1. © 2010 Pearson Education CanadaChapter 11 - 1 Chapter 11 What Are You Worth? © 2010 Pearson Education Canada

2. Chapter 11 - 2 What Are You Worth? Demand & Supply in Input Markets, and Income and Wealth Distributions

3. © 2010 Pearson Education CanadaChapter 11 - 3 LEARNING OBJECTIVES 11.1Explain the sources of poverty and describe trade-offs in policies to help the poor 11.2Explain the four types of income and how they are determined in input markets 11.3Explain how to calculate marginal revenue product, and its importance for smart business hiring decisions continued…

4. © 2010 Pearson Education CanadaChapter 11 - 4 11.4Explain how to calculate present value and how it informs smart investment choices 11.5Describe economic rent, and explain its importance for determining income

5. © 2010 Pearson Education CanadaChapter 11 - 5 SWITCHING SIDES INCOMES ARE PRICES & QUANTITIES IN INPUT MARKETS Incomes are determined by prices and quantities in input markets. In input markets, households supply to businesses labour, capital, land, and entrepreneurship in exchange for wages, interest, rent, and profits.

6. © 2010 Pearson Education CanadaChapter 11 - 6 INCOMES ARE PRICES & QUANTITIES IN INPUT MARKETS In input markets, households are sellers and businesses are buyers continued…

7. © 2010 Pearson Education CanadaChapter 11 - 7 INCOMES ARE PRICES & QUANTITIES IN INPUT MARKETS Income — what you earn — is a flow – flow amount per unit of time – income for labour, capital and land = (price of input) × (quantity of input) = price × quantity Wealth — value of assets you own — is a stock – stock fixed amount at a moment in time continued…

8. © 2010 Pearson Education CanadaChapter 11 - 8 Entrepreneurs’ incomes are determined by price × quantity Entrepreneurs earn profits – normal profits = compensation for entrepreneur’s time & money – economic profits — over and above normal profits – economic profits are a residual — what is left over from revenues after all opportunity costs of production (including normal profits) have been paid for other inputs

9. © 2010 Pearson Education CanadaChapter 11 - 9 Figure 11.2 Inputs & Incomes INPUTINCOME Labour Wages Capital ( $ ) Interest Land ( & other resources) Rent EntrepreneurshipProfits (normal & economic)

10. © 2010 Pearson Education CanadaChapter 11 - 10 WHAT HAVE YOU DONE FOR ME LATELY? LABOUR & MARGINAL REVENUE PRODUCT For maximum profits, businesses should hire additional labour as long as labour’s marginal revenue product (additional benefit) is greater than the wage paid for labour (additional cost).

11. © 2010 Pearson Education CanadaChapter 11 - 11 LABOUR & MARGINAL REVENUE PRODUCT To hire labour business must pay market wage = best opportunity cost of person supplying labour Business demand for labour is derived demand – derived demand demand for output and profits businesses can derive from hiring labour continued…

12. © 2010 Pearson Education CanadaChapter 11 - 12 Marginal product additional output from hiring one more unit of labour – When businesses hire labourers to work with fixed inputs, there is diminishing marginal productivity each additional labourer has lower marginal product than previous labourer continued…

13. © 2010 Pearson Education CanadaChapter 11 - 13 Marginal revenue product additional revenue from selling output produced by additional labourer – labourer’s marginal revenue product = marginal product × price of output – marginal revenue product diminishes for additional labourers continued…

14. © 2010 Pearson Education CanadaChapter 11 - 14 Figure 11.3 Labour Hiring Decision Q LabourMPP OUTPUT MRP 00$15 0 16 $90 25$15 $75 34 $15 $60 43 $15 $45 52 $15$30

15. © 2010 Pearson Education CanadaChapter 11 - 15 Rule for maximum profits for business – hire additional hours of labour as long as marginal revenue product is greater than the wage – hire additional hours of any input as long as marginal revenue product is greater than the input’s price

16. © 2010 Pearson Education CanadaChapter 11 - 16 Figure 11.4 Comparing MRP & Wage Rate $90 $75 $60 $45 $30 0 12 3 45 $90 $60 $75 $15 $45 $30 MRP Q Wage Rate = $50

17. © 2010 Pearson Education CanadaChapter 11 - 17 PRESENT AND ACCOUNTED FOR INTEREST ON CAPITAL & PRESENT VALUE Present value shows what money earned in future is worth today. Present value compares price paid for today’s investment against investment’s future earnings. For a smart choice, present value of investment’s future earnings should be greater than investment’s price today.

