker increased? 1.Marginal Product would increase. 2.Value of each worker would increase. 54

Units of Labor Total Product (Output) Use the following data: Wage = $20Price = $10 Marginal Product (MP) Product Price 0 10 Additional Revenue per worker Each worker is worth more! More demand for the resource. 55

Identify the Resource and Shifter (ceteris paribus): 1.Increase in demand for microprocessors leads to a(n) ________ in the demand for processor assemblers. 2.Increase in the price for plastic piping causes the demand for copper piping to _________. 3.Increase in demand for small homes (compared to big homes) leads to a(n) _________ the demand for lumber. 4.For shipping companies, a(n) __________ in price of trains leads to decrease in demand for trucks. 5.Decrease in price of sugar leads to a(n) __________ in the demand for aluminum for soda producers. 6.Substantial increase in demand for skilled labor, leads to an ___________ in demand for education/training Shifters of Resource Demand

Identify the Resource and Shifter (ceteris paribus): 1.Increase in demand for microprocessors leads to a(n) ________ in the demand for processor assemblers. 2.Increase in the price for plastic piping causes the demand for copper piping to _________. 3.Increase in demand for small homes (compared to big homes) leads to a(n) _________ the demand for lumber. 4.For shipping companies, a(n) __________ in price of trains leads to decrease in demand for trucks. 5.Decrease in price of sugar leads to a(n) __________ in the demand for aluminum for soda producers. 6.Substantial increase in demand for skilled labor, leads to an ___________ in demand for education/training. increase decrease increase 57 3 Shifters of Resource Demand

Resource Supply Shifters Supply Shifters for Labor 1.Number of qualified workers Education, training, & abilities required 2.Government regulation/licensing Ex: What if waiters had to obtain a license to serve food? 3. Personal values regarding leisure time and societal roles. Ex: Why did the US Labor supply increase during WWII? Why do some occupations get paid more than others?

With your partner... Use supply and demand analysis to explain why surgeons earn an average salary of $137,050 and gardeners earn $13,560. Quantity of Workers Wage Rate S L DLDL Supply and Demand For Surgeons Supply and Demand For Gardeners Quantity of Workers Wage Rate S L DLDL

What are other reasons for differences in wage? Labor Market Imperfections- Insufficient/misleading job information- This prevents workers from seeking better employment. Geographical Immobility- Many people are reluctant or too poor to move so they accept a lower wage Unions- Collective bargaining and threats to strike often lead to higher than equilibrium wages Wage Discrimination- Some people get paid differently for doing the same job based on race or gender (Very illegal!).

“Glass Ceilings” – Interpret

Factor Markets (Part 3) The Perfectly Competitive Labor Market 62

Review 1.Who demands in the Factor Market? 2.Who supplies in the Factor Market? 3.Define Derived Demand The demand for resources is determined (derived) by the products they help produce. 4. Identify the Shifters of Factor Demand 1.Derived Demand 2.Productivity of the Resources 3.Price of related resources

Use side-by-side graphs to draw a perfectly competitive labor market and firm hiring 50 workers at a wage of $100 per day. 64

SLSL DLDL Wage Q Q IndustryFirm Q M1 W M1 Q F1 D L = MRP S L = MFC Wage is set by the market demand ( D L ) The firm’s MRP falls

SLSL DLDL Wage Q Q IndustryFirm Q M1 W M1 Q F1 D L = MRP S L = MFC What happens to the wage and quantity in the market and firm if new workers enter the industry?

S L1 DLDL Wage Q Q IndustryFirm Q M1 W M1 Q F1 D L =MRP S L1 =MFC1 What happens to the wage and quantity in the market and firm if new workers enter the industry? S L2 W M2 Q M2 S L2 =MFC2 Q F2

Minimum Wage Assume the government was interested in increasing the federal minimum wage to $15 an hour Do you support this new law? Why or why not 68

S Wage Q Labor D Fast Food Cooks $15 $8 $6 The government wants to “help” workers because the equilibrium wage is too low

S Wage Q Labor D Fast Food Cooks Government sets up a “WAGE FLOOR.” Where? 70 $15 $8 $

S Wage Q Labor D Minimum Wage Above Equilibrium! 71 $15 $8 $

S Wage Q Labor D What’s the result? Q demanded falls. Q supplied increases. 72 $15 $8 $ Surplus of workers (Unemployment) Minimum Wage

Is increasing minimum wage good or bad? GOOD IDEA- We don’t want poor people living in the street, so we should make sure they have enough to live on. BAD IDEA- Increasing minimum wage too much leads to more unemployment and higher prices. 73

Minimum Wage Worksheet 74

Combining Resources Up to this point we have analyzed the use of only one resource. What about when a firm wants to combine different resources?

