Chapters 16.1-16.5, 17.1-17.4, 18.1, 18.2: Input & Labor Markets, Wages & Rent

1. Chapters 16.1-16.5, 17.1-17.4, 18.1, 18.2: Input & Labor Markets, Wages & Rent

2. Input Demand Curve of aCompetitive Firm • Input demand shows the total quantity of the input that will be demanded at various prices • Input demand will depend on the marginal value product (MVP), which is the extra revenue a competitive firm receives by selling the additional output generated when employment of an input is increased by 1 unit • For a competitive firm, MVP = MPL * P (this is b/c output price is constant for a competitive firm) • It makes sense for a firm to hire to the point where MVP = w, w = MPL*P and therefore w/MPL = P

3. Competitive Firms Demand for Labor: All Inputs Variable • When all inputs are variable, an input’s MVP curve shifts with changes in the employment of other inputs • A lower wage rate causes the firm to substitute toward labor and away from capital • Input demand is a “derived demand” reflecting the fact that industry demand for an input ultimately derives from consumers’ demand for the final product produced by that input Dollars per unit Capital A1 MC New expansion path MC’ A 12 E E2 E2 A’ P3 E 10 E1 IQ2 E1 IQ1 q1 q2 0 Output 0 Z’ Z1 20 26 30 Labor Substitution Effect Output Effect

4. Competitive Industry Demand for Labor The firm The market Wage Wage A $300 = w A’ $300 = w B $200 = w’ B’ $200 = w’ C C’ d(P = $100) ∑ d(P = $100) ∑ d’(P = $80) d’(P = $80) D Labor 0 20 27 30 Labor 0 2,000 2,700 3,000

5. Elasticity of an Industry’s Demand Curve for an Input • Elasticity of input demand is the sensitivity of input demand to changes in input cost = (%input demand)/(%input cost) • Four major determinants of the elasticity of an industry’s demand for an input • Elasticity of the final product • The substitutability of one input for another in production • The supply of other inputs • Time period

6. Supply of Inputs Wage Wage S S w2 w2 w1 w1 0 L1 (100,000,000) Labor (in all industries) L1 (5,000) 0 L2 (15,000) Labor (in software programming industry)

7. Equilibrium in Input Markets The Equilibrium Wage and Employment Level for a Competitive Industry Input Price Equalization Across Industries The firm Aerospace industry Telecommunications industry The industry Wage Wage Wage SSA SS’A Wage SST SS’T S $400 = wA $350 = w’A $350 = w’T s $300 = w s $300 = w $250 = w1 $300 = wT d D DA DT l (500) Labor 0 0 L0 (6,000) L (10,000) L1 (12,000) Labor 0 LA (500) L’A (700) Labor 0 LT (800) L’T (1,000) Labor

8. Income Leisure Choice of the Worker Weekly Income A B Y2 E $800 = Y1 U3 U2 G U1 $20 F 1 hr.

9. Supply of Hours of Work Weekly Income A’ H $25 1 hr. $25 1 hr. A E’ $20 1 hr. E1 U2 E U1 L3 L1 Leisure L2 H’ Z 0 S I TE

10. A Backward Bending Labor Supply Curve? Weekly income Hourly wage A’’ $30 E’’ $30 1 hr. A’ E’’ $25 E’ E’ 1 hr. A $25 $20 1 hr. E E $20 Labor 0 L2 L3 L1 ZL3 Z Leisure ZL1 ZL2

11. Why Do Wages Differ? • If wage rates differ across occupations and there is free entry and exit from/into occupations, shouldn’t we see individuals leave the low wage occupation (shifting supply to the left) and enter the high wage occupation (shifting supply to the right), equalizing wages across occupations. So why do wages differ across individuals and occupations? • Compensating wage differentials • Differences in human capital • Differences in ability

12. Minimum Wages S S Wage Wage $5.15 $6.00 $4.00 $5.15 D D 0 Unskilled Labor 0 L2 L1 L3 Unskilled Labor L2 L1 L3

13. Burden of Social Security Tax • Social security is financed by a payroll tax composed of two equal-rate levies, one collected from employers and one collected from employees (about 7.6% on each for the first $80K of income), so who really pays for this tax? Wage Wage S S $10.50 = w’’ $10 = w $10.00 = w Total revenue $8.50 = w’ $8 = w’ $2 $2 D D D’ = D - T D’ = D - T 0 Labor L1 0 Labor L1