18. © 2010 Pearson Education CanadaChapter 11 - 18 INTEREST ON CAPITAL & PRESENT VALUE The present value of a future amount of money is the amount that, if invested today, will grow as large as the future amount, taking account of earned interest = Amount of Money Available in n Years (1 + Interest Rate) n Present Value

19. © 2010 Pearson Education CanadaChapter 11 - 19 Future revenues not worth as much as today's revenues because today’s revenues earn interest – discount reduction of future revenues for forgone interest Present value simplifies future stream of revenues from an investment to a single number today – converts flow of future revenues into a stock, the value today, you can compare with cost today to make a smart choice For a smart choice, the present value of investment’s stream of future revenues should be greater than the price of the investment today

20. © 2010 Pearson Education CanadaChapter 11 - 20 WHY SIDNEY CROSBY PLAYS BY DIFFERENT RULES LAND, ECONOMIC RENT, & SUPERSTAR SALARIES Income for any input in inelastic supply, for example land or superstar talent, is economic rent, which is determined by demand alone.

21. © 2010 Pearson Education CanadaChapter 11 - 21 LAND, ECONOMIC RENT, & SUPERSTAR SALARIES Economic rent income paid to any input in relatively inelastic supply Land is a classical example of an input in inelastic supply For inputs like land in inelastic supply, prices effectively determined by demand alone

22. © 2010 Pearson Education CanadaChapter 11 - 22 For most products/services, high input prices cause high output prices For inputs in inelastic supply, high output prices cause high input prices — high economic rents

23. © 2010 Pearson Education CanadaChapter 11 - 23 WHAT SHOULD YOU BE WORTH? INEQUALITY & POVERTY Government policies to address the market’s unequal distributions of income and wealth involve trade-offs between efficiency and equality.

24. © 2010 Pearson Education CanadaChapter 11 - 24 INEQUALITY & POVERTY “What are you worth?” is a positive question; depends on quantities of inputs you own and prices markets place on those inputs “What should you, or any person, be worth?” is a normative question you must answer as a citizen Poverty results from not owning labour skills or assets the market values, or from not getting high enough price for what you do own

25. © 2010 Pearson Education CanadaChapter 11 - 25 Policy options to reduce inequality and poverty – education & training – progressive tax and transfer system Improving human capital through education and training addresses underlying cause of poverty — lack of inputs the market values Human capital increased earning potential from work experience, on-the-job training, education continued…

26. © 2010 Pearson Education CanadaChapter 11 - 26 Figure 11.8 Education & Income in Canada, 2005 EDUCATIONMEDIAN INCOME Education $32,029 Less than High School$37,403 Trades or Apprentices $39,996 College$42,937 University below Bachelor Degree$47,253 University Bachelor Degree$56,048 Post-Bachelor Degree$66,535

27. © 2010 Pearson Education CanadaChapter 11 - 27 Marginal tax rate rate on additional dollar of income Federal and provincial tax systems use progressive taxes — tax rate increases as income increases – regressive taxes tax rate decreases as income increases – proportional (flat-rate) taxes tax rate same regardless of income Transfer payments payments by government to households continued…

28. © 2010 Pearson Education CanadaChapter 11 - 28 Due to incentive effects, “A more equally shared pie may be a smaller pie” Efficient market outcome not necessarily fair or equitable – may include (poor) people unable to pay for basic necessities like shelter, food, medical care continued…

29. © 2010 Pearson Education CanadaChapter 11 - 29 Governments can reduce poverty & inequality using tax and transfer system to take from rich and give to the poor (Robin Hood) – costs and benefits of policies to help the poor apply to different people – how you feel about Robin Hood’s motto depends on whether you are being taken from or given to

30. © 2010 Pearson Education CanadaChapter 11 - 30 Figure 11.5 Average 2006 Market Income for Canadian Families Average Market Income Quintiles of Families $150,000 Lowest 20% 2 nd Lowest 20% 2 nd Highest 20% Highest 20% $100,000 0 Middle 20% $22,100 $42,900 $72,200 $147,600 $6,600 Average for all Canadian Families $57,900 $50,000

