Download Unit 4 Lesson 1

Unit 4 Lesson 1
The circular flow diagram shows how the factors market (demand for wages) can affect the
cost and output of the product. Ex. What happens if the economy is going so well that wages are
driven up. ( Supply curve in the product market shifts left.)
The factor market (demand for wages) can
affect the cost and output of a product.
Ex: What happens if the economy is going so
well that wages are driven up? Supply in the
product market will shift left.
Money spent on the productive resources gives the households money to purchase goods and
services.
If a good is not in great demand the resources used in production of that good will not be in
great demand.
You have to look at the resources used in production to look at the costs or production. The
cost curves we have been looking at are derived from the factors of production.
When you look at the factor market you have to realize that it is a derived demand. This
means that the demand for the factors of production are derived from the demand for the goods
you are producing.
It is important to look at
1. how productive something is at producing the good and
2. the price of the product. If it is priced high it must mean that people want the good.
Assumptions:
1) In a perfectly competitive factor market each firm is acquiring a very small amount of
resources compared to the entire market. This means they are not affecting the price of the
resources.
2) A resource will be in greater demand if it can produce a product that is in great demand.
monopsony: a market in which there is only one buyer of the good, service, or resource.
Unit 4, Lesson 2
Marginal Product: the change in total product / change in quantity
As units of variable resource is added to production a point is reached where diminishing
marginal returns is reached. As more and more of a variable resource is added to a fixed
resource a point is reached where the additional production added by the next variable resource
will be less than the previous and eventually total production will decrease.
Overhead 4-3
Unit of
Resource
Total
Product
0
1
2
3
4
5
6
7
0
7
13
18
22
25
27
28
Marginal
Physical
Product
(MPP)
Product
Price
Total
Revenue
Marginal
Revenue
Product
(MPR)
2
2
2
2
2
2
2
2
14
26
36
44
50
54
56
14
12
10
8
6
4
2
7
6
5
4
3
2
1
Units of Resource: the variable resource (Ex: labor)
Total Product: The Production achieved from the resource (Q) (Notice that the law of
diminishing returns will set in here. As more units of resource are added a point will be reached
where the total product will actually start back the other way. This is not a monetary thing but a
physical thing.)
Marginal Product (Marginal Physical Product): The change in production from each
additional resource
Product Price: Set price because this is a perfectly competitive product market
Total Revenue: The amount of production achieved times the price. (P x Q)
Marginal Revenue Product: increase in total revenue resulting from the use of each additional
variable input.
It is calculated as the change in Total Revenue. This shows us the change in revenue
associated with the change in variable resource.
Derived demand implies that
1. productivity of resources used in production
2. market value (price of good produced)
Marginal Revenue Product shows how much each variable resource adds to MR.
Overhead 27.1
From this we can derive a Marginal Revenue
Product Schedule: This is the Demand curve
for the variable resource.
It is a demand curve because it shows the
amount of labor that will be demanded at each
price level.
Imperfect Competitor in the product market
For a imperfect competitor in the product
market the company must lower the price in
order to sell more. This means that the MRP
will not only fall because of the law of
diminishing marginal returns but also because
the price has dropped
(See Overhead 4-4)
Determinants of Resource Demand:
1) Changes in Product demand will cause the change in resource demand to go in the same direction.
(Common Sense)
2) Changes in the productivity of the resource will shift the demand curve in the same direction. (If
the resource can make more (MRP) at the same cost (MRC) then the resource would be in greater
demand.
3) Changes in price of other resources:
If price of a substitute good declines the demand for the other good will decline because they can
buy the other good MRC and still get the same output MRP. (Substitution Effect)
However, at the same time since the cost of the other resource declines they can now get more
output from that resource (its demand curve shifts out). This will lead to an increase demand for all
resources. (including the original.) (Output Effect)
This means that the substitution and output effect work in opposite directions. If the substitution
effect outweighs the output effect, a change in the price of a substitute resource will change the demand
for labor in the same direction. If the output effect exceeds the substitution effect, a change in the price
of a substitute resource will change the demand for labor in the opposite direction.
If the price of a complementary good increases the demand for the original good will decrease
because the MRC of the good has increased.
Elasticity of Resource Demand:
1) Rate of MP Decline:
If the marginal product of labor declines slowly as it is added to a fixed amount of capital, the
MRP, or demand for labor will decline slowly and tend to be highly elastic. This means that a small
decline in price of such a resource will yield a relatively large increase in the amount demanded.
