© 2010 pearson education canadachapter 11 - 1 chapter 11 what are you worth? © 2010 pearson...

© 2010 Pearson Education CanadaChapter 11 - 1

Chapter 11

What Are You Worth?

© 2010 Pearson Education Canada


What Are You Worth?

Demand & Supply in Input

Markets,

and Income and Wealth

Distributions


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…


11.4 Explain how to calculate present value

and

how it informs smart investment choices

11.5 Describe economic rent, and explain

its

importance for determining income


SWITCHING SIDESINCOMES 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.


INCOMES ARE PRICES & QUANTITIES IN INPUT MARKETS

• In input markets, households are sellers and

businesses are buyers

continued…


INCOMES ARE PRICES & QUANTITIES IN INPUT MARKETS

• Income — what you earn — is a flow

– flowamount 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

– stockfixed amount at a moment in time

continued…


• 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


Figure 11.2 Inputs & Incomes

INPUT INCOME

Labour Wages

Capital ($) Interest

Land (& other resources) Rent

Entrepreneurship Profits (normal &

economic)


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).


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 demanddemand for output and profits businesses can derive from hiring labour

continued…


• Marginal product

additional output from hiring one more unit

of labour

– When businesses hire labourers to work with fixed inputs, there is diminishing marginal productivityeach additional labourer has lowermarginal product than previous labourer

continued…


• 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…


Figure 11.3 Labour Hiring Decision

Q Labour MP POUTPUT MRP

0 0 $15 0

1 6 $15 $90

2 5 $15 $75

3 4 $15 $60

4 3 $15 $45

5 2 $15 $30


• 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


Figure 11.4 Comparing MRP & Wage Rate

$90

$75

$60

$45

$30

01 2 3 4 5

$90

$60

$75

$15

$45

$30

MRP

Q

Wage Rate = $50


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.


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


• 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


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.


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


• 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


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.


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


• 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…


Figure 11.8 Education & Income in Canada, 2005

EDUCATION MEDIAN

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


• Marginal tax raterate 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…


• 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…


• 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


Figure 11.5 Average 2006 Market Income for Canadian Families

Av

era

ge

Ma

rket

Inco

me

Quintiles of Families

$150,000

Lowest 20%

2nd

Lowest 20%

2nd Highest

20%

Highest 20%

$100,000

0Middle20%

$22,100$42,900

$72,200

$147,600

$6,600

Average for all Canadian Families

$57,900

$50,000


Figure 11.6 Percentage of 2006 Total Canadian Market Income

% o

f T

ota

l Ma

rket

Inco

me

Ea

rned


2%

HypotheticalPerfectEquality

Lowest 20% 2nd

Lowest 20%2nd

Highest 20%Highest

20%Middle20%

60%

50%

40%

30%

20%

0

10% 8%

15%

24%

51%


Figure 11.7 Percentage of Canadian Wealth Owned


Figure 11.9 Average 2006 Canadian Income after Transfers & Taxes

$150,000

Lowest 20%

Inco

me

aft

er

Tra

ns

fer

& T

axe

s


2nd

Lowest 20%

2nd Highest

20%

Highest 20%

$100,000

0

$13,100

$29,100$44,600

$65,200

$119,300

Average for all Canadian Families

$54,300

Middle20%

$50,000


Figure 11.10 Percentage of 2006 Total Canadian Income after Transfers and Taxes

% o

f T

ota

l In

co

me

Ear

ne

d a

fte

r T

ran

sfe

rs a

nd

Ta

xes


5%

HypotheticalPerfectEquality

Lowest 20% 2nd

Lowest 20%2nd

Highest 20%

Highest 20%Middle20%

50%

40%

30%

20%

0

10%11%

16%

24%

44%


Chapter 11Refresh Slides


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…


1. 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?


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…


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.


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?


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…


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?


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?

© 2010 pearson education canadachapter 11 - 1 chapter 11 what are you worth? © 2010 pearson...

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