Download Factor Markets and Vertical Integration

Chapter
Fifteen
Factor Markets
and Vertical
Integration
Factor Markets and Vertical Integration
• In this chapter, we examine four main
topics
– Competitive factor market
– Effect of monopolies on factor markets
– Monopsony
– Vertical integration
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15–2
Competitive Factor Market
• Virtually all firms rely on factor markets
for at least some inputs.
• The firms that buy factors may be
competitive price takers or
noncompetitive price setters, such as a
monopsony.
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15–3
Competitive Factor Market
• Factor markets are competitive when
there are many small buyers and sellers.
• Our earlier analysis of the competitive
supply curve applies to factor markets.
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15–4
Short-Run Factor Demand of a Firm
• A profit-maximizing firm’s demand for a
factor of production is downward sloping:
The higher the price of an input, the less
the firm wants to buy.
• In the short, a firm has a fixed amount
of capital, K , and can vary the number
of workers, L , it employs.
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15–5
Short-Run Factor Demand of a Firm
• marginal revenue product of labor (MRPL)
– the extra revenue from hiring one more
worker
dR dR dq
• MRPL 


 MR  MPL
dL dq dL
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15–6
Short-Run Factor Demand of a Firm
• The firm maximizes its profit by hiring
workers until the marginal revenue
product of the last worker exactly equals
the marginal cost of employing that
worker, which is the wage:
MRPL  w
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15–7
Table 15.1 Marginal Product of Labor,
Marginal Revenue Product of Labor, and
Marginal Cost
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15–8
Figure 15.1 The Relationship Between
Labor Market and Output Market Equilibria
a) The firm’s profit is maximized at L  4
workers per hour where the wage line,
w  $12, crosses the marginal revenue
product of labor, MRPL , curve, which is
also the demand curve for labor.
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15–9
Figure 15.1 The Relationship Between
Labor Market and Output Market Equilibria
b) The firm’s profit is maximized at 22
units of output (produced by 4
workers), for which its marginal cost,
MC  w / MPL, curve equals the market
price, p  $3.
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15–10
Figure 15.1 The Relationship Between
Labor Market and Output Market Equilibria
(a) Labor Profit-Maximizing Condition
18
6
15
Labor supply
curve
w = 12
9
MRPL, Labor
demand curve
2
3
4
5
6
L, Workers per hour
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MC
4
3
6
0
(b) Output Profit-Maximizing Condition
p
2.4
2
0
13
18
22 25 27
q, Units of output per hour
15–11
Figure 15.2 Shift of and Movement Along
the Labor Demand Curve
• If the market price is $3, the firm’s labor
1
demand curve is D . A fall in the wage
causes a shift of the supply curve from S 1
to S 2 and a movement along the
demand curve for labor.
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15–12
Figure 15.2 Shift of and Movement Along
the Labor Demand Curve
• If the wage is w1  $12 , the firm hires 4
workers per hour, equilibrium point a. If
the wage falls to w2  $6 . The firm hires
6 workers, point b . A fall in the market
price to $2 causes a shift of the firm’s
1
2
D
D
demand curve for labor from
to
.
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15–13
Figure 15.2 Shift of and Movement Along
the Labor Demand Curve
• If the market wage stays constant at
w1  $12, the fall in the market price
causes a movement along the supply
curve S 1: The number of workers the
firm hires falls from 4, point a on D1
1
2
1
S
and , to 2, point c on D and S .
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15–14
Figure 15.2 Shift of and Movement
Along the Labor Demand Curve
D 1 = $3  MPL
w = 12
1
D 2 = $2  MPL
c
a
S1
8
b
w =6
2
0
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2
4
S2
5
6
L, Workers per hour
15–15
APPLICATION
• The firm has a Cobb-Douglas production
function:
q  L0.6 K 0.2 .
• The marginal product of labor function,
when we hold capital fixed at K  32 is
MPL  1.2 L0.4 .
Thus if a competitive thread mill faces a
market price of $50, its labor demand
curve is
0.4
MRPL  p  MPL  $50 1.2 L
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0.4
 $60 L
.