2) Ease of Resource Substitutability:
The larger the number of good substitute resources available, the greater will be the elasticity of
demand for a particular resource.
3) Elasticity of Product Demand:
The greater the elasticity of product demand (the good being produced), the greater the elasticity
of resource demand. (If the price of the good being produced goes up and it is elastic that means the
quantity demanded will drop greatly. If this is the case their will be a big drop in the demand for the
resources that make it.
4) The more that the production costs play in the price of the good the more elastic the demand for
the product. Ex. If production costs go up then the demand for the good will decrease. This in turn
causes the demand for the production resources to decline.
Units of
Resource
Total
Product
0
1
2
3
4
5
6
7
0
7
13
18
22
25
27
28
Marginal
Physical
Product
(MPP)
7
6
5
4
3
2
1
Product
Price
Total
Revenue
2.80
2.60
2.40
2.20
2.00
1.85
1.75
1.65
0
18.20
31.20
39.60
44.00
46.25
47.25
46.20
Marginal
Revenue
Product
(MPR)
18.20
13.00
8.40
4.40
2.25
1.00
-1.05
How do we know this is an imperfect competitor? The product price changes.
The MRP of the imperfectly competitive firm falls more rapidly than the MRP of the perfect
competitor? This is because it must lower the price of all the previous units of the product in
order to sell more.
What happens if new technology increases efficiency?
Output Increases, MPP increases
TR increases, and MRP increase. This means you will hire more workers at the same wage rate.
The perfect competitive factor market (Lesson 3)
Wages: the price paid for the use of labor.
Nominal Wages: amount paid to the worker
Real Wages: the quantity of Goods and Services one can obtain with nominal wages. (purchasing
power)
The demand for labor (any variable resource) depends on its productivity. (If it can produce a lot
it will be in great demand.)
Labor may be more productive (ex: U.S. vs. China) because of
1. Capital: machinery, buildings....
2. Natural Resources: many high quality resources
3. Technology:
4. Labor Quality: health, vigor, education, training, attitudes...
COMPETITIVE MODEL:
1. Many firms hiring
2. Many qualified workers with identical skills acting independently
3. Wage taker (too small to set the wage rate) Notice that different types of companies
demanding the same type of labor (ex. business managers) will make up a market.
In the perfect competitive factor market the
demand curve is the sum of the individual
firms demand curves. The demand curve is the
MRP of the market.
The supply curve for the factor market
supply curve is upsloping because the firms
must pay more to the workers to get them away
from other occupations. (Pay for opportunity
costs)
Overhead 28.3
For the individual firm the demand curve is
the also mrp.
In a perfectly competitive industry the firm
has no influence on the wage rate paid to the
workers. (They do not hire enough workers to
change the rate) Since this is the case they
have to accept the rate set by the market.
A firm will also look at how much additional it costs to hire each variable resource. This is
known as Marginal Resource Cost.
In order to Maximize profits will hire resources up to the point where MRP = MRC. This
makes sense. If the last person hired adds more to cost than it adds to product than the company
is losing money.
This means that when a new worker is hired the total resource cost will increase by the
amount of the wage. The bottom line is that the wage rate and the marginal resource cost are
the same.
MONOPSONY MODEL: (Regarding labor usage not necessarily sellers)
This type of firm is not very common. Usually towns have many employers and workers are
free to change occupations. (Ex. Steel mills, sugar producers) Other examples are when the
workers are not totally free to move (Ex. hospitals, major league sports, school teachers...)
1) Firm is large portion of the total employment
2) Labor is immobile
3) Firm is Wage Maker
Since it must pay all workers a higher wage
when it pays a higher wage to attract the
additional worker its Marginal Resource Cost
will increase at a higher rate than its supply
curve.
(SEE OVERHEAD 28-4)
The firm will hire until MRC is equal to MRP.
At this point we go to the supply curve to get
the
If you were to look at the monopsony it will
hire less workers than a perfectly competitive
industry. It is not efficient.wage rate paid.
Why is the MRC higher than the firm's supply of labor curve?
What would be the wage level and employment level if this firm were buying labor in a
perfectly competitive market?
What quantity of labor would be purchased in a monopsonistic labor market? Why?
What is the wage level in a monopsonistic labor market> Why
What determines the wage in a competitive labor market?
Why is the supply curve for an individual firm in a competitive merket horizontal (perfectly
elastic)?
