Download Microeconomic Theory

Resource Markets
Remember that the following terms are just
different words for the same things.
Resources
Inputs
Factors of Production
Whichever they’re called, they are things that are
used to produce output.
Input and output markets can be perfectly competitive
or not. So there are four possibilities.
Output Market
Perfectly
Not Perfectly
competitive
competitive
Perfectly
competitive
Input
Market
Not Perfectly
competitive
A firm uses inputs to produce outputs.
So there are four possibilities.
Perfectly
competitive
Input
Market
Not Perfectly
competitive
Output Market
Perfectly
Not Perfectly
competitive
competitive
Perfectly
competitive in
both input &
output markets
A firm uses inputs to produce outputs.
So there are four possibilities.
Output Market
Perfectly
Not Perfectly
competitive
competitive
Perfectly
Perfectly
competitive in
competitive
both input &
output markets
Input
Market
Perfectly
Not Perfectly
competitive in
competitive
neither input nor
output market
A firm uses inputs to produce outputs.
So there are four possibilities.
Output Market
Perfectly
Not Perfectly
competitive
competitive
Perfectly
Perfectly
Perfectly
competitive in
competitive in
competitive
both input &
input but not
output markets
output market
Input
Market
Perfectly
Not Perfectly
competitive in
competitive
neither input nor
output market
A firm uses inputs to produce outputs.
So there are four possibilities.
Output Market
Perfectly
Not Perfectly
competitive
competitive
Perfectly
Perfectly
Perfectly
competitive in
competitive in
competitive
both input &
input but not
output markets
output market
Input
Market
Perfectly
Perfectly
Not Perfectly competitive in
competitive in
competitive output but not neither input nor
input market
output market
Input Market Possibilities
• Perfect Competition – many buyers of the input with no
influence on the input price
• Monopsony – one buyer of the input
• Oligopsony – a few buyers of the input
• Monopsonistic Competition – many buyers but with
some influence over input price
Perfect Competitors have a horizontal input supply curve.
Monopsonists, oligopsonists, & monopsonistic competitors
face an upward sloping input supply curve.
Output or Product
Industry
P
P*
D
S
P*
Q*
D
Q
W
Input or Labor
P
Perfectly
Competitive Firm
Q
W
S
W*
W*
S
D
L*
L
L
Derived Demand
Because the demand for an input is derived
from the demand for the output that it is used
to produce, the demand for an input is called a
derived demand.
To determine how much input a firm will use, we
need a few concepts.
If a firm hires all workers at the same wage, then the
total resource cost (TRC) or total cost of labor (TCL) is
the wage per unit of labor times the amount of labor hired.
TRC = TCL = W•L
Marginal Resource Cost (MRC)
the change in total variable cost that results
from the employment of an additional unit of
an input.
MRC = TVC / L = dTVC/dL
Average Resource Cost (ARC)
the total variable cost per unit of input
ARC = TCL / L
If the firm hires all workers at the same wage, then
ACL or ARC = TCL / L = (W•L)/L = W
Marginal Physical Product (MPP) or
Marginal Product (MP)
the change in the quantity of output that
results from the employment of an additional
unit of an input.
MPP = Q /L = dQ/dL
Marginal Revenue Product (MRP)
the change in total revenue that results from
the employment of an additional unit of an
input.
MRP = TR /L = dTR/dL
What is the difference between MPP & MRP?
Suppose your company produces chairs.
The MPP tells how many more chairs you
can make if you hire another worker.
The MRP tells how much more revenue you
can make from the additional chairs
produced by the additional worker.
Alternative formula for MRP
MRP = TR = TR Q
L
L Q
= TR Q
Q L
= MR . MPP
So, MRP = MR . MPP
Sales Value of the Marginal Product (SVMP) or
Value of the Marginal Product (VMP)
the price of the output multiplied by the
marginal physical product of the input.
VMP = P . MPP
Sometimes MRP = VMP,
but not always.
Recall: If a firm is a perfect competitor in
the product market, marginal revenue is
equal to the price of the output (MR = P).
Then, MRP = MR . MPP
= P . MPP
= VMP
So, MRP = VMP
for a firm that is a perfect competitor in the
product market.
Recall: If a firm is a not perfect competitor in
the product market, marginal revenue is less
than the price of the output (MR < P).
Since MRP = MR . MPP
and VMP = P . MPP,
MRP < VMP,
for a firm that is not a perfect competitor in the
product market.