15–16
Long-Run Factor Demand
• In the long run, the firm may vary all of
its putout. Now if the wage of labor rises,
the firm adjusts both labor and capital.
The long-run labor demand curve takes
account of changes in the firm’s use of
capital as the wage rises.
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15–17
Long-Run Factor Demand
• In the short run, the firm cannot vary
capital, so the short-run MPL curve and
hence the short-run MRPL curve are
relatively steep. In the long run, when
the firm can vary all inputs, its long-run
MPL curve and MRPL curves are flatter.
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15–18
Figure 15.3 Labor Demand of a
Thread Mill
Short-run demand (K = 108)
15
a
b
10
c
Long-run
demand
Short-run demandK( = 32)
0
32
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88
162
L, Workers per hour
15–19
Factor Market Demand
• A factor market demand curve is the
sum of the factor demand curves of the
various firms that use the input.
Determining a factor market demand
curve is more difficult than deriving
consumer’s market demand for a final
good.
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15–20
Factor Market Demand
• To derive the labor market demand
curve, we first determine the labor
demand curve for each output market
and then sum across output markets to
obtain the factor market demand curve.
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15–21
The Marginal Revenue Product
Approach
• Earlier we derived the factor demand of
a competitive firm that took the output
market price as given. The problem we
face is that the output market price
depends on the factor’s price.
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15–22
Figure 15.4 Firm and Market Demand for
Labor
• When the output price is p  $9 , the
individual competitive firm’s labor
demand curve is MRPL ( p  $9) . If
w  $25 per hour, the firm hires 50
workers, point a in panel a , and the 10
firms in the market demand 500 workers,
point A on the labor demand curve
D ( p  $9) in panel b .
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15–23
Figure 15.4 Firm and Market Demand for
Labor
• If the wage falls to $10, each firm would
hire 90 workers, point c , if the market
price stayed fixed at $9. The extra
output, however, drives the price down
to $7, so each firm hires 70 workers,
point b. The market’s demand for labor
that takes price adjustments into
account, D (price varies), goes through
points A and B .
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15–24
Figure 15.4 Firm and Market
Demand for Labor
(b) Market
(a) Firm
D (price varies)
a
25
A
25
MRPL ( p = $9)
MRPL ( p = $7)
10
0
D (p = $7)
b
c
50
70
90
L, Firm’
s labor per hour
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10
0
D (p = $9)
B
C
500
700
900
L, Market’
s labor per hour
15–25
An Alternative Approach
• It takes one microchip, which costs pm ,
and one plastic case, which costs p p , to
produce a calculator, so the marginal
cost of a calculator is MC  pm  p p .
Competitive firms operate where the
price of a calculator is p  pm  p p . Thus
the demand curve for a microchip lies p p
below that of a calculator.
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15–26
Figure 15.5 Demand for Microchips
in Calculators
pp
Demand for
calculators
Demand for
microchips
Q, Calculators per day
M, Microchips per day
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15–27
Competitive Factor Market Equilibrium
• The intersection of the factor market
demand curve and the factor market
supply curve determines the competitive
factor market equilibrium.
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15–28
Competitive Factor Market
Equilibrium
• Factor prices are equalized across
markets. For example, if wages were
higher in one industry than in another,
workers would shift from the low-wage
industry to the high-wage industry until
the wages were equalized.
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15–29
Effect of Monopolies on Factor
Markets--Market Structure and Factor Demands
• Factor demand curves vary with market
power. The marginal revenue of a profitmaximizing firm is MR  p(1  1/  ) .
• Thus the firm’s marginal revenue
product of labor function is
 1
MRPL  p 1   MPL
 
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15–30
Market Structure and Factor
Demands
• A monopoly operates in the elastic
section of its downward sloping demand
curve, so its demand elasticity is less
than -1 and finite:     1 . At any
given price, the monopoly’s labor
demand, p(1  1/  ) MPL , lies below the
labor demand curve, pMPL , of a
competitive firm with an identical
marginal product of labor curve.
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15–31
Market Structure and Factor
Demands
• A Cournot duopoly firm’s labor demand
curve, p 1  1/(2 ) MPL,lies above that of
a monopoly but below that of a
competitive firm.