Why is the supply curve for labor up sloping? (Cost Benefit)
Why is the demand curve for labor and the MRP for labor the same thing?
Why is the market demand for labor down sloping?
In the perfect competitive industry we have a supply and demand for labor. If you hire a cashier
to work in the moon dust shop (you are the only seller of moon dust in the state).
What are you in the product market?
What are you in the factor market?
Micro Unit 4 (Lesson 4)
Review concept of diminishing Marginal Utility and Utility Maximization Theory.
As we consume more of a product our utility diminishes.
When we purchase goods we purchase goods so as to maximize our Marginal Utility per $$$
MUa/Pa = Mub/Pb
What do you do if they are not equal????
Optimal Combination of Resources: Given all the resources you must choose the combination
that produces the most for the dollar.
Firms can vary the amount of their inputs. In so doing they will try to produce using the
combination of resources that maximizes profits and minimizes losses.
The Least-Cost Rule:
Assume two resources: labor and capital
The cost of any output is minimized when the marginal product per dollar's worth of each
resource used is the same.
MP= MPP: change in production from additional resource
MP of labor = MP of capital
price of labor
price of capital
MPl = MPk
Pl
Pk
Ex:
If MPl/pl = 20/1 and MPc/pc = 10/1 what must you do?
Spend money on labor not capital. By doing so you lose the 10 in capital but you gain the 20
in labor. The overall gain is $10 for the same amount of money. You keep adjusting until the
least cost rule is satisfied.
What if MPl is 50 and MPc is 25 with the price of both being 1.
You would be better hiring more labor because you are getting more for your dollar.
What if the MPl/pl = 50/2 and MPk/pk = 50/1
In this example the firm will take a dollar away from labor and give it to capital. This moves
capital down its MP curve for capital and up the MP curve for labor.
The net result of this is that we gain 50 units from capital and lose 25 units from labor. The
net result is an increase in MP of 25 units/dollar.
You have now increase output without increasing costs.
This is the same thing as producing the same amount of a good at a lower cost.
The Profit-Maximizing Rule:
NOTICE THAT MRP IS MP X PRICE
Now that we have figured out how to produce at the least cost we must look at how to
maximize our profit in terms of output. In order to maximize profit from a cost standpoint you
should hire resources so that the price of the resource (Pl) is equal to the MRP of the resource
(MRPl). (MRC = MRP or Pl = MRPl)
Pl = MRPl take this and divide both sides by the Pl and you get
MRPl = 1
Pl
When you look at this the additional cost of hiring the additional worker is their price. This
means that in effect P1 = MRC. This means this is MRP1/MRC1 = 1. Our rule is hire until
MRP = MRC.
Now what do you do when you add in other resources?
MRPl = MRPc = MPR... = 1
Pl
Pc
P...
If all of these are equal and equal to one then you are in the profit maximization point.
*** If any one of these is more than the others then you need to use more of that product. ***
Notice that a firm could satisfy the least-cost rule but do so in such a manner that it is
producing the wrong quantity. In order to fix this it must look at the profit maximization rule.
Q
0
1
2
3
4
5
6
7
TP
0
12
22
28
33
37
40
42
Labor (price =$8)
MP MP/P
0
12
1.5
10
1.25
6
.75
5
.625
4
.5
3
.375
2
.25
TR
0
24
44
56
66
74
80
84
MRP
0
24
20
12
10
8
6
4
Q
0
1
2
3
4
5
6
7
Captial (price =$12)
TP MP MP/P
TR
0
0
0
13
13
1.08
26
22
9
.75
44
28
6
.5
56
32
4
.33
64
35
3
.25
70
37
2
.166
74
38
1
.083
76
MRP
0
26
18
12
8
6
4
2
Go Through the columns and make sure they understand them.
WHAT TYPE OF AN INDUSTRY IS THIS? (perfect competitor because price is $2 at all
levels.)
FIRST FIND OUT WHAT THE LEAST COSTLY WAY OF PRODUCING 50 UNITS IS?
You must figure out the minimum based on how much money you have to spend.
MPl/Pl = MRc/Pc
Use 3 units of labor and 2 units of capital
At this level of production your MPl/Pl = 6/8 = 3/4
your MPc/Pc = 9/12 = 3/4
(3 x 8) + (2 x 12) = $48. This is the least total cost.
We can see that the least cost rule is satisfied.