31. © 2010 Pearson Education CanadaChapter 11 - 31 Figure 11.6 Percentage of 2006 Total Canadian Market Income % of Total Market Income Earned Quintiles of Families 2% Hypothetical Perfect Equality Lowest 20%2 nd Lowest 20% 2 nd Highest 20% Highest 20% Middle 20% 60% 50% 40% 30% 20% 0 10% 8% 15% 24% 51%

32. © 2010 Pearson Education CanadaChapter 11 - 32 Figure 11.7 Percentage of Canadian Wealth Owned

33. © 2010 Pearson Education CanadaChapter 11 - 33 Figure 11.9 Average 2006 Canadian Income after Transfers & Taxes $150,000 Lowest 20% Income after Transfer & Taxes Quintiles of Families 2 nd Lowest 20% 2 nd Highest 20% Highest 20% $100,000 0 $13,100 $29,100 $44,600 $65,200 $119,300 Average for all Canadian Families $54,300 Middle 20% $50,000

34. © 2010 Pearson Education CanadaChapter 11 - 34 Figure 11.10 Percentage of 2006 Total Canadian Income after Transfers and Taxes % of Total Income Earned after Transfers and Taxes Quintiles of Families 5% Hypothetical Perfect Equality Lowest 20%2 nd Lowest 20% 2 nd Highest 20% Highest 20% Middle 20% 50% 40% 30% 20% 0 10% 11% 16% 24% 44%

35. © 2010 Pearson Education CanadaChapter 11 - 35 Chapter 11 Refresh Slides

36. © 2010 Pearson Education CanadaChapter 11 - 36 PRICES & QUANTITIES IN INPUT MARKETS 1.What are the two types of markets in the circular-flow road map? Identify the buyers and sellers in each market. 2.If you have $10,000 in a savings account, and no other assets, what is your income from capital if the interest rate is 8%? What is your wealth? continued…

37. © 2010 Pearson Education CanadaChapter 11 - 37 3.When Wahid (Chapter 6) started his own web business using his savings and a small inheritance from his grandfather, he played multiple roles on the circular flow road map. Identify those roles as he set up his business, and the roles he continues to play as the business begins producing web services. What are his types of income?

38. © 2010 Pearson Education CanadaChapter 11 - 38 MARGINAL REVENUE PRODUCTS 1.What is marginal revenue product? 2.In the example from Chapter 3, your boss is willing to pay you triple-time wages for working extra time. Explain the calculation she must have made in offering you that much money if she was making a smart hiring decision. continued…

39. © 2010 Pearson Education CanadaChapter 11 - 39 3.In the example in Figure 11.3, what would happen to Wahid’s hiring decision if the price he could sell web pages for rose from $15 per page to $20 per page? Does that fit with your general impression of business hiring when sales and revenues are strong? Explain your answer.

40. © 2010 Pearson Education CanadaChapter 11 - 40 INTEREST ON CAPITAL & PRESENT VALUE 1.In your own words, explain present value? What is its formula? 2.What is comparison problem that the concept of present value helps solve? 3.Suppose someone offers you a bond that will pay you $2000 at the end of a year. If the interest rate is 7% (0.07), what is the most you would be willing to pay for the bond today? Why?

41. © 2010 Pearson Education CanadaChapter 11 - 41 LAND & ECONOMIC RENT 1.Define economic rent. 2.For most products/services, what is the relationship between input prices and output prices? For inputs in inelastic supply, what is the relationship between input prices and output prices? continued…

42. © 2010 Pearson Education CanadaChapter 11 - 42 3.Music groups usually go on tour to promote a new album. Given the availability of digital album downloads, what do you think is the difference in the elasticity of supply of albums versus the elasticity of supply of concert performances? Where are (talented) musicians more likely to earn economic rents?

43. © 2010 Pearson Education CanadaChapter 11 - 43 INEQUALITY & POVERTY 1.Explain the differences between income and wealth. 2.What are the two main policy options for reducing poverty and inequality? What other policies can you think of that would address other causes of poverty? 3.Where does your family fit into the Canadian distribution of income? Of wealth? Are you surprised?