1. Chapter 11 Markets for Factors of Production

2. 11 Markets for Factors of Production
Chapter 11 Outline
11.1 The Competitive Labor Market
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff
11.3 Wage Inequality
11.4 The Market for Other Factors of Production: Physical Capital and Land
Key Ideas
The three main factors of production are labor, physical capital, and land.
Firms derive the demand for labor by determining the value of marginal product of labor.

3. Key Ideas 11 Markets for Factors of Production
3. The supply of labor is determined by trading off the marginal benefit from labor given by earnings against the marginal cost, the value of foregone leisure.
4. Wage inequality can be attributed to differences in human capital, differences in compensating wages, and discrimination in the job market.
5. In addition to labor, a producer must derive the demand for physical capital and land to achieve its production objectives.

4. Why does a firm hire labor?
11.1 The Competitive Labor Market The Demand for Labor
Why does a firm hire labor?
Remember that consumers demand a good or service because they get utility or satisfaction from consuming it.
Why would a firm hire labor? Does it get utility from having workers around all day? FACT: demand for labor is a derived demand—that firms hire labor because labor produces an output for them. So their demand for labor is directly related to the market’s demand for their product.

5. Hiring – based on the MPL, i.e. productivity of labor.
11.1 The Competitive Labor Market The Demand for Labor
Hiring – based on the MPL, i.e. productivity of labor.
Exhibit 11.2 Production Data for The Wisconsin Cheeseman
Value of marginal product of labor = how much each worker contributes to revenue. The contribution of an additional worker to a firm’s revenues.
= Equal to MPL x output price

6. 11.1 The Competitive Labor Market The Demand for Labor
If we can sell each one of these for $2 (P =$2) , then worker 5 contributes $228 in revenue to the firm, etc.
Assume the wage (W) =$118
Need to check whether VMPL =W
Exhibit 11.2 Production Data for The Wisconsin Cheeseman
With 15, who should not be hired since the value is $110 and the wage is $118. We keep hiring until VMP = W is no longer true.

7. Exhibit 11.3 Demand for Labor
11.1 The Competitive Labor Market The Demand for Labor
Exhibit 11.3 Demand for Labor

8. 11.1 The Competitive Labor Market
The Demand for Labor
Assumptions:
Perfect competition in the output market, for example, P =$2 and remained that way.
Perfect competition in the labor market, the W =$118 and remained that way.
Maximizing Profit:
1. In choice of how much to produce
MR = MC
2. In choice of how many workers to hire
MP x P = W or VMPL = W

9. Why don’t they work all the time?
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff
Why don’t they work all the time?
Why don’t they work all the time?
Individuals create a balance between paid work and time spent on other things.

10. How much work vs. how much leisure…
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff
How much work vs. how much leisure…
Understand that the consumption of anything or any activity is done until the marginal benefit of doing it is equal to its marginal cost.
The marginal cost of one more hour of leisure –what are you giving up?—is the wage that could have been earned if that hour was spent working (assuming labor and leisure are the only two options). That is, the opportunity cost of leisure is the wage.
Marginal benefit of leisure = Wage

11. Exhibit 11.4 Total Days of Labor Supplied per Year for Alice and Tom
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff
Two things in this table.
First, the higher the wage rate, the more hours both Alice and Tom are willing to work.
Second, that Alice is willing to work more at each wage rate than Tom.
Table really represents is a relationship between the price of work and the quantity of work. This is a supply relationship.
Exhibit 11.4 Total Days of Labor Supplied per Year for Alice and Tom

12. Exhibit 11.5 Individual Labor Supply Curves
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff
Exhibit 11.5 Individual Labor Supply Curves

13. Exhibit 11.6 Labor Market Equilibrium
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff Labor Market Equilibrium: Supply Meets Demand
the demand and supply curves for labor determine an equilibrium price (wage) and an equilibrium quantity (some time period of work).
Exhibit 11.6 Labor Market Equilibrium
The demand and supply curves for labor determine an equilibrium price (wage) and an equilibrium quantity (some time period of work).

14. Exhibit 11.3 Demand for Labor
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff Labor Demand Shifters
The demand curve for labor is the same thing as the VMPL. Because that is so, the curve would shift if either of its two components (price of output and labor productivity) changes.
Exhibit 11.3 Demand for Labor
Shifts of the labor demand curve:
Price of the good the firm produces
Technology used in production

15. If Tom’s marginal product is 5 units of output, and
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff Labor Demand Shifters
Price of the good the firm produces -- if the price of the output increases, each worker is worth more to the firm.
Example:
If Tom’s marginal product is 5 units of output, and
Thus, the demand for labor shifts right
Price of output = $10
Price of output = $12
VMPL = 5 x $10 = $50
VMPL = 5 x $12 = $60

16. Exhibit 11.7 A Rightward Shift in the Labor Demand Curve
11.2 The Supply of Labor: Your Labor-Leisure Trade of Labor Demand Shifters
Exhibit 11.7 A Rightward Shift in the Labor Demand Curve

17. Why do tickets to professional sporting events
11 Markets for Factors of Production
Why do tickets to professional sporting events
cost so much money?
Recall: VMPL = W—that workers are paid according to their value to the firm
Incorrect: but that the causality is exactly reversed: athletes’ salaries are so high because ticket prices are so high. That is, the demand for tickets not only increases ticket prices, but it also increases the demand (and salaries) for athletes.

