Download - EA Session 20: August 23, 2007
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EA Session 20: EA Session 20: August 23, 2007August 23, 2007
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Overview• Typology of Situations to be covered
• Equilibrium in Competitive Factor Markets– Characteristics of Competitive Factor Markets
– Demand for Factor Input with Only One Variable Factor
– Distinguishing between Marginal Revenue Product (MRPL) & Value of Marginal Product (VMPL) of Labor
– Comparing Input and Output Market Equilibrium Conditions
– Firm’s Demand Curve for Labor (with Variable Capital)
– Industry Demand for Labor
– A Firm’s Input Demand in a Competitive Factor Market
– Labor Market Equilibrium under Competition & Monopoly
– Economic Rent
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Typology of Situations
Typology 1 2 3 4 5 6 7 8
Seller(Product) comp m’ply comp m’ply comp m’ply
comp m’ply
Buyer(Labor) comp comp m’sny m’sny comp comp
m’sny m’sny
Seller(Labor) comp comp comp comp m’ply m’ply
m’ply m’ply
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Characteristics of Competitive Factor
Markets
1) Large number of buyers & sellers of the factor of production
2) The buyers and sellers of the factor of production are price takers
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Demand for Factor Input with Only One Variable Factor
• Demand for factor inputs is a derived demand, derived from factor cost and output demand.
• Measuring the Value of a Worker’s Output– Marginal Revenue Product of Labor (MRPL)
– MRPL = (MPL)(MR)
• In a competitive product market – MR = P => VMPL=P.MPL
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Marginal Revenue Product (MRPL) &
Value of Marginal Product (VMPL) of
Labor
Hours of Work
Wages($ perhour)
VMPL = MPLx P
Competitive Output Market (P = MR)
MRPL = MPL x MR
Monopolistic Output Market
(MR <P)
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w* SL
In a competitive labor market, a firm faces a perfectly elastic supply of labor
and can hire as many workers as it wants at w*.
Hiring by a Firm in theLabor Market (with Capital Fixed)
Quantity of Labor
Price ofLabor
VMPL = DL
L*
The profit maximizing firm willhire L* units of labor at the point
where the marginal revenue productof labor is equal to the wage rate.
Can we interpret this point of equilibrium as MR=MC?
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A Shift in the Supply of Labor (e.g., due to baby boom/ female
entry)
Quantity of Labor
Price ofLabor
w1S1
VMPL = DL
L1
w2
L2
S2
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Comparing Input and Output Market Equilibrium
Conditions
• Input market equilibrium condition:– Under monopoly: MRPL = MR.MPL = W => MR =
W/MPL = MC
– Under competition: VMPL = P. MPL = W => P = AR = MR = W/MPL = MC
• So, input market equilibrium condition is the same as the profit-maximization condition in the output market
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VMPL1 VMPL2
When two or more inputs arevariable, a firm’s demand for one input
depends on the marginal revenue product of both inputs.
Firm’s Demand Curve for Labor
(with Variable Capital)
Hours of Work
Wages($ perhour)
0
5
10
15
20
40 80 120 160
When the wage rate is $20, A represents one point on the firm’sdemand for labor curve. When the wage rate falls to $15, the MRP curve shifts, generating a new point C on the firm’s demand for labor curve. Thus A and C are on the demand for labor curve, but B is not. Thus, demand curve for laboris more elastic in the presence of anothervariable factor, which opens up scope for substitution.DL
A
B
C
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• Assuming all firms respond to a lower wage– All firms would hire more workers.– Market supply of output would increase.– The market price of output will fall. – The quantity demanded of labor by the
firm will be smaller, given lower output price.
– Thus, industry demand curve would be less elastic as compared to the curve w/o
any price fall.
Industry Demand for Labor
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VMPL1
Derivation of the Industry Demand for
Labor
Labor(worker-hours)
Labor(worker-hours)
Wage($ perhour)
Wage($ perhour)
0
5
10
15
0
5
10
15
50 100 150 L0 L2
DL1
Horizontal sum ifproduct price
unchanged
120
VMPL2
L1
Industrydemand
curve withprice falling
DL2
Firm Industry
Step 1 Step 1More labor=>More output=>Less price=>VMPL shifts back
step2
Step 2
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SMarket Supplyof fabric
A Firm’s Input Demand in aCompetitive Factor Market
Yards ofFabric (thousands)
Yards ofFabric (thousands)
Price($ peryard)
Price($ peryard)
D
Market Demandfor fabric
100
ME = AE10 10
Supply ofFabric Facing Firm
50
Demand for Fabric
VMP
Observations1) The firm is a price taker at $10.2) S = AE = ME = $103) ME = VMP @ 50 units
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SL = AE
SL = AE
DL = VMPL DL = MRPL
VMPL =P *MPL
Labor Market Equilibrium (typology 1 & 2)
Number of Workers Number of Workers
Wage WageCompetitive Output Market Monopolistic Output Market
wC
LC
wM
LM
vM
AB
WC
LC
With monopoly, w↓, L ↓, Q ↓
(VM – WM) =‘exploitation of labor under monopoly
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Labor Market Equilibrium
• Equilibrium in a Competitive Output Market– DL(VMPL) = SL
– wC = VMPL
– VMPL = (P)(MPL)– Markets are efficient
• Equilibrium in a Monopolistic Output Market– MR < P– MRP = (MR)(MPL)
– Hire LM at wage wM
– vM = marginal benefit to consumers
– wM = marginal cost to the firm
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Labor Market Equilibrium
• Equilibrium in a Competitive Output Market– DL(VMPL) = SL
– wC = VMPL
– VMPL = (P)(MPL)– Markets are efficient
• Equilibrium in a Monopolistic Output Market– MR < P– MRP = (MR)(MPL)
– Hire LM at wage wM
– vM = marginal benefit to consumers
– wM = marginal cost to the firm
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Total expenditure (wage) paidis rectangle 0w* AL*Economic Rent
Economic rent is ABW*
B
Economic Rent
Number of Workers
Wage
SL = AE
DL = VMPL
w*
L*
A
0
The economic rent associated with theemployment of labor is the excess of wages
paid above the minimum amount neededto hire workers.
How can rent toLabor disappear?
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EconomicRent
s1
EconomicRent
s2
Land Rent
Number of Acres
Price($ peracre)
Supply of Land
D2
D1
Why is economic rentincreasing?