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15–32
Figure 15.6 How Thread Mill Labor
Demand Varies with Market Structure
Competitive demand
Duopoly demand
Monopoly demand
L, Workers per hour
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15–33
A Model of Market Power in Input and
Output Markets
• When a firm with market power in either
the factor or the output market raises its
price, the price to final consumers rises.
As a result, consumers buy fewer units,
so fewer units of the input are
demanded.
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15–34
Competitive Factor and Output
Markets
• The labor demand function is the same
as the output demand function, where
we replace p with w and Q with L :
w  80  L.
• The intersection of this output supply
curve and the output demand curve
occurs at Q1  60 and p1  $20. A
competitive firm’s average cost, w1 ,
exactly equals the price at which it sells
its good, p1, so the competitive firm
breaks even.
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15–35
Figure 15.7 Effect of Output Market
Structure on Labor Market Equilibrium
80
Competitive labor demand,
Output demand
e3
p = p = w = 50
3
2
3
π = $900
e2
p = w = w = 20
1
2
1
e1
Supply of labor
Monopoly labor
demand, MR
0
20
30
Q =L
2
2
Q =L
3
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3
40
60
Q =L
1
1
80
Q, Units per hour
L, Workers per hour
15–36
Competitive Factor Market and
Monoplized Output Market
• Because the monopoly’s marginal
product of labor is 1, its demand curve
for labor equals its marginal revenue
curve:
MRPL  MRQ  MPL  MRQ .
w  80  2L.
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15–37
Competitive Factor Market and
Monoplized Output Market
• The intersection of the competitive labor
supply curve, w2  $20 , and the
monopoly’s demand for labor curve
determines the labor market
equilibrium, e2 , where 80  2L  20. Thus
the equilibrium amount of labor
is L2  30 .
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15–38
Monopolized Factor Market and
Competitive Output Market
• The labor monopoly operates at e3 in
Figure 15.7, where its marginal revenue
equals its marginal cost of $20:
80  2L  20.
• The labor monopoly sells L3  30 hours
of labor services. Substituting this
quantity into the labor demand curve,
Equation 15.4, we find that the
monopoly wage is w3  $50.
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15–39
Monopolized Factor Market and
Competitive Output Market
• The profit goes to the monopoly
regardless of which market is
monopolized.
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15–40
Monopoly in Successive Markets
• If there are two successive monopolies,
consumers are hit with a double
monopoly markup. The labor market
equilibrium is e4 . Where the wage, w4 , is
$30 above the labor market’s marginal
and average cost of $20. The product
market monopoly’s price, p4, is $15
above its marginal cost, w4. If the labor
monopoly integrates vertically,
consumers gain ( p3  p4 ), and total
profit increases from A  B to B  C .
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15–41
Figure 15.8 Double Monopoly Markup
80
p = 65
4
A = $225
p = w = w = 50
3
4
3
e
e
4
3
Output demand
B = $450
C = $450
MC of labor
20
MRL
0
15 20
Q =L
4
4
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30
Q =L
3
3
Labor demand, MRQ
40
80
Q, Units per hour
L, Workers per hour
15–42
Monopsony
• A monopsony, a single buyer in a
market, chooses a price-quantity
combination from the industry supply
curve that maximizes its profit.
• A monopsony is the mirror image of
monopoly, and it exercises its market
power by buying at a price below the
price that competitive buyers would pay.
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15–43
Monopsony Profit Maximization
a) The marginal expenditure curve—the
monopsony’s marginal cost of buying
one more unit—lies above the
upwardsloping market supply curve.
The monopsony equilibrium, em ,occurs
where the marginal expenditure curve
intersects the monopsony’s demand
curve. The monopsony buys fewer
units at a lower price, wm  $20, than a
competitive market, wc  $30, would.
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15–44
Monopsony Profit Maximization
b) The supply curve is more elastic at the
optimum than in (a), so the value that
the monopsony places on the last unit
(which equals the marginal
expenditure of $40) exceeds the price
the monopsony pays, wm  $30, by less
in (a).
