Markets for Factors of Production

Markets for Factors of Production Factors of Production -Land -Labour -Physical Capital -Human Capital -Other These factors are bought and sold in a factor market with supply and demand curves similar to the goods market

Markets for Factors of Production These markets are important because: • money incomes are primarily determined by the prices set in these markets. • distribution of income • production costs determine which factors are used and in what quantities • resource allocation

CIRCULAR FLOW Products Product Market Products $ Spending $ Revenue PRODUCTS $SPENDING Products & Services Products & Services Households Resource Owners Government Business Firms $ Taxes $ Taxes $SPENDING RESOURCES $ Income Resource Market $ Costs Resources Resources LAND LABOR CAPITAL

(a) The Market for Apples (b) The Market for Apple Pickers Price of Apples Supply Supply Wage of Apple Pickers  P  W Demand Demand L 0 0 0 Q Quantity of Apples Quantity of Apple Pickers The Versatility of Supply & Demand

Shifters of Labor Demand • Factors other than Wage that affect Labour Demand • 1) Changes in demand for the product • 2) Changes in labour productivity (technology, etc) • 3) Change in the price of other factors (land, human capital, etc.)

Shifters of Labour Supply • 4) Expectations • Future wages • Income • Job availability • 5) Population (workforce) • Examples of Factors other than Wage which affect Labour Supply: • 1) Income, wealth • 2) Lifestyle • 3) The wage of competing jobs Essentially, all factors affecting demand have a parallel affecting labour supply

Labour Market:Perfect Competition • 1. many firms competing with one another in hiring a specific type of labour. • 2. numerous qualified workers with identical skills independently supplying this type of labour service. • 3. neither firms nor workers can exert control over the market wage rate. • price takers.

Labour Market: Perfect Competition S w1 w1 SL D L1 Industry Labour Market The Firm: on the demand side is a price taker Wage Wage Labour Input (workers per week) Labour Input (workers per week)

Labour Market: Perfect Competition • There are many households selling to many firms, and no one household or firm has any power to influence the price. Demand for Labour • Assume that the firm on the demand side of the market is • buying (hiring) apple pickers in a perfectly competitive labour market, and • selling apples in a perfectly competitive goods market.

Labour Market: Perfect Competition: Demand for Labour. • The firm, on the Demand side of the market, is a “price taker”. • It has to decide: • how many apple pickers to hire • given the price of apples ( goods market) • given the wage rate for apple pickers (factor market) • in order to maximize profit

Marginal Review Marginal Product of Labour • Additional production of last worker hired • MPL=Q /L Marginal Revenue Product • Additional revenue of last worker hired • MRP=P x MPL • MRP= TR /  L

The Competitive Firm Decides How Much Labour to Hire: Price of Apples=$10/bu. Wage Rate=$500/week MRP marginalrevenueproduct MRP marginalrevenueproduct Output (Bushels/ Week) (Q) 0 100 180 240 280 300 Marginal Product of Labour (MPL=Q /L) 100 80 60 40 20 Labor (# of workers) (L) 0 1 2 3 4 5 of Labour (MRP=PxMPL) $1000 800 600 400 200 of Labour (TR /  L) $1000 800 600 400 200 TR Total revenue $1000 1800 2400 2800 3000

The Demand for Labour: The Profit Max Hiring Decision • In order to find the MR of the Profit Maximizing decision: The firm must consider : • 1. the production function - how the size of the work force affects the amount produced by each worker, MPL • 2. the contribution to revenue, MRPL,and to the profit equation that each worker makes • MRP = TR /  # of workers. • MRP = Product Price x MPL. • When MP   MRP  .

