1. Warm-up: November 14, 2016
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:
Land – resources made by nature
Labor – work done by humans
Capital
Physical capital – machinery, buildings, tools, etc
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 6

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

8. 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?? 8

9. The Production Function for George and Martha’s Farm
(a) Total Product
(b) Marginal Product of Labor
Quantity of wheat (bushels)
Marginal product of labor (bushels per worker)
100 TP 19 17 80 15 13 60 11 9 40 7 5 20
MPL
Figure Caption: Figure 20-2: The Production Function for George and Martha’s Farm
Panel (a) shows how the quantity of output of wheat on George and Martha’s farm depends on the number of workers employed. Panel (b) shows how the marginal product of labor depends on the number of workers employed. 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8
Quantity of labor (workers)
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?

10. 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!!

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

12. Value of the Marginal Product
VMPL (P x MPL)
$380
340
300
260
220
180
140
100
(remember: price = $20; wage rate = $200)
To maximize profit, George and Martha will employ workers up to the point at which, for the last worker employed, VMPL = W. 12

13. The Value of the Marginal Product Curve
Wage rate, VMPL
Optimal point
$400
300 A
Market wage rate
200
Value of the marginal product value curve
Figure Caption: Figure 20-3: The Value of the Marginal Product Curve
This curve shows how the value of the marginal product of labor depends on the number of workers employed. It slopes downward because of diminishing returns to labor in production. To maximize profit, George and Martha choose the level of employment at which the value of the marginal product of labor is equal to the market wage rate. For example, at a wage rate of $200 the profit-maximizing level of employment is 5 workers, shown by point A. The value of the marginal product curve of a factor is the producer’s individual demand curve for that factor.
100
VMPL (or MRP) 1 2 3 4 5 6 7 8
Quantity of labor (workers)
Profit-maximizing number of workers
The VMPL (or MRP) curve is the same as the individual producer’s labor demand curve!

14. Marginal product of labor Value of marginal product of labor
Practice – 11/14/16
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 1 9 2 15 3 19 4 22 5 24

15. Marginal product of labor Value of marginal product of labor
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 1 9 2 15 3 19 4 22 5 24

16. Warm-up: November 15, 2016
Now Patty buys a new high-tech pizza oven that allows her workers to become twice as productive as before. In other words, the 1st 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.

17. Businesses use multiple resources to produce (labor, capital, etc)
Businesses use multiple resources to produce (labor, capital, etc). So what’s the best combination?
Least Cost Hiring Rule
MPL / PL = MPK / PK (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:

18. Current level of production: 2 workers, 5 units of capital TP MP 1 60 2
150 90 3
240 4
320 80 5
390 70 6
450
# capital TP MP 1
110 2
170 70 3
220 50 4
250 30 5
260 10 6
265
Current level of production: 2 workers, 5 units of capital
Each worker and unit of capital costs $1 each
Is this business using the best combination of labor and capital?
How should this business change the amounts of labor and capital to achieve the lowest cost combination?
How many workers and units of capital should they employ?

19. So…
If MPL / PL > MPK / PK Hire more workers, less capital
If MPL / PL < MPK / PK Fire workers, buy more capital
…until MPL / PL = MPK / PK

20. Remember: MPL / PL = MPK / PK
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 L
MPL
# of K
MPK 1 50
100 2 40 90 3 30 80 4 20 60 5 10 45 6
Remember: MPL / PL = MPK / PK

21. Warm-up: November 16, 2016
Warm up problem on board:
Scenario: There has been a recent increase in immigration into the area.
How will this affect the market for farm hands? Show on the graph.
How does this affect Carhart’s farm? Show on the graph.

22. The Supply of Labor (11/16/16)
Work vs. Leisure
Reality: most people don’t get to decide how many hours to work
Time allocation – what should we do with our time?
One hour of work = more income = reduction of leisure
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
Optimal labor supply choice (total # of hours): where MU of hour of work = MU of hour of leisure

23. 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. 23

24. The Individual Labor Supply Curve
(b) The Income Effect Dominates
(a) The Substitution Effect Dominates
Wage rate
Wage rate
Individual labor supply curve
$20
$20 10 10
Figure Caption: Figure 20-10: The Individual Labor Supply Curve
When the substitution effect of a wage increase dominates the income effect, the individual labor supply curve slopes upward, as in panel (a). Here a rise in the wage rate from $10 to $20 per hour increases the number of hours worked from 40 to 50. But when the income effect of a wage increase dominates the substitution effect, the individual labor supply curve slopes downward, as in panel (b). Here the same rise in the wage rate reduces the number of hours worked from 40 to 30.
Individual labor supply curve 40 50 30 40
Quantity of work (hours)
Quantity of work (hours)

25. What is a monopoly?

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

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

28. 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.)

29. 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.

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

31. 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

32. 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

33. 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

34. Earnings Differentials by Education, Gender, and Ethnicity
Annual median earnings, 2006
$70,000
No HS degree
HS degree
College degree
60,000
50,000
40,000
30,000
20,000
Figure Caption: Figure 20-9: Earnings Differentials by Education, Gender, and Ethnicity, 2006
It is clear that, regardless of gender or ethnicity, education pays: those with a high school diploma earn more than those without one, and those with a college degree earn substantially more than those with only a high school diploma. Other patterns are evident as well: for any given education level, White males earn more than every other group, and males earn more than females for any given ethnic group.
10,000
White male
White female
African-American male
African-American female
Hispanic man
Hispanic female