1. Warm-up: December 17, 2014 Suppose that the government places price controls (a price ceiling) on the market for college professors. Describe the effect of this policy on the production of college degrees. What sectors of the economy do you think will be adversely affected by this policy? What sectors of the economy might benefit?

2. Quick – what are the four factors of production?

4. Factors o’ production: 1. Land – resources made by nature 2. Labor – work done by humans 3. Capital a.Physical capital – machinery, buildings, tools, etc b.Human capital – knowledge, training, education (entrepreneurship can fit here)

5. The importance of factor prices affects allocation of resources Ex: Mississippi and Louisiana after Hurricane Katrina Average wage rate in affected areas increased by at least 30% - why??

6. Two features that make these markets special: – Demand for the factor, which is derived from the firm’s output choice (known as DERIVED DEMAND) Ex: if a ton of kids sign up for Microeconomics, then the demand for econ teachers will increase Ex: if people dislike baseball all of a sudden, then the demand for workers at Louisville Slugger will decrease – Factor markets are where most of us get the largest shares of our income

7. Factor Incomes and the Distribution of Income A.Income mostly comes from wages and salaries B.Some get income from physical capital (ex: stock ownership) C.Income also can come from rent earned on land D.Factor distribution of income: how total income of economy is divided between labor, land, and capital

8. Factor Distribution of Income in U.S. in 2007 Interest 5.4% Rent 0.6% Corporate profits 14.3% Proprietors’ income 9.3% Compensation of employees 70.4%

9. Marginal Productivity and Factor Demand We’re still going to compare marginal costs with marginal benefits! (Told you MC = MR was important.) An employer’s marginal cost of a worker = worker’s wage rate But what is the marginal benefit??

10. MPL 786543210 19 17 15 13 11 9 7 5 Marginal product of labor (bushels per worker) 786543210 100 80 60 40 20 Quantity of wheat (bushels) (a) Total Product(b) Marginal Product of Labor TP Quantity of labor (workers) The Production Function for George and Martha’s Farm Quantity of labor (workers) Assume that workers must be paid $200 each, and that wheat sells for $20 per bushel. What is their optimal # of workers?

11. We know how to do this by finding total cost and marginal cost…remember the huge spread sheets? Another way to find optimal level of output to maximize profit: Value of the marginal product of labor (VMPL) = P x MPL Optimal level of output occurs where VMPL = W (wage) – this is the same thing as where marginal cost (wage) = marginal revenue!!

12. Value of Marginal Product of Labor (VMPL) = Marginal Revenue Product of Labor (MRP or MRP L ) You will most likely see MRP or MRP L on the AP test, so get used to seeing it both ways!

13. To maximize profit, George and Martha will employ workers up to the point at which, for the last worker employed, VMPL = W. Value of the Marginal Product VMPL (P x MPL) $380 340 300 260 220 180 140 100 (remember: price = $20; wage rate = $200)

14. The Value of the Marginal Product Curve Value of the marginal product value curve VMPL (or MRP) A 0 12348765 $400 300 200 100 Wage rate, VMPL Profit-maximizing number of workers Optimal point Market wage rate Quantity of labor (workers) The VMPL (or MRP) curve is the same as the individual producer’s labor demand curve!

15. Practice – 4/26/16 1. Patty’s Pizza Parlor has the production function per hour shown below. The hourly wage rate for each worker is $10. Each pizza sells for $2. a. Calculate the marginal product of labor for each worker and the value of the marginal product of labor per worker. b. Draw the VMPL (MRP) curve. Use your diagram to determine how many workers Patty should employ. c. Now the price of pizza increases to $4. Calculate the VMPL, and draw the new VMPL curve onto the diagram from part b. How many workers should Patty employ now? Quantity of Workers Quantity of pizzas Marginal product of labor Value of marginal product of labor 00 19 215 319 422 524

16. 2. Now, the hourly wage rate rises from $10 to $15. The price of pizza remains $2 each. Use a diagram to determine how Patty’s demand for workers responds as a result of this wage rate increase. Quantity of Workers Quantity of pizzas Marginal product of labor Value of marginal product of labor 00 19 215 319 422 524

17. Shifts in the Factor Demand Curve 1.Changes in the prices of goods If the price of wheat increases, will the profit- maximizing level of employment increase or decrease?

18. Shifts of the Value of the Marginal Product Curve A B 2085 $200 VMPL 1 2 A C 05 $200 VMPL 3 1 (a) An Increase in the Price of Wheat(b) A Decrease in the Price of Wheat Quantity of labor (workers) Wage rate Market wage rate

19. 2. Changes in supply of other factors Let’s say George and Martha acquire more land to cultivate wheat. Will this increase or decrease the profit-maximizing level of employment?