Profit Maximizing Hiring Decision • In order to find the MC of the profit maximizing decision; the firm must find • 3 The Marginal Factor Cost (MFC) = wage rate in perfect competition = additional cost of hiring one more unit of labour in all types of markets • hire workers up to the point where: • MRP  Wage (MFC) • (MR) (MC)

Demand for Labour: To maximize profit the firm hires the quantity of labour where the MRP = MFC (W in P.C.) • The quantity of labour a firm will hire at any given wage, cet. par. MRPscheduleis the Demand for Labour, for a competitive profit maximizing firm

Profit Max: MRP=W(MFC): The MRP is the Demand for Labour W1 MFC • MRP = P x MPL • (the value of the worker’s output) • MFC = W • (the cost of hiring a worker) • Optimal number of employees • occurs where MFC = MRP • Labour Demand is down sloping W2 MFC W3 MFC D=MRP Q1 Q3 Q2 Wage Market demand for labour in perfect competition 0 Labour Input (workers per week)

“Shifters of Labour Demand” demand for resources is a “Derived” Demand • labour does not satisfy wants directly: • and therefore depends on • 1. How productive (MP) labour is • Non labour inputs, technological progress, labour quality, prices of other resources • Price of the product • Price of other inputs

Market Supply of Labour • To attract workers, the wage rate paid must cover • the opportunity costs of alternative uses of time spent, • in other labour markets, • in house-hold activities • in leisure. • Higher wages attract people whose opportunity costs are not covered at lower wages: therefore the Supply of labour to any labour market is upward sloping.

Supply Shifters • The supply of labour changes and the supply curve shifts if • The adult population changes • Technology and capital in the home change • Preferences change

Equilibrium Wage Rate:Perfectly Competitive Labour Market S Surplus Wage Rate per Worker per Week ($) 498 Shortage D 0 Q1 Quantity of Labour • The wage adjusts so Qn.D=Qn.S • Shifts of demand or supply will change the equilibrium wage and the MRPL by the same amount since they are always equal

Labour Market: Perfect Competition S w1 w1 SL D L1 Industry Labour Market The Firm: on the demand side is a price taker Wage Wage Labour Input (workers per week) Labour Input (workers per week)

Monopsony A monopsony is a market in which there is a single buyer. • A monopsonist faces the Market Supply of Labour \To hire more labour, a higher wage must be paid: \marginal cost of labour (MFC) curve is upward sloping. To maximize profit the monopsonist hires until the marginal cost of labour , that is , the marginal factor cost , is equal to the marginal revenue product.

Supply of labour: monopsony in the hire of labour (1) Units of labor 0 1 2 3 4 5 6 (2) Wage rate $5 6 7 8 9 10 11 (3) Total labor cost (wage bill) $0 6 14 24 36 50 66 (4) Marginal factor(labour) cost TFactorC/QL $6 8 10 12 14 16 • the cost of an extra worker : MFC  the wage rate by the amount needed to bring the wage rate of all workers currently employed up to the new wage.

Marginal Factor Cost : Monopsonist: Profit Max Employment MFC S We MRP Qe • Monopsony decreases the level of employment and the wage rate, compared to perfect competition MRP > W E MFC and MRP per Worker-Week ($) Wm Hire Qm where MFC = MRP and pay Wm Qm Labour Input (worker-weeks)

Monopsony Results A monopsony reduces employment and wages when compared to PC • Provides rationale for regulation of monopsony’s Monopsonistic exploitation – workers are paid a wage rate less than the monopsonist’s revenues • Programs such as work camps, free housing, and after-education work contracts can benefit the producers more than the workers

Minimum Wage in Monopsony Increase in employment MFCL • The supply now becomes perfectly elastic at the minimum wage • MFC follows suit • To maximize profit, MFC =MRP monopsony hires 75 hours at $7.50 an hour. S Wage rate (dollars per hour) 10.00 7.50 Minimum wage • The minimum wage has increased the wage rate by $2.50 an hour and the amount of labour employed by 25 hours a day. 5.00 MRP = D 0 50 75 Labour (hours per day)

2) Unions: Monopoly on the Supply Side of the Labour Market Imperfect Competition • In some markets, workers collectively “sell” their labour through unions. • Labour unions are worker/employee organizations • Engage in collective bargaining to establish a contract which sets out • Wages,fringe benefits, maximum work days, working conditions