If a firm is perfectly competitive in the
product market, then MRP = VMP.
If a firm is not perfectly competitive in the
product market, then MRP < VMP.
Example: A firm sells its shirts in a perfectly competitive product
market for $10 each.
L
0
10
20
30
40
50
60
70
Q
0
70
130
180
220
250
270
280
Example: A firm sells its shirts in a perfectly competitive product
market for $10 each.
L
0
10
20
30
40
50
60
70
Q MPP=Q/L
--0
7
70
6
130
5
180
4
220
3
250
2
270
1
280
Example: A firm sells its shirts in a perfectly competitive product
market for $10 each.
L
0
10
20
30
40
50
60
70
Q MPP=Q/L TR=PQ
0
--0
70
7
700
130
6
1300
180
5
1800
220
4
2200
250
3
2500
270
2
2700
280
1
2800
Example: A firm sells its shirts in a perfectly competitive product
market for $10 each.
L
0
10
20
30
40
50
60
70
Q MPP=Q/L TR=PQ MR =TR/Q
0
--0
--70
7
700
10
130
6
1300
10
180
5
1800
10
220
4
2200
10
250
3
2500
10
270
2
2700
10
280
1
2800
10
Example: A firm sells its shirts in a perfectly competitive product
market for $10 each.
L
0
10
20
30
40
50
60
70
MRP =TR/L
Q MPP=Q/L TR=PQ MR =TR/Q MRP= MR•MPP
--0
--0
--70
70
7
700
10
60
130
6
1300
10
50
180
5
1800
10
40
220
4
2200
10
30
250
3
2500
10
20
270
2
2700
10
10
280
1
2800
10
Focusing on the first and last columns of the previous table, we have
the MRP schedule.
L
0
10
20
30
40
50
60
70
MRP
--70
60
50
40
30
20
10
Plotting points we have a graph
of the MRP curve.
MRP
70
60
50
40
30
20
10
0
MRP
10 20 30 40 50 60 70
labor
Suppose we want to maximize our profits.
How much input we should use?
MRP > MRC
MRP < MRC
MRP = MRC
employ more input
cut back employment
profit-maximizing
employment level
profit-maximizing condition
for input usage:
MRP = MRC
The Perfectly Competitive Labor Market Firm
Each time a firm hires another unit of labor, its cost increases by the
price of the labor (W).
So for a firm in a perfectly competitive labor market, MRC = W .
(If a firm is not in a perfectly competitive labor market, this isn’t
true.)
Also, remember that the supply curve of labor for a firm that is
perfectly competitive in the labor market is a horizontal line at the
going wage W.
Recall that for a firm that hires all workers at the same wage,
ARC = W.
So for a firm that is perfectly
W
competitive in the labor
SL = MRC = ARC
market, MRC, ARC, and SL
are all the same horizontal
L
line at the wage W.
Suppose the firm in the example we considered
earlier is also perfectly competitive in the labor
market.
So the MRC is the same as the price of labor
or the market wage.
Let’s see what the demand curve for labor
is for this firm.
Let’s first assume that other inputs are fixed.
What we need to know is how many workers
will be hired at various wage levels.
Remember: You hire workers as long as
they add at least as much to revenues as they add to cost.
L
0
10
20
30
40
50
60
70
MRP
--70
60
50
40
30
20
10
Suppose the market wage is $70.
workers will you hire?
10
Suppose the market wage is $60.
workers will you hire?
20
Suppose the market wage is $50.
workers will you hire?
30
Suppose the market wage is $40.
workers will you hire?
40
How many
How many
How many
How many
Remember we have been trying to determine
what the demand curve for labor looks like for
this firm.
All of our demand curve points have been
points on the MRP curve.
The demand curve for labor by the firm is
just (the downward sloping part of) the
MRP curve.
A Firm’s Demand Curve for Labor
$
70
60
50
40
30
20
10
0
demand curve for labor
10 20 30 40 50 60 70
labor
In the last few slides, we were assuming that
inputs other than labor were fixed.
Suppose now that all inputs are variable; we are in a
long run situation.
When the wage decreases, firms will adjust their usage
of other inputs, such as capital.
When the wage dropped, the cost of production fell. So
the firm would probably produce more and would
therefore need more capital.
However, they may use less capital, substituting the
now less expensive labor input.
So, when the price of an input drops, the amount used of
other inputs may increase, decrease, or remain the
same.
Suppose that when the wage falls from W1 to W2, the amount of capital used
increases from K1 to K2.
