1. Factor markets -- Labor markets Dr. D. Foster – ECO 284 & General Equilibrium

2. Factor Markets Look at perfectly competitive factor markets. Focus on labor market.  Results applicable to other factor markets. Consider in the context of competitive output markets. Omit the following: Omit the following: C26: Case 2 (481-482), Case 4 (485-487), Factors affecting the elasticity of derived demand (483-484). C26: Case 2 (481-482), Case 4 (485-487), Factors affecting the elasticity of derived demand (483-484). C27: Unions (507-512). C27: Unions (507-512).

3. Factor Markets Look at perfectly competitive factor markets. Focus on labor market.  Results applicable to other factor markets. Consider in the context of competitive output markets. Results: Wages are equal. Results: Wages are equal. Why do wages differ? Why do wages differ?

4. Factor Markets Role reversal:  Demand – comes from firms.  Supply – comes from us (labor). derived Demand = derived from the demand for output produced by the factor. What would be the profit maximizing rule? Labor L* Wage D S w* Hire until the marginal benefit equals marginal cost: Marginal Revenue Product = Marginal Factor Cost

5. Factor Markets Marginal Revenue Product (MRP) is … revenue generated by this unit of labor MP L P e = MP L x P e or = MPP L xP e $ L MRP Actually, this is MP L · MR, not the price MP L · P e. But, in a perfectly competitive output market, the MR = P. We will content ourselves with this simple case.

6. Factor Markets Marginal Factor Cost (MFC) = Wage Rate (w) If a firm hires too few workers, they are giving up profitable production. If they hire too many, they are losing profit on the last unit(s) of labor. $ L MRP MFC w* ℓ*

7. Factor Markets What would change the equilibrium level of workers hired ( l *)?  A change in the equilibrium wage (w*) Due to a change in the Supply of labor. Due to a change in the Demand for labor.  A change in the equilibrium output price (P e ) The price affects the profitability of each worker.  A change in the productivity of labor (MP L ) Changes in skills, education, experience. Changes in the amount of capital Changes in the price of other (substitutable) factors.

8. Perfectly Competitive Labor Markets price taker Everyone is a price taker. no barriers There are no barriers to entry/exit. mobile Labor is mobile...  in use.  in location. the same All labor is the same. the same All job environments are the same. Result: In the LR, all wages are the same! Result: In the LR, all wages are the same!

9. Perfectly Competitive Labor Markets Why do wage rates differ? Why do wage rates differ? not All labor is not the same. differdiffersdiffers  Skills differ – education differs – experience differs not mobile Labor is not mobile in use. Labor is not perfectly mobile in location. differ Job environments differ. Result: Even with P.C. wages will differ! Result: Even with P.C. wages will differ!

10. Factor Markets – Work Problem Derive and plot MRP & MFC: i. when P=$4 & w=$24 ii. when P=$2 & w=$24 iii. when P=$4 & w=$8 Find the optimal level of labor. LaborQuantity 00 115 227 337 445 551 655 757 858

11. General Equilibrium Putting Output & Factor Markets Together Factor market assumptions Factor market assumptions –  competitive;  wage differentials reflect job environments;  labor is mobile;  capital is abundant;  when wages change, equilibrium is disrupted in SR;  LR equilibrium restored when differences reflect values placed on differing environments.

12. General Equilibrium Putting Output & Factor Markets Together Output market assumptions Output market assumptions –  competitive;  long-run constant costs;  there are only two goods – coal and wheat;  all income is spent; Current (long run equilibrium) condition Current (long run equilibrium) condition –  Wages: wheat workers $5; coal miners $8.  Prices: wheat is $3/bushel; coal is $10/ton. Draw these market curves for our next class.

13. Factor markets -- Labor markets Dr. D. Foster – ECO 284 & General Equilibrium