Unions: Goal, Increase Wages • Suppose a union is formed in an otherwise competitive market,  the union is bargaining with a large number of employers. • Assume the major goal is to increase wages • A variety of ways to achieve this

Unions: Increase Wages W1 E We D` Q1 Qe Wage increases and more labour is hired S • 1)Increase Demand for Labor. • increase demand for the product - union label. • Decrease demand for alternatives • Often self-fulfilling, as higher wages lead to higher quality • increase productivity Wage Rate per Hour D Quantity of Labour per Time Period

Unions: Increase Wages S2 E2 16 E3 15 E1 14 D2 S1 D1 Q1 Q2 If union membership is limited to Q1, wages increase to $16 instead of $15 when demand increases • 2)Restrict Labour Supply • exclusive or craft union: • union that comprises workers of a given skill. • occupational licensing. Wage Rate per Hour ($) Number of Workers per Time Period

Unions: Increase Wages MRP=MFC Wc Wage Rate per Hour ($) D= MRP Qc Number of Workers per Time Period Supply becomes horizontal at the union wage rate: MFC=Wu. Su Wu • 2) Restrict Labour Supply. • inclusive/ industrial union: • union that seeks as members all unskilled, semi skilled & skilled workers in a given industry. SL Qu

Unions: Goal, Increase Wages • Contracts for higher wages can be negotiated via the THREAT of reduced labour supply (ie: a strike) • Control over the supply side of the labour market is required here

Unions: Employ workers D2 S1 This union goal is less common due to the decrease in wages for employed workers E2 W1 • 2)A union may want to employ more workers than at equilibrium. This requires, however a reduction in wage from W1 to W2 E3 W2 Wage Rate per Hour ($) Q1 Q2 Number of Workers per Time Period

3.) Bilateral Monopoly • In communities with a single major employer, there is typically also a union. A bilateral monopoly exists when a union (monopoly seller) faces a monopsony buyer. • Wages are determined by bargaining.

3.) Bilateral Monopoly MCL S • The monopsony hires 50 hours and pays $5/hour. • The union may agree to work 50 hours, but seeks the highest wage rate the employer can be forced to pay — $10/hour=MRPL 10.00 7.50 Wage rate (dollars per hour) 5.00 MRP 0 50 75 Labour (hours per day)

3.) Bilateral Monopoly MCL S • It is unlikely the union will get $10/hour or that the firm can keep wages at $5.00/hr. • The monopsony firm and union bargain over the wage rate • It will settle between $5 and $10/hour (depending upon who is stronger). Wage rate (dollars per hour) 10.00 7.50 5.00 MRP 0 50 75 Labour (hours per day)

Wage Differentials • If all labour was homogeneous and all jobs were equally attractive, and all labour markets were perfectly competitive, then all wages would be the same…….. • Wages & earnings typically exhibit wide variations: • 1) Labour Market Imperfections • workers are not always mobile • institutional restrictions – unions.. • discrimination – hiring practices - another model of labour market imperfection

Wage Differentials • 2) Compensating Differences • jobs vary in attractiveness • 3) Non-competing Occupational Groups • workers aren’t homogeneous, they have different ability, different education and training.

Union Benefits • 1) Allows for increased productivity, skill and efficiency • 2) Reduce wage inequality • 3) Reduce profits (transfer surplus to workers) • 4) Provide a voice for workers • 5) Increase workforce stability (and job security)

Union Drawbacks • 1) Job security can lead to reduced productivity. Free-riding = expecting others to work hard Featherbedding = forcing employers to use more workers than needed • 2) Increase wage inequality between union and non-union workers • 3) Cause businesses with little economic profit to fold, resulting in unemployment • 4) Generally causes unemployment • 5) Often prevents natural market mechanisms to take place (ie: raises to hard workers, fire others)

Markets for Factors of Production