When labor has more capital with which to work, labor is more productive.
So the MRPL is greater.
Therefore, the demand curve is derived from parts of different MRPLs.
When capital can not be changed, the quantity of labor demanded (in response
to the wage drop) only increases from L1 to L’.
When capital can be changed, the quantity of labor demanded increases to L2.
$
W1
W2
DL
MRPL2 (amt of capital is K2)
MRPL1 (amt of capital is K1)
L1 L’
L2
labor
Substitution & Output Effects of a change in wage
Suppose that at the initial wage, the firm is operating at point A,
the tangency of isocost 1 and isoquant 1.
The slope of an isocost is –PL / PK = -W / PK , so when the wage falls,
the isocosts become flatter.
Capital
expansion path
Isocost 1
C
A
Isoquant 2
Isocost 2a
B
Isocost 2b
Isoquant 1
Labor
The firm moves to point B, the
tangency of isoquant1 with the flatter
isocost2a, substituting away from
capital and toward labor.
Then since production has become
less costly, the firm moves out to point
C.
It has moved out along the expansion
path to the tangency between
isoquant2 and isocost2b (which is
parallel to isocost2a).
Substitution & Output Effects of a change in wage
The movement from A to B represents the substitution effect.
The firm uses more labor and less capital, since labor has become
relatively cheaper.
The movement from B to C is
Capital
expansion path
Isocost 1
C
A
Isoquant 2
Isocost 2a
B
Isocost 2b
Isoquant 1
Labor
the output effect.
The firm uses more labor and
more capital, at C than at B,
since it has expanded production
in response to the drop in the
cost of production.
The combined effect is to use
more labor in response to the
wage drop.
In this particular graph, the
combined effect on capital is to
use slightly more capital.
(C is higher than A.)
However, in response to a drop in the wage,
the amount of capital used may
Capital
expansion path
Isocost 1
C
A
Isoquant 2
Isocost 2a
B
Isocost 2b
Isoquant 1
Labor
increase if the output effect is
larger than the substitution
effect,
decrease if the output effect is
smaller than the substitution
effect, or
remain the same if the output
effect is the same size as the
substitution effect.
A perfectly competitive industry’s demand for labor
Let’s start with the DL and a wage of W1. (Suppose the price of the product is 100.)
When the wage (or price of an input) falls, firms increase production.
The increase in industry supply drives down the price of the product (perhaps to 80).
This reduces VMPL = P·MPPL which is also DL = MRPL = MR·MPPL.
So the DL decreases or shifts leftward.
So instead of just adding up the individual firms’ DLs, the industry demand curve for
labor consists of points from different ΣDLs.
wage
wage
The Firm
The Industry
DL
W1
W1
ΣDL1 (P = 100)
DL1 (P = 100)
W2
W2
ΣDL2 (P = 80)
DL2 (P = 80)
L1
L2
labor
L1
L2
labor
4 major determinants of an industry’s elasticity
of demand for labor with respect to its wage
1. Price elasticity of demand for the product.
2. Ease of substitution of one input for another
in the production process.
3. Elasticity of supply of other inputs.
4. The amount of time allowed for adjustment
to the change in wage.
1. Price elasticity of demand for the product.
Suppose the wage increases.
That will drive up the price of the product.
If the demand for the product is very responsive (or
elastic) to price increases, the quantity demanded of
the product will decrease considerably.
The quantity demanded of labor will therefore also
decrease considerably.
So the more elastic the demand for the product is with
respect to its price, the more elastic the demand for
labor will be with respect to its wage.
2. Ease of substitution of one input for another
in the production process.
Again suppose the wage increases.
If it is easy to substitute another input for the
labor whose wage has increased, firms will
reduce considerably the quantity of labor whose
wage has gone up.
So the easier substitution is, the greater the
elasticity of demand for labor with respect to its
wage will be.
3. Elasticity of supply of other inputs.
Again suppose the wage increases.
Suppose also that the supply of other inputs is very
responsive (elastic) to the prices of those inputs.
Then when firms start looking for alternative inputs to
substitute for the labor that has become more expensive,
it won’t take a very large increase in the price of the
alternative inputs to bring about a large increase in the
supply of those inputs.
So it will not be very costly to switch to other inputs and
the firms will be able to cut back on the labor quite a bit.
So the greater the elasticity of supply of alternative
inputs, the greater the elasticity of demand for labor.
4. The amount of time allowed for adjustment to
the change in wage.
One more time, suppose the wage increases.