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15–45
Figure 15.9 Monopsony
(b) More Elastic
(a) Less Elastic
60
ME, Marginal expenditure
ME, Marginal expenditure
60
Supply
ME = 40
ME = 40
ec
wc = 30
wm = 20
0
wm = 30
20
10
em
20
em
20
Supply
Demand
Demand
30
60
L, Workers per day
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0
20
60
L, Workers per day
15–46
Monopsony Profit Maximization
• Monopsony power is the ability of a
single buyer to pay less than the
competitive price profitable. The size if
the gap between the value the
monopsony places on the last worker
(the height of its demand curve) and the
wage it pays (the height of the supply
curve) depends on the elasticity of
supply at the monopsony optimum.
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15–47
Welfare Effects of Monopsony
• By setting a price, pm, below the
competitive level, pc,a monopsony
causes too little to be sold by the
supplying market, thereby reducing
welfare.
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15–48
Figure 15.10 Welfare Effects of
Monopsony
Marginal expenditure
A
ME
Supply
B
C
pc
pm
E
D
F
Demand
Qm
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Qc
Q, Units per day
15–49
Monopsony Price Discrimination
• If some consumers have monopsony
power while others do not, sellers offer
those with monopsony power lower
prices.
• A monopsony may directly price
discriminate in much the same way as a
monopoly or an oligopoly.
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15–50
Vertical Integration
• To sell a good or service to consumers
involves many sequential stages of
production and sales activities.
Profitability determines how many
stages a firm performs itself.
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15–51
Stages of Production
• Raw inputs produced upstream are
combined using a production process,
Q  f ( M , L) , downstream to produce a
final good, which is sold to consumers.
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15–52
Figure 15.11 Vertical Organization
Inputs
Materials
M
Final good
q = f (M, L)
Labor
L
Upstream
Downstream
Consumers
q
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15–53
Degree of Vertical Integration
• A firm that participates in more than one
successive stage of the production or
distribution of goods or services is
vertically integrated. A firm may
vertically integrate backward and
produce its own inputs.
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15–54
Degree of Vertical Integration
• All firms are vertically integrated to
some degree, but they differ
substantially as to how many
successive stages of production they
perform internally. It may produce a
good but rely on others to market it. Or
it may produce some inputs itself and
buy others form the market.
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15–55
Produce or Buy
• Whether a firm vertically integrates,
quasi-vertically integrates, or relies on
markets depends on which approach is
the most profitable.
• When deciding whether to integrate
vertically, the firm must take into
account not only the direct costs of
integrating, such as legal fee, but also
the higher cost of managing a larger,
more complex company.
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15–56
Produce or Buy
• Five Possible Benefits from Vertical
integration
– Lowering transaction costs
– Ensuring a steady supply
– Avoiding government intervention
– Extending market power
– Eliminating market power
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15–57
Lowering Transaction Costs
• Probably the most important reason to
integrate is to avoid transaction cost:
the costs of trading with others besides
the price, including the costs of writing
and enforcing contracts.
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15–58
Lowering Transaction Costs
• An important source of transaction costs
is opportunistic behavior: taking
advantage of someone when
circumstances permit.
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15–59
Ensuring a Steady Supply
• Like the electronic game manufacturer,
many firms are at mercy of their
suppliers. A supplier that delivers a
crucial part late imposes substantial
costs on these manufactures.
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15–60
Avoiding Government Intervention
• Firms may also vertically integrate to
avoid government price control, taxes,
and regulations. A vertically integrated
firm avoids price controls by selling to
itself.
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15–61
Avoiding Government Intervention
• Firms also integrate to lower their taxes.
By shifting profits from a high-tax
jurisdiction to a low-tax jurisdiction, a
firm can increase its after-tax profits.
• Government regulations create
additional incentives for a firm to
integrate vertically (or horizontally)
when the profits of only one division of a
firm are regulated.
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15–62
Extending Market Power
• By vertically integrating, a firm may be
able to increase its monopoly profits by
price discriminating or by monopolizing.
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15–63
Eliminating Market Power
• A firm that faces a monopsony buyer or
monopoly seller may try to eliminate
that market power by vertically
integrating.
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15–64