Factor Markets Unit VII

Basic concepts Similar to those of: supply and demand And product markets Same concepts with new application

Circular Flow (review) Shows the difference and interaction between factor and product markets The real flow and money flow Households supply the factor market Businesses supply the product market Households are demand in the product market Business is the demand in the factor market

Factor, or resource markets ( inputs) What is the difference between factor markets and product markets?

A firm is both a seller in the product market and a buyer in the factor market Factor markets may be perfectly competitive or imperfectly competitive. MRP=MRC rule

Big Ideas about Factor, or Resource, Markets 1. Economic concepts are similar to those for product markets. 2. The demand for a factor of production is derived from the demand for the good or service produced from this resource. 3. A firm tries to hire additional units of resources up to the point where the resource’s marginal revenue product (MRP) is equal to its marginal resource cost (MRC). 4. In hiring labor, a perfectly competitive firm will do best if it hires up to the point where MRP= the wage rate. Wages are the marginal resource cost of labor.

More Big Ideas about Factor, or Resource, Markets 5. If you want a high wage: A. Make something people will pay a lot for. B. Work for a highly productive firm. C. Be in relatively short supply. D. Invest in your human capital. 6. Real wages depend on productivity. 7. Productivity depends on real or physical capital, human capital, labor quality and technology

Important terms Derived demand Marginal revenue product Marginal physical product Marginal resource cost Profit maximizing rule for employing resources Activity 44-45 . Finish for HW

Factor Markets day 2 Warm up: Explain the profit maximizing rule for factor markets. Don’t just state it. Make sure you understand how and why it works.

Why is the MRP (or demand) downward slopping? DMR: as more workers are hired, the MP of each additional worker goes down. Each of those products has a price ( in a PC market the price is constant, so P=MR) so the additional revenue earned from the additional product of the next worker, MRP, goes down DMR: as more workers are hired, the MP of each additional worker goes down. Each of those products has a price ( in a PC market the price is constant, so P=MR) so the additional revenue earned from the additional product of the next worker, MRP ,goes down

Changes in demand What are factors that can shift demand for a resource? Remember that the product market and factor market are interrelated: derived demand

Factors that can shift demand for a resource: 1. change in product price (MR=P for PCF) 2. change in productivity ( the MP or MPP) 3. changes in the price of substitutes or complementary resources depending on the substitution effect and the output effect

Determinants of the elasticity of resource demand: Rate of MRP decline Elasticity of product demand Ease of resource substitutability The proportion of total costs that the resource represents

Complete Activity 46 in class Things to keep in mind: A monopoly firm will hire fewer workers than a perfectly competitive firm. The examples in # 46 compare monopoly and perfectly competitive firms in the product markets, even though the analysis is for the factor markets. They are interrelated. Activity 46 and 47

COMPETITIVE MODEL: 1. Many firms hiring 2. Many qualified workers with identical skills acting independently 3. Wage taker (too small to set the wage rate) Notice that different types of companies demanding the same type of labor (ex. business managers) will make up a market.

COMPETITIVE MODEL In the perfectly competitive factor market, the demand curve is the sum of the individual firms demand curves. The demand curve is the MRP of the firm The supply curve for the factor market is upsloping because the firms must pay more to the workers to get them away from other occupations. (Pay for opportunity costs)

For the individual firm the demand curve is also the mrp For the individual firm the demand curve is also the mrp. In a perfectly competitive industry the firm has no influence on the wage rate paid to the workers. (They do not hire enough workers to change the rate) Since this is the case they have to accept the rate set by the market. Price taker.

A firm will also look at how much is the additional cost to hire each variable resource. This is known as Marginal Resource Cost. In order to Maximize profits, it will hire resources up to the point where MRP = MRC. This makes sense. If the last person hired adds more to cost than it adds to product than the company is losing money. This means that when a new worker is hired the total resource cost will increase by the amount of the wage. The bottom line is that the wage rate and the marginal resource cost are the same for PC.

Monopsony model MONOPSONY MODEL: (Regarding labor usage not necessarily sellers) This type of firm is not very common. Usually towns have many employers and workers are free to change occupations. (Ex. Steel mills, sugar producers) Other examples are when the workers are not totally free to move (Ex. hospitals, major league sports, school teachers...) 1) Firm is large portion of the total employment 2) Labor is immobile 3) Firm is Wage Maker Sometimes defined as the only buyer of the resource.

Since it must pay all workers a higher wage when it pays a higher wage to attract the additional worker, its Marginal Resource Cost will increase at a higher rate than its supply curve.

The firm will hire until MRC is equal to MRP The firm will hire until MRC is equal to MRP. At this point we go to the supply curve to get the wage. . If you were to look at the monopsony, it will hire less workers than a perfectly competitive industry. It is not an efficient wage rate paid

Minimum Wage How does minimum wage affect Ql in a monopsonistic labor market? What does a normal monopsonistic firm look like? If the government imposes a minimum wage what happens to Ql? We have to know where the minimum wage will be set in order to know that answer.

If minimum wage is set below the wage rate that the monopsonist is paying , then it is ineffective because the monoponist will just ignore it and pay the people what they were paying them before the minimum wage rate was set.

If minimum wage is set above old wage rate but below S and MRP intersection then the monopsonist will hire up to the Supply curve and no further. This means they will stop at the supply curve. They will hire more workers at the higher wage rate but only up to the supply curve.

If minimum wage is set above old wage rate, & above S and MRP intersection but below the MRP/MRC intersection then minimum wage is the MRC curve, so we hire where MRP = MRC. This means we hire more workers at this higher wage.

If minimum wage is set above the MRP/MRC intersection the minimum wage is the MRC so we still hire where MRP = MRC but the quantity of labor hired is less than before. The net effect is that it depends where the minimum wage is set as to how many workers we will hire. Employment rate=indeterminant