20. Shifts of the Value of the Marginal Product Curve A B 2085 $200 VMPL 1 2 A C 05 $200 VMPL 3 1 (a) An Increase in land(b) A Decrease in land Quantity of labor (workers) Wage rate Market wage rate

21. Warm-up: December 17, 2015 Now Patty buys a new high-tech pizza oven that allows her workers to become twice as productive as before. In other words, the 1 st worker now produces 18 pizzas per hour instead of 9, and so on. Use the production function from yesterday’s problem 1, and keep the price of pizza at $2 and the wage rate $10 per hour. a. Calculate the new MPL and new MRP. b. Use a diagram to determine how Patty’s hiring decision responds to this increase in the productivity of her workforce. Include the new MRP curve and the initial MRP curve from problem 1.

22. 3. Changes in technology If technology improves, will this increase or decrease the profit-maximizing level of employment?

23. It depends! Example 1: Tractors reduce the demand for horses Example 2: Over the long run, machinery has actually increased the demand for labor

24. Quantity of Workers Quantity of pizzas Marginal product of labor Value of marginal product of labor 00 118 36 2301224 338816 444612 54848

25. Data for a yo-yo manufacturer (perfect competition) Units of resource Total product (Q) Marginal physical product Price of yo-yos Total revenue (P x Q) Marginal revenue product (MPP x price) 00---$2.00$0--- 188216$16 214622812 3192 4232 5262 6282 7292

26. 1. Why does the # of extra yo-yos produced decrease as more workers are hired? 2. If the wage is $12, how many workers should the company hire? Why? 3. If the demand for yo-yos increases so that the company can sell as many yo-yos as they want for $4 each, how many workers can they hire now? (Hint: you’ll need to re-do 3 of the columns to reflect this new price.)

27. MRP depends on marginal product and the price of the good or service being produced. For the following situations, identify whether MPP of the factor or price of the product is affected and indicate whether the demand for the resource will increase or decrease. SituationMPPriceDemand for labor A new yo-yo machine increases productivity of labor The price of yo-yos increases Better training increases the output of yo-yo labor The demand for yo-yos increases New technology increases the output of yo-yo labor Consumers become sick of yo-yos

28. Warm-up: January 5, 2015 Howard and Robin work at Dairy Queen. Howard opens the restaurant and therefore has to start cooking, and Robin comes in later and makes the shakes and sundaes. Both are paid the current market wage of $8.25 per hour, and both have the same skills. But Howard feels that he should be paid much more per hour than Robin because the revenue generated from the burgers he flips is much higher than the revenue generated by the ice cream Robin serves. Does Howard’s argument make sense?

29. Businesses use multiple resources to produce (labor, capital, etc). So what’s the best combination? Least Cost Hiring Rule MP L / P L = MP K / P K (L = labor, K = capital) We’ve seen this type of thing before, but regarding consumers and matching marginal utility per dollar spent of two products:

30. # workersTPMP 00 160 215090 324090 432080 539070 645060 # capitalTPMP 00 1110 217070 322050 425030 526010 62655 Current level of production: 2 workers, 5 units of capital Each worker and unit of capital costs $1 each 1.Is this business using the best combination of labor and capital? 2.How should this business change the amounts of labor and capital to achieve the lowest cost combination? 3.How many workers and units of capital should they employ?

31. So… If MP L / P L > MP K / P K Hire more workers, less capital If MP L / P L < MP K / P K Fire workers, buy more capital …until MP L / P L = MP K / P K

32. Another example: A producer of gadgets pays $5 for each hour of labor and $10 for each hour of capital employed. You can only spend $40. Find the least-cost combination of labor and capital. # of LMP L # of KMP K 1501100 240290 330380 420460 510545 65630 Remember: MP L / P L = MP K / P K

33. Warm-up: January 6, 2015 For each of the following situations, give the most likely explanation for these wage differences. 1.Test pilots for new jet aircraft earn higher wages than airline pilots. 2.College graduates usually have higher earnings in their first year on the job than workers without college degrees have in their first year. 3.Unionized workers are generally better paid than non-unionized workers. 4.Across all ethnicities, women’s median earnings are less than men’s median earnings for any given educational level.

