1 ECONOMICS 200 PRINCIPLES OF MICROECONOMICS Professor Lucia F. Dunn Department of Economics

2 Distribution of Income 1.Functional Distribution: Refers to which factors of production get what fraction of the total national income. - National Income = rents + wages + salaries + interest + profits So: Rents go to landlords, wages and salaries go to labor, interest goes to capital owners, profits goes to entrepreneurs. 2. Size Distribution of Income: Refers to how income is distributed to certain fractions of the population. Ex. What fraction of total national income goes to the top 20% of income-earners, the bottom 20%, etc.

3 Income Distribution Lorenz Curve o % of household income earned % of households 45 o line represents complete equality.

4 Demand In Factor Markets 1 2 If demand for automobiles increases, the demand for auto workers will increase. – Call “Derived Demand” because it is derived from demand for final product. Total Labor Market

5 The Individual Firm’s Decision on Factor Use Profit-Maximizing Hiring Rule for Any Factor of Production Says hire up to point where: Marginal Cost of Hiring = Marginal Revenue Product from Hiring. MC = MRP OR  MRP = MPP MR If all markets are competitive, then MR=P. (1) So: MRP = MPP  P Product All workers (of a certain type) are paid the same wage. (2) So: MC = Wage

6 Marginal Revenue Product Curve Q of Labor Quantity of Product MPP Q of Labor $ MPR = MPP  P Product The MRP curve becomes the firm’s demand curve for the factor.

7 The Individual Firm’s Decision on Factor Use Q Q Labor D 0 Total Labor Market S Q Q Labor S=MC One Firm 0 How Is the Going Wage Rate Set?

8 The Individual Firm’s Decision on Factor Use Q of Labor Wage MRP=D Q of Labor Wage WOWO S=MC LOLO MRP W1W1 W2W2 W3W3 If wage changes, firm always goes to point where MRP=W.  So the MRP curve is the demand curve for labor for the firm.

9 The Individual Firm’s Decision on Factor Use So the return a factor earns should be equal to the MRP, or the value of what it is contributing to a firm’s revenues in equilibrium.

10 The Individual Firm’s Decision on Factor Use What Determines the Elasticity of a Derived Demand Curve: (1) The larger the proportion of total cost accounted for by the factor, the more elastic will be the demand for it. (2) The more elastic the demand for the final product, the more elastic will be the demand for the factor that makes it.

11 Factors Influencing the Supply of Labor 1. Population 2. Labor Force Participation 3. Hours of Work Labor Force Participation Rate =

12 Economic Rent If a factor of production gets paid more than is necessary to keep it from moving to another use, we say it is earning an “economic rent”. “Transfer earnings” are the amount just necessary to prevent a factor from moving. Economic rent is common in the entertainment and sports areas. Econ. Rent Transfer Earning NOTE: The steeper (i.e., move inelastic) the supply curve a factor, the greater will be its economic rent.

13 Economic Rent Q S 0 D QOQO Case I : Perfectly Elastic Supply  no economic rent Case II : Perfectly Inelastic Supply Q S 0 D QOQO  all payment to factor is economic rent

14