Chapter 9

THE MARKET FOR FACTORS OF PRODUCTION 1. Perfect markets Supply of Labour Demand for labour Distribution of Income when Markets are competitive Imperfect competition in factor markets 1. Perfect markets Supply of Labour Demand for labour Distribution of Income when Markets are competitive Imperfect competition in factor markets

P Q P Q £ £ ££ Factor services Goods Factor services (1) Goods demand demand (4) Factor supply supply (3) Factor demand demand (2) Goods supply supply P1P1 O Q1Q1 O D1D1 S S The circular flow of incomes and expenditure D1D1

THE MARKET FOR FACTORS OF PRODUCTION Perfectly competitive factor markets Everyone is a price taker, worker, firm, and suppliers of capital and land. Freedom of Entry and Exit Factors are homogeneous – –Same level of skill and motivation Perfect Knowledge – –Know the contract, conditions and alternatives – –How good is your worker? Perfectly competitive factor markets Everyone is a price taker, worker, firm, and suppliers of capital and land. Freedom of Entry and Exit Factors are homogeneous – –Same level of skill and motivation Perfect Knowledge – –Know the contract, conditions and alternatives – –How good is your worker?

A labour market: Whole market O Labour hours Hourly wage S all workers in the market D all firms in the market

A labour market: Individual employer O Labour hours Hourly wage D individual employer

A labour market: Individual worker O Labour hours Hourly wage S individual worker

Units of CONSUMPTION I1I1 Consumption Versus Work a Like Consumption Don’t like work What are our indifference curves shaped like? Hours worked

Units of CONSUMPTION I1I1 Consumption Versus Work a Consider point a Hours worked

Units of CONSUMPTION I1I1 Consumption Versus Work a Hours worked

Units of CONSUMPTION I1I1 Consumption Versus Work U0U0 U1U1 U2U2 C Up, Work down, U rising Hours worked

Units of CONSUMPTION Constraint & Optimum Hours worked U0U0 U1U1 U2U2 24 hours

Units of CONSUMPTION Hours worked Suppose now wages rise 24 Hours =£24 U0U0 U1U1 U2U2 U3U3

The supply of hours worked O Hours worked Hourly wage S L0L0 L1L1 w0w0 w1w1

Backward-bending supply curve of labour S WIWI Hourly wage Hours O

WAGE DETERMINATION UNDER PERFECT COMPETITION The supply of labour – –the supply of hours by an individual worker   marginal disutility of work   income and substitution effects of wage changes   the shape of the individual’s supply curve of labour – –the supply of labour to an individual employer   Elastic from the perspective of the employer – –the market supply of a given type of labour   Generally upward sloping The supply of labour – –the supply of hours by an individual worker   marginal disutility of work   income and substitution effects of wage changes   the shape of the individual’s supply curve of labour – –the supply of labour to an individual employer   Elastic from the perspective of the employer – –the market supply of a given type of labour   Generally upward sloping

WAGE DETERMINATION UNDER PERFECT COMPETITION Elasticity of supply – –the mobility of labour – –economic rent and transfer earnings Elasticity of supply – –the mobility of labour – –economic rent and transfer earnings

The market for nurses O Wage rate Number of nurses S D

The market for Dame Edna Everage Dame Edna’s salary Number of Dame Ednas W S D 1 2

WAGE DETERMINATION UNDER PERFECT COMPETITION The demand for labour: marginal productivity theory – –the marginal revenue product of labour ( MRP L ) What is the additional output a firm can get from hiring one more worker? How much will they get for that output The demand for labour: marginal productivity theory – –the marginal revenue product of labour ( MRP L ) What is the additional output a firm can get from hiring one more worker? How much will they get for that output

The marginal revenue product of labour ( MRP L ) What is the additional output a firm can get from hiring one more worker? How much will they get for that output What is the additional output a firm can get from hiring one more worker? How much will they get for that output

The marginal revenue product of labour ( MRP L ) What is the additional output a firm can get from hiring one more worker? How much will they get for that output UNDER PERFERCT COMPETTITON

The marginal revenue product of labour ( MRP L ) How much will they get for that output How much does it cost them to hire that worker? W Therefore hire workers until:

The profit-maximising level of employment O £ MRP L= MR* MPP L x Q of labour

WAGE DETERMINATION UNDER PERFECT COMPETITION The demand for labour: marginal productivity theory – –the marginal revenue product of labour ( MRP L ) – –derivation of the firm's demand curve for labour The demand for labour: marginal productivity theory – –the marginal revenue product of labour ( MRP L ) – –derivation of the firm's demand curve for labour

Deriving the firm’s demand curve for labour O Q of labour £ MRP L W1W1 MC L 1 Q1Q1 a

WAGE DETERMINATION UNDER PERFECT COMPETITION Equality and inequality of wages under perfect competition – –the tendency towards equality – –causes of inequality under perfect competition – –Who are the poor and who are the rich? Equality and inequality of wages under perfect competition – –the tendency towards equality – –causes of inequality under perfect competition – –Who are the poor and who are the rich?

WAGE DETERMINATION IN IMPERFECT MARKETS Factor market power: Monopsony A firm which is a monopoly purchaser of a factor – –E.g. Single Employer in a Town – –Government A Monopolist restricts Quantity sold to keep price up A Monopsonist restricts quantity purchased to keep price down!!! Factor market power: Monopsony A firm which is a monopoly purchaser of a factor – –E.g. Single Employer in a Town – –Government A Monopolist restricts Quantity sold to keep price up A Monopsonist restricts quantity purchased to keep price down!!!

Monopsony O Q of labour £ MRP L AC L  W (supply curve)

WAGE DETERMINATION IN IMPERFECT MARKETS Types of factor market power Firms with monopsony power in employing labour – –MC L > W – –effects on wages and employment Monopsony implies Wages and Employment Down Types of factor market power Firms with monopsony power in employing labour – –MC L > W – –effects on wages and employment Monopsony implies Wages and Employment Down