MICROECONOMICS: Theory & Applications Chapter 17 Wages, Rent, Interest, and Profit By Edgar K. Browning & Mark A. Zupan John Wiley & Sons, Inc. 9 th Edition, copyright 2006 PowerPoint prepared by Della L. Sue, Marist College

Copyright 2006 John Wiley & Sons, Inc Learning Objectives Investigate a worker’s decision concerning how many work hours to supply. Examine the income and substitution effects of a higher wage rate and whether the net result of a wage increase involves a worker supplying more work hours. Analyze the general level of wage rates and why wages differ among jobs. Define when economists mean by the term “rent”. (Continued)

Copyright 2006 John Wiley & Sons, Inc Learning Objectives (continued) Explore selling or monopoly power in input markets and show how unions attempt to exercise such power in labor markets. Explain how the interest rate is determined through the interplay of the supply of and demand for capital. Overview why interest rates differ across specific credit markets.

Copyright 2006 John Wiley & Sons, Inc The Income-Leisure Choice of the Worker Leisure – the portion of a worker’s time when he or she is not receiving compensation from an employer Figure 17.1

Copyright 2006 John Wiley & Sons, Inc Is the Income-Leisure Model Plausible? Common objection: workers do not really have the ability to vary their work hours. Justifications: –Options to workers that give them control over how much they work: overtime, vacation leave, leave without pay, moonlighting, sick leave, early retirement –The model is fundamentally correct analytically. –The model provides a basis for analyzing work effort decisions involving groups of workers, not necessarily one specific worker.

Copyright 2006 John Wiley & Sons, Inc The Supply of Hours of Work Question: Does a higher wage always lead a workers to work more? Substitution effect - a higher wage rate encourages more work Income effect – a higher wage rate encourages less work The total effect is the sum of the effects: if larger effect will determine whether there is an increase or a decrease in work hours.

Copyright 2006 John Wiley & Sons, Inc Worker’s Response to a Change in the Wage Rate [Figure 17.2]

Copyright 2006 John Wiley & Sons, Inc Is a Backward-Bending Labor Supply Curve Possible? A supply curve of work hours can be backward-bending beyond some wage rate if the normal income effect of a higher wage rate exceeds the substitution effect. Figure 17.3

Copyright 2006 John Wiley & Sons, Inc The Market Supply Curve A market supply curve of work hours is obtained by horizontally summing the individual supply curves of all workers competing in a given labor market. Like the individual supply curve, the market supply curve can slope upward, bend backward, or show a combination of the two. The elasticity of the supply curve of labor to a specific job or industry depends upon how the number of workers varies with wage rates in those occupations.

Copyright 2006 John Wiley & Sons, Inc The General Level of Wage Rates The aggregate demand curve for labor reflects the marginal productivity of labor to the economy as a whole. Real wages are higher in developed countries than in less developed countries because of the factors determining the position of the demand curve: capital, technology, and skills. Figure 17.4

Copyright 2006 John Wiley & Sons, Inc Why Wages Differ Assumptions behind the equalization of wage rates across firms or industries: –Workers are identical. –Workers evaluate the desirability of jobs only in terms of money wage rates. Figure 17.5

Copyright 2006 John Wiley & Sons, Inc Factors Attributable to Equilibrium Difference in Wage Rates Compensating wage differentials – differences in wages paid that are created by the forces of supply and demand when workers view some jobs as intrinsically more attractive than others Human capital investment – the process by which people augment their earning capacity Differences in ability

Copyright 2006 John Wiley & Sons, Inc Economic Rent Economic rent – that portion of the payment to an input supplier in excess of the minimum amount necessary to retain the input in its present use Figure 17.6

Copyright 2006 John Wiley & Sons, Inc Economic Rent with an Upward- Sloping Supply Curve [Figure 17.7]

Copyright 2006 John Wiley & Sons, Inc Monopoly Power in Input Markets: The Case of Unions [Figure 17.8]

Copyright 2006 John Wiley & Sons, Inc Some Alternative Views of Unions and an Assessment of the Impact of Unions on Worker Productivity Unions protect workers’ rights and wages, counteracting the monopsony power possessed by input-buying firms. Unions set up effective grievance procedures. Unions give workers a “voice” with their employers.

Copyright 2006 John Wiley & Sons, Inc Borrowing, Lending, and the Interest Rate Interest rate –The price paid by borrowers for the use of funds –The rate of return earned by capital as an input in the production process Figure 17.9

Copyright 2006 John Wiley & Sons, Inc Investment and the Marginal Productivity of Capital Gross marginal productivity – the total addition to productivity that capital investment contributes Net marginal productivity – the total addition to productivity that capital investment contributes, less the cost of capital

Copyright 2006 John Wiley & Sons, Inc The Investment Demand Curve Investment demand curve – the relationship between the rate of return generated and various levels of investment Figure 17.10

Copyright 2006 John Wiley & Sons, Inc Saving, Investment, and the Interest Rate [Figure 17.11]

Copyright 2006 John Wiley & Sons, Inc The Level of Investment and Productive Capacity [Figure 17.12]

Copyright 2006 John Wiley & Sons, Inc Equalization of Rates of Return Tendency: capital is allocated across firms and industries so that the rate of return is equal Why? Owners of capital have an incentive to shift their investments to industries where the return is higher => output in that industry will expand and price falls until the industry earns a normal profit. Adjustments occur until all industries earn a normal profit.

Copyright 2006 John Wiley & Sons, Inc Why Interest Rates Differ Reasons: –Difference in risk –Differences in the duration of the loan –Cost of administering loans –Differences in tax treatment

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