34. unattractive/dangerous jobs usually demand higher wages ex: truckers who haul hazardous materials differences in talent ex: Derek Jeter generates a higher value of marginal product than a lower-ability person – commands higher price

35. difference in quantity of human capital education, training, experience Other reasons for disparities: market power – the role of unions efficiency wages – incentives for hard work and reduction of worker turnover leads to inefficiency – translates into unemployment

36. Discrimination Market forces tend to work against discrimination Discrimination takes place: When there is excess supply of workers When it’s institutionalized in govt policy Past discrimination plays a role – ex: education

37. Earnings Differentials by Education, Gender, and Ethnicity White male $70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 Annual median earnings, 2006 White female African- American male No HS degreeHS degreeCollege degree African- American female Hispanic man Hispanic female

38. The Supply of Labor (4/27/16) I.Work vs. Leisure A.Reality: most people don’t get to decide how many hours to work B.Time allocation – what should we do with our time? 1.One hour of work = more income = reduction of leisure C.Ex: You make $10 an hour. To decide how many hours to work, you compare the marginal utility of an add’l hour of leisure to the marginal utility of $10 worth of stuff you could buy D.Optimal labor supply choice (total # of hours): where MU of hour of work = MU of hour of leisure

39. The Supply of Labor A rise in the wage rate causes both an income and a substitution effect on an individual’s labor supply. – The substitution effect of a higher wage rate induces longer work hours, other things equal (leisure time is now more expensive in terms of opportunity cost) – This is countered by the income effect: higher income leads to a higher demand for leisure, a normal good (you feel richer) If the income effect dominates, a rise in the wage rate can actually cause the individual labor supply curve to slope the “wrong” way: downward.

40. The Individual Labor Supply Curve Individual labor supply curve 50400 $20 10 400 $20 10 30 (a) The Substitution Effect Dominates Quantity of work (hours) (b) The Income Effect Dominates Wage rate Quantity of work (hours)

41. Shifts of the Labor Supply Curve The market labor supply curve is the horizontal sum of the individual supply curves of all workers in that market. It shifts for four main reasons: – changes in preferences and social norms – changes in population – changes in opportunities – changes in wealth

42. What is a monopoly?

43. So… take a guess: What is a monopsony?

44. Best examples of monopsony: 1.A coal mine in a small town in the Appalachians 2.GM and Ford back in the day in Detroit (it kinda works) 3.A monopoly that buys equipment from other businesses (think Standard Oil in the late 1800s)

45. A monopolist exerts market power by limiting quantities produced and jacking up the price, right? So how would a monopsony exert ITS market power? (Think about a coal mine hiring workers.)

46. Monopsonist will choose quantity L and wage rate w. Perfectly competitive conditions (most efficient point) should be a quantity of L’ workers and a wage rate of w’. Monopsonists choose fewer workers and pay a lower wage, similar to how a monopolist chooses lower quantity and higher price for good – they have the power to do so.

47. All Producers Face the Same Wage Rate – why?? 50 $200 Wage rate Market wage rate 7 $200 VMPL wheat VMPL corn VMPL wheat = P x MPL VMPL corn = P corn x MPL corn (a) Farmer Jones(b) Farmer Smith Profit-maximizing number of workers Farmer Smith’s Farmer Jones's wheat Wage rate Quantity of labor (workers) Profit-maximizing number of workers

48. The Marginal Productivity Theory of Income Distribution Assume that the labor market is in equilibrium - # of workers willing to work equals # of workers that producers want to employ Market Labor Supply Curve E Market Labor Demand Curve L* W* Quantity of labor (workers) Rental rate

49. Equilibria in the Land and Capital Markets Quantity (a) The Market for Land Quantity (b) The Market for Capital Rental rate D Land R* Capital S S Land D Capital Q* Land Q* Capital R* Land Rental rate Rental rate: explicit or implicit cost of using a unit of land or capital for a set period of time.

50.  Each firm will hire labor up to the point at which the VMPL is equal to the equilibrium wage rate.  This means that, in equilibrium, the VMPL will be the same for all employers.  So the equilibrium (or market) wage rate is equal to the equilibrium value of the marginal product of labor—the additional value produced by the last unit of labor employed in the labor market as a whole.  According to the marginal productivity theory of income distribution, every factor of production is paid its equilibrium value of the marginal product. Equilibrium in the Labor Market

51. So let’s apply this theory to the economy as a whole. Does this theory hold water? Is every worker paid the equilibrium value of the marginal product – the same wage rate?

52. What if we look at specific labor markets? What about the market for teachers? Pastry chefs? Restaurant hosts/hostesses? Does the theory hold water now?

53. Yes, but only if 2 assumptions are made: 1. The market for labor is perfectly competitive 2. All workers are of the same ability