18. Example: If the price of the output is $10, and Tom’s MP = 5 units
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff Labor Demand Shifters
2. Technology used in production -- the other component is worker productivity. Technology could make workers more productive…
Example: If the price of the output is $10, and
Tom’s MP = 5 units
Tom’s MP = 7 units
VMPL = 5 x $10 = $50
VMPL = 7 x $10 = $70
MPL increased from 5 units to 7 units, selling for P= $10.
If labor and technology are complements, the labor demand curve shifts to the right.
Labor and technology could also be substitutes, as technology could replace workers, so the labor demand curve shifts to the left.

19. Shifts of the labor supply curve Population changes
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff Labor Supply Shifters
Shifts of the labor supply curve
Population changes
Changes in worker preferences and tastes
Opportunity costs
Population changes = The more people there are, the greater the supply of labor, so the labor supply curve shifts to the right.

20. Exhibit 11.8 A Shift in the Labor Supply Curve
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff Labor Supply Shifters
Exhibit 11.8 A Shift in the Labor Supply Curve
2. Changes in worker preferences and tastes
Examples:
Greater proportion of women in the labor force
Greater proportion of older workers wanting to continue working rather than retire

21. Exhibit 11.8 A Shift in the Labor Supply Curve
11.2 The Supply of Labor: Your Labor-Leisure Tradeoff Labor Supply Shifters
Exhibit 11.8 A Shift in the Labor Supply Curve

22. 11.2 The Supply of Labor: Your Labor-Leisure Tradeoff Labor Supply Shifters
3. Opportunity costs = if the alternatives to working change overall, or for a particular industry or firm, the labor supply curve will shift.
Example:
The Affordable Care Act could cause some workers to leave the labor force because they can get insurance coverage outside of employment.

23. Exhibit 11.9 U.S. Hourly Wage Distribution (2012)
11.3 Wage Inequality
Not really one equilibrium wage
Although the labor market doesn’t determine one wage, an equilibrium wage is relevant for specific industries and types of workers.
Exhibit 11.9 U.S. Hourly Wage Distribution (2012)

24. Why are wages different? Differences in human capital
11.3 Wage Inequality
Why are wages different?
Differences in human capital
Differences in compensating wages
The nature and extent of discrimination in the job market
Human capital = each person’s investment in themselves, leading to the ability to be more productive
Examples: education, job training, health
College =you are investing in your human capital.

25. 2. Differences in compensating wage differentials
11.3 Wage Inequality Differences in Human Capital
Job training
Industry-specific training increases productivity within an entire industry.
Firm-specific training increases productivity for just the hiring firm.
2. Differences in compensating wage differentials
Compensating wage differentials = wage premiums necessary to attract workers into occupations that have
unattractive aspects.
Examples:
Window washer
Worker on Alaska pipeline
Garbage collector

26. 3. Discrimination in the job market
11.3 Wage Inequality Discrimination in the Job Market
3. Discrimination in the job market
Taste-based discrimination = discrimination that arises due to people’s prejudices against a group of people
Statistical discrimination = discrimination that arises due to expectations about a group of people
Employers cannot know a potential worker’s productivity with certainty
Might use characteristics as a proxy for productivity (gender, race, etc.)

27. 11.3 Wage Inequality Discrimination in the Job Market
Taste-based discrimination = can originate with employers, other employees, or customers
Any other reasons that explains this wage difference between Hispanics and non-Hispanics: differences in income.
Ever heard the statistic that women earn 76 cents for every dollar a man earns. Point out that women also have lower levels of job training and are more likely to come into and out of the labor force because of child-rearing. The point is that just looking at the wages between two groups should not lead one to conclude that there is discrimination.
Exhibit Mean Hourly
Wage of Hispanic and Non-
Hispanic Workers (2013)

28. Physical capital = Lasting input into the production process
11.4 The Market for Other Factors of Production: Physical Capital and
Land
Physical capital = Lasting input into the production process
Land =Includes other natural resources
Capital and land can either be owned or rented -- unlike labor, which can only be rented
Raw materials that are used up in the course of production are intermediate goods, not an example of labor, capital, or land. The distinction between intermediate goods and physical capital is that capital is not used up, such as machinery or buildings.

29. 11.4 The Market for Other Factors of Production: Physical Capital and
Value of marginal product of capital (VMPK) - how much each additional unit of capital contributes to the firm’s revenues
In the case of capital, the price is the rental price—the cost of using the capital for some period of time.

30. Exhibit 11.13 Production Schedule for The Wisconsin Cheeseman
11.4 The Market for Other Factors of Production: Physical Capital and
Land
Unlike the case of labor, this time the firm needs to make a decision about how many machines to use. Again, the price of the output is $2 per unit, and the last column represents the value of each machine to the firm.
How many machines the firm would want if the rental price is $80?move down the last column to demonstrate that the value is greater than the price until we get to 10 machines.
Exhibit Production Schedule for The Wisconsin Cheeseman

31. Exhibit 11.14 Demand for Physical Capital
11.4 The Market for Other Factors of Production: Physical Capital and
Land
Exhibit Demand for Physical Capital
Demand for capital - a relationship between price of capital and how much the firm wants. Recognize that this is a demand relationship and equilibrium is the same as with labor—the firm will utilize any input until the marginal benefit is equal to the marginal cost.

32. Evidence-Based Economics Example:
11 Markets for Factors of Production
Evidence-Based Economics Example:
Is there discrimination in the labor market?
Using many different data sets, industries, and methodologies, the EBE points out that it does seem that there is discrimination in the labor market, although it is difficult to pinpoint its cause exactly.
These studies look at labor market discrimination—there could also be significant pre-labor market discrimination—discrimination that could exist before an individual even gets to the labor market - discrimination in the acquisition of education or training, for example.