When firms have more time to adjust to the
change, more options may become available.
For example, new machines may be developed to
do the work that the now more expensive labor is
doing.
So firms will be able to cut back more on their
labor usage.
So the more time allowed for adjustment, the
greater the elasticity of demand for labor.
Market demand for labor
(accountants, for example)
To determine the demand curve for accountants,
we just horizontally sum the various industry
demand curves for all the industries that hire
accountants.
The shape of the supply curve of an input depends
on the specific case.
The supply curve to one industry will be flatter
(more elastic) than the supply curve to the
economy as a whole.
The smaller the share of the total market
accounted for by a particular industry, the more
elastic its input supply curve.
The supply curve to an individual firm in a
perfectly competitive input market will be
horizontal (perfectly elastic).
Suppose a firm is perfectly competitive in both its product market and
its input market.
Then the firm will take the going wage as given and face a horizontal
supply curve at that wage.
wage
wage
The Firm
SL
W*
The Industry
SL
W*
DL
DL
L*
labor
L*
labor
Suppose there are many industries that employ a
particular type of input, engineers for example.
Then the wage of engineers will tend to be the same
across industries. Why?
If the engineers in industry A were paid more than
the engineers in industry B, engineers would move
from B to A.
As a result of the reduction in the supply of engineers
in industry B, the wage would increase there.
As a result of the increase in the supply of engineers
in industry A, the wage would fall there.
Engineers would continue to move until the wages
were the same in the two industries.
Input Price Determination in a Multi-Industry Input Market
Industry A
wage
Industry B
Total Labor Market
wage
SLA
wage
SLT
SLB
W*
W*
W*
DLB
DLA
LA*
labor
LB*
labor
DLT
LT*
labor
While the amount of labor hired by different industries may be very
different, the wages paid will tend to be the same.
What happens if there is an increase in demand for the
product of the one of the industries?
Industry A
wage
Industry B
S’LA
Total Labor Market
wage
wage
SLT
SLB
W’
W*
W’
W*
W’
W*
SLA
D’LT
D’LB
DLA
DLT
DLB
LA’ LA*
labor
LB* LB’
labor
LT* LT’
labor
The demand for labor in industry B will increase, raising the wage
in industry B.
Labor will move from A to B in response to the higher wages.
As the supply of labor in A drops, the wage in A rises, until the
wages are once again equal in the two industries.
Monopsony
An input market in which a single firm is the
only purchaser of the input
In monopsony, the supply curve of labor to the firm
is the same as the market labor supply curve.
So the monopsonist faces an upward sloping labor supply curve SL.
The SL curve tells the wage the firm must pay to get a specific
amount of labor.
wage
MRCL = MCL
As we found earlier, the wage is the
same as the ACL, if the firm pays all
workers the same wage.
So the SL curve is the same as the ACL
curve.
SL = ACL
Recall that when an average curve is
sloping upward the marginal must be
above it.
So since the SL = ACL slopes upward,
the MRCL or MCL must lie above the
Labor
ACL.
Monopsony employment and wage level
To determine the profitmaximizing input level,
the firm equates MRPL to
MRCL.
The wage that is paid for
that amount of labor,
however, is determined
by the SL curve.
wage
MRCL = MCL
SL = ACL
W*
DL = MRPL
L*
Labor
Other firms that are not perfect competitors in the input
market (oligopsonists and monopsonistic competitors)
face similar input curves to monopsonists.
wage
MRCL = MCL
Their SL curves, however,
are not the same as the
labor market supply curve
and are likely to be more
elastic.
SL = ACL
W*
DL = MRPL
L*
Labor
Impact of Minimum Wage Law:
Perfectly Competitive Labor Market Case
When there is no minimum wage
law, the equilibrium wage and
employment level are W* and L*.
When a minimum wage above the
equilibrium wage is imposed, the
quantity of labor demanded is
lower (Ld) and the quantity
supplied of labor is higher (Ls).
The Ls – Ld is the difference
between the number of people
who want to work at that wage and
the number of jobs available.
wage
SL
Wm
W*
DL
Ld
L* Ls
Labor
Impact of Minimum Wage Law: Monopsony Case
Without the minimum wage law
the monopsonist paid W* and
hired L* workers.
Now suppose the minimum wage
Wm is set at the intersection of SL
and DL.
The new SL curve is a horizontal
line at Wm up to the intersection
of SL and DL. At that point the SL
becomes the same as the old one.
The new MCL curve is the three
part curve shown.
