Download input markets - Pearson Canada

Chapter 11
Input Markets and the
Allocation of Resources
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Perfectly Competitive Input Markets

1.
2.
There are two types of input markets:
Primary input markets include
resources that have not been processed
by other firms, such as land, oil and
labour.
Intermediate input markets are the
processed output from other firms, such
as iron ingots, hog bellies and rolled
steel.
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Assumptions of Perfectly
Competitive Input Markets
1.
2.
3.
4.
Large Numbers-There are a large number of input
demanders/suppliers and no individual buys (sells) a
significant portion of total quantity traded.
Perfect Information-Demanders/suppliers have
perfect knowledge of prices and all firms have perfect
information of production functions.
Input Homogeneity-In any input market, all units
of the input are identical.
Perfect Mobility of Resources-All inputs are
perfectly mobile.
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The Supply of Non-Labour Inputs
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
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Renewable resources, such as land, can
be used over and over again.
Non-Renewable resources, like oil, once
it is used it is gone.
In the analysis that follows, it is assumed
that the supply of non-labour inputs is
perfectly price-elastic.
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The Supply of Labour

1.
2.
An individual faces two constraints:
The time constraint says that total
time available (T) equals work time
(h) plus leisure time (x1): h+x1=T
The income constraint says that a
person’s income (x2) is the sum of
work income (wage x h) and non-work
income (A): x2=wh+A
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The Leisure-Income Constraint
 The
leisure income constraint:
wx1+x2=A+wT
 The wage (w) is the price of leisure and
the slope of the budget constraint.
 A+wT is full (all work) income.
 The utility maximizing bundle of
leisure/labour is where the indifference
curve is tangent to the leisure-income
constraint in Figure 11.1
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Figure 11.1 The demand for
leisure and the supply of labour
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Figure 11.2 Leisure as a normal good
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Figure 11.3 Income and substitution
effects for a wage change
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Response to a Change in Wage Rate
When leisure is a normal good, the hours of
work may increase or decrease in response to a
wage increase, depending upon whether the
income effect is greater than or less than the
income effect.
 When leisure is an inferior good, an increase in
wage rate invariably leads to a decrease in
leisure hours and an increase in work hours.

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Figure 11.4 (a & b) The demand for
leisure and the supply of labour
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Firm’s Demand for One Variable Input
 The
short-run demand function
relates to a scenario where only one
input is variable.
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Input Demand in a One-Good Economy
 For
any wage less than the maximum
value of the average product, the firm’s
demand function is the downward sloping
portion of the marginal product curve.
 For any wage rate greater than the
maximum value of the average product,
the firm maximizes profits by hiring no
labour.
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Figure 11.5 Input demand in a one-good economy
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Transforming the Product Curves
into Revenue Curves
 Marginal
Revenue Product is the
marginal product from an additional unit
of labour times the marginal revenue
when the additional output is sold:
MRP(z)=MR(y)MP(z)
 Similarly, Average Revenue Product
equals the price of the output times
average product of the variable input:
ARP(z)=pAP(z)
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Figure 11.6 The firm’s demand for
one variable input
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The Firm’s Demand Curve for One
Variable Input
For input prices less than the maximum values
of ARP, the firm’s demand function is the
downward-sloping portion of MRP.
 For input prices greater than the maximum
value of ARP, the firm will demand none of the
variable input.
 Given an initial positive quantity of the input
demanded, an increase in the price of an input,
will cause the firm to reduce the quantity
demanded of that input.

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The Firm’s Demand Curve for One
Variable Input
 The
value of the marginal product
(VMP) of the variable input (VMPz) is
output price time marginal product:
VMPz=pMP(z).
 For a perfect competitor, VMP =MRP
(since p=MR).
 For a monopoly, MRP<VMP since MR<P.
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Input Demand with Many Variable Inputs
 In
the long run all inputs are variable.
 In the long run, the firm’s response to
an input price change will, via both
the substitution effect and the
output effect, produce a downward
sloping input demand curve.
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Figure 11.7 The substitution effect
of an input price change
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Figure 11.8 Comparing long-run and
short-run input demand functions
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Elasticity Rules for Derived Demand
 The
response to an input price
change, in both the short and long
run, is to demand more (less) of an
input as its price falls (rises).
 The response to a input price change
is greater in the long run than in the
short run.
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Equilibrium in a Competitive Market
In the long run, a firm that is a perfect
competitor in both its output and input market
will chose an input bundle such that for each
input:
we=MRP(z)=pMP(z)=VMP(z)
 In long-run equilibrium, a firm that is a perfect
competitor in its input markets but a
monopolist in its output market, will choose an
input bundle such that for each input:
we=MRP(z)=MR(y)MP(z)<pMP(z)=VMP(z)

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Figure 11.9 Equilibrium in a
competitive input market
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Monopsony in Input Markets
A
monopsonist has significant
control over what it pays for an
input.
 The relationship between input price
(w) and quantity of the input (z) is
determined by the market supply
function for the input: w=S(w).
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Monopsony in Input Markets
 The
monopsonist buys all units of an
input at the same price (average
factor cost or AFC).
 Total factor cost (TFC) is quantity
(z) times AFC or price S(z):
TFC(z)=zS(z)
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Monopsony in Input Markets
 The
marginal factor cost (MFC) is the
rate at which TFC changes as the
quantity of output (z) changes.
 When a monopsonist buys a positive
quantity of the input, the MFC exceeds
price (w) or average factor cost.
 The MFC=w+z(slope of supply curve):
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Figure 11.11 A monopsonist’s
profit-maximizing decision
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Profit Maximizing Input Decisions
 The
general profit-maximizing rule in an
input market is to buy an input up to the
point where marginal factor cost is
equal to marginal revenue product.
 For a competitive input market:
MRP(z*)=MFC(z*)=w*
 For a monopsonist:
MRP(z*)=MFC(z*)>w*
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Figure 11.13 The inefficiency of monopsony
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Figure 11.15 Resource allocation summarized
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The Firm’s Demand for Capital Inputs
Since capital is durable, the sum of present
values of MRP through time is:
ΣMRP=MRP0+[MRP1/(1+i)]+…+[MRP1/(1+i)D-1]
 The optimal quantity of capital input is the
quantity where the present value of the
marginal revenue products over its life is equal
to the present value of all costs of this input
(p= ΣMRP).
 The ΣMRP is the firm’s demand curve for
gadgets.

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Figure 11.16 The demand for a capital input
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Human Capital Decisions Over Time
 Human
capital - investments in
education and training.
 Human capital production function:
R=F(H)
Which says additional income (return on
human capital investment) (R), is a
diminishing function of the quantity of
human capital (H).
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Figure 11.17 Investing in human capital
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From Figure 11.17
 Invest
in an additional dollar of human
capital if the marginal product (MP)
exceeds the rate at which current
foregone consumption can generate
future consumption (1+i).
 To maximize the present value of net
income, invest in human capital up to the
point where MP=(1+i).
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Figure 11.18 Another perspective on
the human capital investment
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Figure 11.19 The life-cycle choice
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