You can check this out by determining what the cost per unit is? $48/50 = .96/unit
NOW SUPPOSE YOU CHOOSE A DIFFERENT COMBINATION:
Use 5 units of labor and 1 unit of capital
Have we produced the 50 units? Yes
Have we done it at the least costly way? NO
How much does it cost? (5 x 8) + (1 x 12) = $52 This is more than the above.
At this level of production your MPl/Pl = 4/8 = 1/2
your MPc/Pc = 13/12 = 1 1/12
From this you can see that you are not meeting the Least Cost Rule.
The loss minimization production is 3 labor and 2 capital. Now does this maximize
profits?
MRPl/P/ = MRPc/Pc = 1
12/8 = 18/12 This does not work. We know that in order to maximize output from our
resources the MRP = P. If it is more then you hire more of that resource.
You can see that we are meeting the least cost rule but not the profit maximization rule. This
output tells us that we must use more labor and capital. Both are under utilized because they are
more than 1.
At 5 units labor MRPl/Pl = 1 = 8/8
At 3 units capital MRPc/Pc = 1 = 12/12
At this point you are maximizing profits. Then if you go back and look at costs you are
minimizing costs. However, you are increasing production to do it.
If you meet the MRPl/Pl = MRPc/Pc (profit maximization rule) you are meeting the least
cost rule!!!
Answer the following questions on a separate piece of paper.
1.
A. The Acme Yo-Yo firm uses labor and capital to produce a given amount of Yo-Yos.
At the present time, the firm is operating at a point at which the MPPl is 4 Yo-Yos and the MPPc
is 40 Yo-Yos. The cost of labor is $2 and the cost of capital is $30. Is the firm maximizing
profit in its hiring of inputs? Explain (verbally (written) and numerically).
B. Should it increase or decrease the quantity of labor relative to capital or the quantity of
capital relative to labor to produce the given output? Explain what the effects will be.
2. A. Suppose Acme is hiring labor and capital at the point at which
MPPl/Pl = MPPc/Pc and there is an increase in the wage rate, or Pl. What adjustments should
Acme make. Explain.
3. Acme can hire labor for $2 per unit and capital for $4 per unit, and the firm can produce 50
yo-yos using any one of the 3 following combinations of factors:
Method of Production
A
B
Units of Labor
2
5
Units of Capital
9
7
C
6
5
1. Which method should Acme use?
2. If the price of labor increases to $4 per unit and the price of capital decreases to $3 per unit,
which method should Acme use?
More on MRP
Keep in mind that the MRP comes from the change in Total Revenue.
Unit of
Resource
Total
Product
0
1
2
3
4
5
6
7
0
7
13
18
22
25
27
28
Marginal
Physical
Product
(MPP)
7
6
5
4
3
2
1
Product
Price
Total
Revenue
Marginal
Revenue
Product
(MPR)
2
2
2
2
2
2
2
2
14
26
36
44
50
54
56
14
12
10
8
6
4
2
This means that if this is a perfectly competitive factor market and the wage rate is $8 we will
hire 4 units of resource.
If you plot the points above on the MRP what
you will find is that if we hire the 4 units of
resource we will produce 22 units. With those
22 units we will sell them for $2 each.
So, based on this graph, what is total revenue?
It is the area below the MRP. This is because
the additional revenue being brought into the
company by each worker times the number of
workers is the the same thing as saying P *Q.
If the MRC wage rate we are paying them and
we know how much total we are paying them,
that means the area under the MRC will be the
profit we get from this resource.
Minimum Wage (Lesson 5)
How does minimum wage affect Ql in a monopsonistic labor market?
What does a normal monopsonistic firm look like?
If the government imposes a minimum wage what happens to Ql? We have to know where the
minimum wage will be set in order to know that answer.
If minimum wage is set below the wage rate
that the monopsonist is charging then it is
ineffective because the monoponist will just
ignore it and pay the people what they were
paying them.
If minimum wage is set above old wage rate
but below S and MRP intersection then the
monopsonist will hire up to the Supply curve
and no further. They will not be willing to
pay people more money to get more workers
than they were hiring before. This means
they will stop at the supply curve. They will
hire more workers at the higher wage rate but
only up to the supply curve.
If minimum wage is set above old wage rate
above S and MRP intersection but below the
MRP/MRC intersection then minimum wage is
the MRC curve so we hire where MRP =
MRC. This means we hire more workers at
this higher wage.
If minimum wage is set above the MRP/MRC
intersection the minimum wage is the MRC
so we still hire where MRP = MRC but the
quantity of labor hired is less than before.