When the firm equates MRPL
and MRCL, it hires more workers
(Lm) at the new higher wage.
MRCL = MCL
wage
SL
Wm
DL = MRPL
W*
L*
Lm
Labor
A strong union operating
with a monopsonistic
employer can have a
similar effect.
MRCL = MCL
wage
SL
Recall that a freely operating
monopsonist would pay W* and
hire L* workers.
If the union is able to negotiate a
wage of W1, it will raise
employment (to L1) along with
the wage.
W1
DL = MRPL
W*
L*
L1
Labor
If the union were able to
negotiate a wage of W2,
employment would be the
same as with a freely
operating monopsonist
(L*=L2) but the wage
would be much higher.
MRCL = MCL
wage
SL
W2
W1
DL = MRPL
W*
L*=L2
L1
Labor
Example: Consider a firm that is perfectly competitive in the
product market, where the going price of the product is $2.
The firm is not perfectly competitive in the labor market.
Labor Output wage
0
0
---
10
180
12
20
350
14
30
510
16
40
660
18
50
800
20
60
930
22
70
1050
24
80
1160
26
Determine the MPPL for the given employment levels.
Recall: MPPL = Q/L
Example: For the first 10 workers, MPPL = (180-0)/(10-0) = 18
Labor Output wage MPPL
0
0
---
10
180
12
20
350
14
30
510
16
40
660
18
50
800
20
60
930
22
70
1050
24
80
1160
26
Determine the MPPL for the given employment levels.
Recall: MPPL = Q/L
Example: For the first 10 workers, MPPL = (180-0)/(10-0) = 18
Labor Output wage MPPL
0
0
---
---
10
180
12
18
20
350
14
17
30
510
16
16
40
660
18
15
50
800
20
14
60
930
22
13
70
1050
24
12
80
1160
26
11
Determine the total cost of labor for the given employment levels.
Recall: TCL = W•L
Example: For 10 workers, TCL = W•L = (12)(10) = 120
Labor Output wage MPPL
0
0
---
---
10
180
12
18
20
350
14
17
30
510
16
16
40
660
18
15
50
800
20
14
60
930
22
13
70
1050
24
12
80
1160
26
11
TCL
Determine the total cost of labor for the given employment levels.
Recall: TCL = W•L
Example: For 10 workers, TCL = W•L = (12)/(10) = 120
Labor Output wage MPPL
TCL
0
0
---
---
0
10
180
12
18
120
20
350
14
17
280
30
510
16
16
480
40
660
18
15
720
50
800
20
14
1000
60
930
22
13
1320
70
1050
24
12
1680
80
1160
26
11
2080
Determine the MRCL or MCL for the given employment levels.
Recall: MRCL = TCL/L
Example: For the first 10 workers, MRCL = (120-0)/(10-0) = 12
Labor Output wage MPPL
TCL
0
0
---
---
0
10
180
12
18
120
20
350
14
17
280
30
510
16
16
480
40
660
18
15
720
50
800
20
14
1000
60
930
22
13
1320
70
1050
24
12
1680
80
1160
26
11
2080
MRCL
or MCL
Determine the MRCL or MCL for the given employment levels.
Recall: MRCL = TCL/L
Example: For the first 10 workers, MRCL = (120-0)/(10-0) = 12
Labor Output wage MPPL
TCL
MRCL
or MCL
0
0
---
---
0
---
10
180
12
18
120
12
20
350
14
17
280
16
30
510
16
16
480
20
40
660
18
15
720
24
50
800
20
14
1000
28
60
930
22
13
1320
32
70
1050
24
12
1680
36
80
1160
26
11
2080
40
Determine the MRPL for the given employment levels.
Recall: MRPL = TR/L = MR•MPPL = P•MPPL
(since the firm is perfectly competitive in the product market).
Also remember the price of the product is $2.
Example: For the first 10 workers, MRPL = (2)(18) = 36
Labor Output wage MPPL
TCL
MRCL
MRPL
or MCL
0
0
---
---
0
---
10
180
12
18
120
12
20
350
14
17
280
16
30
510
16
16
480
20
40
660
18
15
720
24
50
800
20
14
1000
28
60
930
22
13
1320
32
70
1050
24
12
1680
36
80
1160
26
11
2080
40
Determine the MRPL for the given employment levels.
Recall: MRPL = TR/L = MR•MPPL = P•MPPL
(since the firm is perfectly competitive in the product market).
Also remember the price of the product is $2.