If you only have $35, what combination of robots and workers will maximize output? Least Cost Rule # Times Going MP (Robots) MP/P R (PriceR =$10) MP (Workers) MP/P W (PriceW =$5) 1st nd rd th $10$5 How much additional output does each resource generate per dollar spent?

If you only have $35, the best combination is 2 robots and 3 workers Least Cost Rule # Times Going MP (Robots) MP/P R (PriceR =$10) MP (Workers) MP/P W (PriceW =$5) 1st nd rd th $10 MPx = MPy Px Py $5 Resource xResource y

Profit Maximizing Rule for a Combing Resources MRPx = MRPy = MFCx MFCy 1 This means that the firm is hiring where MRP = MFC for each resource x and y

Practice: What should the firm do – comparing MRP and P for 2 resources 2. MRP L = $5; P L = $10; MRP K = $10; P K = $15 3. MRP L = $25; P L = $20; MRP K = $15; P K = $15 4. MRP L = $12; P L = $12; MRP K = $50; P K = $40 5. MRP L = $20; P L = $15; MRP K = $100; P K =$40 MORE LESS STAY PUT MORE STAY PUT LESS 1. MRP L = $15; P L = $6; MRP K = $10; P K = $10

Practice: What should the firm do – Comparing MP and P for 2 resources 2. MP L = 5; P L = $10; MP K = 10; P K = $15 3. MP L = 20; P L = $20; MP K = 15; P K = $15 4. MP L = 40; P L = $20; MP K = 100; P K = $50 5. MP L = 20; P L = $1; MP K = 60; P K =$2 MORE LABOR, Less Capital MORE CAPITAL, Less Labor STAY PUT MORE CAPITAL, Less Labor STAY PUT 1. MP L = 12; P L = $6; MP K = 10; P K = $10

2010 Practice FRQ (in problem set) 81

Factor Markets (Part 4) The IMPERFECTLY Competitive Labor Market AKA: Monopsony 83

Use the concept of derived demand to explain this cartoon What about SUPPLY? 84

Shifter Review 3 Resource Demand Shifters (Based on MRP) 1.Demand (price) of the product 2.Productivity of the resource 3.Price of related resources 3 Resource Supply Shifters 1.Number of qualified workers Education, training, & abilities required 2.Government regulation/licensing Ex: What if waiters had to obtain a license to serve food? 3. Personal values and traditions regarding leisure time and societal rolls. Ex: Why did the US Labor supply increase during WWII? 85

Imperfect Competition: Monopsony Characteristics: One firms hiring workers The firm is large enough to manipulate the market Workers are relatively immobile Firm is wage maker To hire additional workers the firm must increase Examples: Central American Sweat Shops Midwest small town with a large Car Plant NCAA 86 Perfect Competition Monopsony Resource Markets

Assume that this firm CAN’T wage discriminate (same idea as price discrimination) and must pay each worker the same wage. Acme Coal Mining Co. Wage rate (per hour) Number of Workers Marginal Factor Cost $

Assume that this firm CAN’T wage discriminate and must pay each worker the same wage. Acme Coal Mining Co. Wage rate (per hour) Number of Workers Marginal Resource Cost $ $ For monopsony, MFC does NOT equal wage

SLSL Wage QEQE WEWE D L = MRP MFC Monopsony If the firm can’t “wage discriminate”… where is MFC?

Labor Unions Goal is to increasing wages and benefits

How can Unions Increase Wages? 1.Convince Consumers to buy only Union Products Ex: Advertising the quality of union/domestic products 2.Lobbying government officials to increase demand Ex: Teacher’s Unions petition governor to increase spending. 3.Increase the price of substitute resources Ex: Unions support increases in minimum wage so employers are less likely to seek non-union workers

Labor Markets

Labor Markets and Globalization

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Why is Globalization Happening? Globalization is the result of firms seeking lowest costs. Firms are seeking greater profits. Parts are made in China because labor in significantly cheaper. What is Outsourcing? Outsourcing is when firms send jobs overseas. What types of jobs are outsourced? For many years it was only unskilled jobs, but now other skilled jobs are sent overseas.

Outsourcing- Advantages and Disadvantages Disadvantages Increases U.S. unemployment Less US tax revenue generated from workers and corporations means less public benefits Foreign workers don’t receive same protections as US workers Advantages Lowers prices for nearly all goods and services Decreases world unemployment Improves quality of life and decreases poverty in less developed countries

Video 1: Outsourcing Child Care Video 2: Stossle Outsourcing