The net effect is that it depends were the minimum wage is set as to how many workers we
will hire.
Unit 4 Lesson 6
Labor Unions: workers organizations that seek to secure economic improvements for their
members.
Unions try to increase demand for labor by:
1) Increasing product demand: advertising,
politics... (derived demand increases demand
for labor)
2) Increasing productivity: making
companies buy better machinery (if it does not
replace workers)
3) Increase in price of substitutes and
reduce price of complements.
Figure 28.5
When this happens they will change the demand curve for the product and this in turn will
affect the MRP for the resource.
Unions tend to lead to a monopoly in the supply of labor. One of their major roles is to
establish wage rates above equilibrium.
Unions also try to decrease the supply of labor
1) Restrict immigration
2) reduce child labor
3) encourage compulsory retirement
4) shorter workweeks
5) Restriction on hiring to union members
only.
They will then make it hard to get into
the union or make it a lengthy process. The net
effect is less workers and higher wages.
Fig 28.6
6) Requirement of licenses: AMA, barbers,
teachers...
By entering the market and setting a
specific minimum wage the union
will alter the supply curve. (SEE
OVERHEAD 28-7) This means less
union members are working.
Unit 4 Lesson 7 (Rent, Interest, and profits)
Economic Rent: the payment for the use of any resource over and above its opportunity cost.
We have economic rent on Labor: Tom Glavin makes a lot more as a baseball player than he
would doing his next best alternative (flipping hamburgers). This excess pay is economic rent.
Economic rent serves to allocate resources (land, labor...) to the highest valued use. This
goes back to Allocative efficiency.
Since there is only so much land the supply curve will be fixed. It will be a perfectly inelastic
(vertical) supply curve. Quantity is set and the price is determined by the location of the
demand curve. (OVERHEAD Figure 4.7)
Land will be around even if we did nothing with it. For this reason economist consider any
payment for land to be a surplus payment. It is unnecessary to pay for it.
In the 1800's it was proposed to tax away almost all income on land. Since earnings from
land are just because someone hold property that is in great demand. The feeling is that everyone
should profit from this (government).
A tax on land would not affect the allocation of it. The amount of land is not effected by the
tax. This is not true for any other resource. A tax increases the cost of business on every other
resource and that means a reduction in production.
INTEREST:
Interest Rate: the price paid for the use of money. It is the amount of money that a person
must pay for the use of others money.
: the market return earned by capital as a factor of production
1) Interest Rates stated in %.
2) Money itself is not a resource. Instead, it can buy resources.
In regards to interest rates we will determine how these are calculated in Macro Economics.
Nominal Interest Rates: the rate expressed in terms of current values
Real Interest Rates: the rate expressed in terms of constant or inflation adjusted value. As
inflation increases the same amount of money paid this year is not worth as much next year as it
is now. This means that if you are paying 15% a year for 30 year that in 30 years the 15% will
not buy near as much as it is now.
Real = Nominal/Price Level
Interest rates vary because of:
1) Risk
2) Maturity: the longer money is held the higher the interest rates.
3) Size of Loan: the smaller the loan the higher the interest rate because of administrative
costs.
4) taxability: tax free type of loans will demand a lower interest rate (pay a higher interest rate
if you consider taxes.)
All this is taken into account in determining the Supply and Demand for these loanable funds
ECONOMIC PROFITS:
Economic Profits: those profits earned after all cost are paid out. This includes both implicit
(opportunity costs...) and explicit costs.
Example: Nominal wage is $6 in 1999 (base year). In 2000 we give you a raise to $6.10. Are
you better off? Must know price level.
If price level is 102%
6.10/1.02 = 5.98 This is your purchasing power in 1999. You are worse off.
If nominal wages increase by 8% and price level goes up by 5% you are 3% better off.
% change in real wages = % change in nominal wages -% change in price level.
Micro Unit 4 Review: (what to know)
Know everything about MPR. How to graph it and how to calculate it:
How to calculate MRP for both perfectly competitive market and an imperfectly competitive
market. (change in total revenue). This means you have to be able to get it from TP and Product Price.
How to calculate MRC for both perfectly competitive market and an imperfectly competitive market.
(change in the cost of the resource over change in quantity used)
Know how to allocate resources in order to maximize profits.
Pl = MRPl
Pc = MRPc
MPRl = MRPc = 1
Pl
Pc
Know that resources are employed until MRP = MRC for a perfectly competitive market.