Example: For the first 10 workers, MRPL = (2)(18) = 36
Labor Output wage MPPL
TCL
MRCL
MRPL
or MCL
0
0
---
---
0
---
---
10
180
12
18
120
12
36
20
350
14
17
280
16
34
30
510
16
16
480
20
32
40
660
18
15
720
24
30
50
800
20
14
1000
28
28
60
930
22
13
1320
32
26
70
1050
24
12
1680
36
24
80
1160
26
11
2080
40
22
What are the profit-maximizing wage and employment level?
Recall the -max employment condition is MRPL = MRCL.
So 50 workers will be hired at a wage of 20.
Labor Output wage MPPL
TCL
MRCL
MRPL
or MCL
0
0
---
---
0
---
---
10
180
12
18
120
12
36
20
350
14
17
280
16
34
30
510
16
16
480
20
32
40
660
18
15
720
24
30
50
800
20
14
1000
28
28
60
930
22
13
1320
32
26
70
1050
24
12
1680
36
24
80
1160
26
11
2080
40
22
Next, suppose a minimum wage of $24 is imposed.
Indicate the wage for the given employment levels.
Labor Output wage MPPL
TCL
Wage
MRCL
MRPL (with min
or MCL
wage=24)
0
0
---
---
0
---
---
10
180
12
18
120
12
36
20
350
14
17
280
16
34
30
510
16
16
480
20
32
40
660
18
15
720
24
30
50
800
20
14
1000
28
28
60
930
22
13
1320
32
26
70
1050
24
12
1680
36
24
80
1160
26
11
2080
40
22
Next, suppose a minimum wage of $24 is imposed.
Indicate the wage for the given employment levels.
Labor Output wage MPPL
TCL
MRCL
MRPL
or MCL
Wage
(with min
wage=24)
0
0
---
---
0
---
---
24
10
180
12
18
120
12
36
24
20
350
14
17
280
16
34
24
30
510
16
16
480
20
32
24
40
660
18
15
720
24
30
24
50
800
20
14
1000
28
28
24
60
930
22
13
1320
32
26
24
70
1050
24
12
1680
36
24
24
80
1160
26
11
2080
40
22
26
Determine the total cost of labor for the given employment
levels, under the minimum wage of $24.
TCL is still equal to W•L.
Example: For the first 10 workers, TCL = 24•10 = 240
Labor Output wage MPPL
TCL
TCL
Wage
MRCL
MRPL (with min (with min
or MCL
wage=24) wage=24)
0
0
---
---
0
---
---
24
10
180
12
18
120
12
36
24
20
350
14
17
280
16
34
24
30
510
16
16
480
20
32
24
40
660
18
15
720
24
30
24
50
800
20
14
1000
28
28
24
60
930
22
13
1320
32
26
24
70
1050
24
12
1680
36
24
24
80
1160
26
11
2080
40
22
26
Determine the total cost of labor for the given employment
levels, under the minimum wage of $24.
TCL is still equal to W•L.
Example: For the first 10 workers, TCL = 24•10 = 240
Labor Output wage MPPL
TCL
TCL
Wage
MRCL
MRPL (with min (with min
or MCL
wage=24) wage=24)
0
0
---
---
0
---
---
24
---
10
180
12
18
120
12
36
24
240
20
350
14
17
280
16
34
24
480
30
510
16
16
480
20
32
24
720
40
660
18
15
720
24
30
24
960
50
800
20
14
1000
28
28
24
1200
60
930
22
13
1320
32
26
24
1440
70
1050
24
12
1680
36
24
24
1680
80
1160
26
11
2080
40
22
26
2080
Determine the MRCL under the minimum wage of $24.
MRCL is still equal to TCL/L.
Example: For the first 10 workers, MRCL = (240-0)/(10-0) = 24
Labor Output wage MPPL
TCL
TCL
Wage
MRCL
MRPL (with min (with min
or MCL
wage=24) wage=24)
0
0
---
---
0
---
---
24
---
10
180
12
18
120
12
36
24
240
20
350
14
17
280
16
34
24
480
30
510
16
16
480
20
32
24
720
40
660
18
15
720
24
30
24
960
50
800
20
14
1000
28
28
24
1200
60
930
22
13
1320
32
26
24
1440
70
1050
24
12
1680
36
24
24
1680
80
1160
26
11
2080
40
22
26
2080
MRCL
(with min
wage=24)
Determine the MRCL under the minimum wage of $24.
MRCL is still equal to TCL/L.
Example: For the first 10 workers, MRCL = (240-0)/(10-0) = 24
Labor Output wage MPPL
TCL
TCL
Wage
MRCL
MRPL (with min (with min
or MCL
wage=24) wage=24)
MRCL
(with min
wage=24)
0
0
---
---
0
---
---
24
---
24
10
180
12
18
120
12
36
24
240
24
20
350
14
17
280
16
34
24
480
24
30
510
16
16
480
20
32
24
720
24
40
660
18
15
720
24
30
24
960
24
50
800
20
14
1000
28
28
24
1200
24
60
930
22
13
1320
32
26
24
1440
24
70
1050
24
12
1680
36
24
24
1680
24
80
1160
26
11
2080
40
22
26
2080
40
What are the -max. wage and employment level under the minimum wage law?
Recall the -max employment condition is still MRPL = MRCL.
So 70 workers will be hired at a wage of 24.
Notice that there is more employment at a higher wage than before,
when 50 workers were hired at a wage of 20.
Labor Output wage MPPL
TCL
MRCL
MRPL
or MCL
TCL
Wage
(with min (with min
wage=24) wage=24)
MRCL
(with min
wage=24)
0
0
---
---
0
---
---
24
---
24
10
180
12
18
120
12
36
24
240
24
20
350
14
17
280
16
34
24
480
24
30
510
16
16
480
20
32
24
720
24
40
660
18
15
720
24
30
24
960
24
50
800
20
14
1000
28
28
24
1200
24
60
930
22
13
1320
32
26
24
1440
24
70
1050
24
12
1680
36
24
24
1680
24
80
1160
26
11
2080
40
22
26
2080
40
Another Monopsony Example
Suppose that for a monopsonistic labor market,
the equation of the supply curve of labor or
average cost of labor is ACL = W = 160 + 3L,
where L is the amount of labor used per day and
W is the wage per day. Suppose the marginal
revenue product of labor is MRPL = 240 – 2L.
Graph the supply of labor or ACL = W = 160 + 3L
curve and the MRPL = 240 – 2L curve.
$
240
SL = ACL
MRPL
160
Labor
Determine the intersection of ACL = W = 160 + 3L
and MRPL= 240 – 2L.
ACL = MRPL
wage
160 + 3L = 240 – 2L
5L = 80
SL = ACL
240
L = 16
Then ACL = W = 160 + 3L
= 160 + 3(16)
= 208
or MRPL = 240 – 2L
= 240 – 2(16)
= 208
208
160
MRPL
16
Labor
Given our average cost of labor equation
ACL = W = 160 + 3L, determine the equations for
the total cost of labor TCL and the marginal cost of
labor MCL (or marginal resource cost of labor).
TCL = ACL(L)
= (160 + 3L) L
= 160L + 3L2.
MCL = dTCL/dL
= 160 + 6L.
Graph the MCL = 160 + 6L curve.
wage
MRCL = MCL
240
SL = ACL
208
160
MRPL
16
Labor
Determine the profit-maximizing employment
level and the profit-maximizing wage level.
We knew MRPL = 240 – 2L
and we found MCL = 160 + 6L.
For profit-maximization,
MRPL = MCL.
So 240 – 2L = 160 + 6L
80 = 8L
10 = L
MCL = 160 + 6L
= 160 + 6(10)
= 220
Given SL, we have
W = 160 + 3L
= 160 + 3(10)
= 190.
wage
MRCL = MCL
240
SL = ACL
220
208
190
160
MRPL
10
16
Labor
If a minimum wage of $208 per day were imposed,
what would the new employment level be?
At that minimum wage, the
new supply curve is the purple
line.
240
The new MCL curve is the
gray line.
220
Equating MRPL to MCL, we
find L = 16.
At that employment level, the
new supply curve shows that
the wage is 208.
wage
MRCL = MCL
SL = ACL
208
190
160
MRPL
10
16
Labor
If a minimum wage of $220 per day
were imposed, what would the new
employment level be?
MRCL = MCL
At that minimum wage, the
new supply curve is the purple
line.
240
The new MCL curve is the
gray line.
220
Equating MRPL to MCL, we
find L = 10.
At that employment level, the
new supply curve shows that
the wage is 220.
wage
SL = ACL
208
190
160
MRPL
10
16
Labor
Individuals’ Labor Supply Decisions
When individuals decide to work more hours in
the labor market, they are trading non-labor time
for money to buy goods.
An individual’s non-market time is generally
believed to be a normal good.
That is, when you have more money, you want
to purchase more of all normal goods, including
your own time.
When wages increase, the response of individuals
involves income and substitution effects.
The income effect is the response to having more
income to spend.
The substitution effect is the response to changes
in relative prices.
The Income Effect of a Wage Increase
When the wage increases, the individual earns
more money.
He/she therefore feels richer and consumes
more of all normal goods, including his/her own
time.
He/she therefore works less as a result of the
income effect.
The Substitution Effect of a Wage Increase
When the wage increases, the price of one’s
non-labor time increases relative to the price of
other goods.
The individual, therefore, consumes less nonlabor time and more of other goods.
He/she therefore works more as a result of the
substitution effect.
So for a wage increase, the income effect is to
work less, and the substitution effect is to work
more.
If the substitution effect is greater than the
income effect, the individual will work more
when his/her wage increases.
If the income effect is greater than the
substitution effect, the individual will work less
when his/her wage increases.
At lower wage levels, the substitution effect is usually
larger than the income effect, but there may be a level
at which the income effect dominates.
As the wage increases
wage
fromW1 to W2, hours
S
worked per week increases
W
from L1 to L2.
However, when the wage
W
increases from W2 to W3,
hours worked per week
W
decrease from L2 to L3.
As a result, an individual’s
L L L
labor supply curve bends
hours worked per week
backward.
L
3
2
1
1
3
2
To determine the market supply curve, we need only
horizontally sum the individual labor supply curves.
Theoretically, the market supply curve could slope
upward, downward, or a combination of both.
Empirical evidence suggests that it slopes upward.
Why do wages differ?
1. Differences in human capital investment.
People who have invested more in education and
training tend to earn more.
2. Differences in ability.
Some people have inherited greater abilities.
3. Compensating wage differentials.
Less pleasant or more dangerous jobs pay more.
4. Discrimination.
People may earn less because of characteristics unrelated
to their productivity. They may be discriminated against
on the basis of their gender, race, ethnicity, disability,
religion, sexual orientation, etc.
Borrowing, Lending,
and the Interest Rate
Interest rate
• The price paid by borrowers for the use of funds
• The rate of return earned by capital as an input in
the production process
The rate of return earned by capital is the interest rate
that equates the present value of the cost and the present
value of the returns for the investment in the capital.
For example, suppose the cost (C) of an investment is
incurred now and the returns (R1, R2, and R3) are
received over the next three years.
Then the present value of the returns is
R1 / (1 + i)1 + R2 / (1 +i)2 + R3 / (1 + i)3
Since the cost is incurred now, its present value is just
the amount of that cost C.
So, the rate of return earned by the capital is the value of
i such that
C = R1 / (1 + i)1 + R2 / (1 +i)2 + R3 / (1 + i)3
Investment and the
Marginal Productivity of Capital
Gross marginal productivity – the total addition
to productivity that capital investment
contributes
Net marginal productivity – the total addition to
productivity that capital investment
contributes, less the cost of capital
Example: If Robinson Crusoe fishes by hand, he can catch 20
fish each week. If he takes a week off to make a net, he can then
catch 25 fish a week with the net until it wears out in 10 weeks.
In order to avoid starving during the week that he is weaving the
net, he can borrow 10 fish from Friday, on the condition that he
pays back the 10 fish plus an extra 5 fish.
The cost of the net is the 20 fish that he gave up by not fishing for
a week plus the 5 extra fish paid to Friday, or 25 fish.
The gross marginal productivity of the net (the total addition to
productivity that it contributes) is
(5 fish per week)•(10 weeks) = 50 fish.
The net marginal productivity of the net (the total addition to
productivity that it contributes, less its cost) is
(50 fish) – (25 fish) = 25 fish.
The demand for investment curve shows the
relationship between the rate of return generated
and various levels of investment.
Recall that the law of
diminishing marginal returns
implies that each additional
dollar of capital adds less to
total output.
Therefore, as the quantity of
investment increases, the rate
of return decreases.
Therefore, the curve
representing the demand for
investment curve slopes
downward.
rate of
return
i2
i1
DI
I2 I1 investment
Why does the rate of return on capital investment
tend to equal the interest rate for borrowed funds?
Suppose that the rate of return on capital investment was greater
than the interest rate for borrowed funds.
Then investors would benefit by borrowing funds and investing in
capital.
So the level of investment will increase, and as it does the rate of
return declines (due to diminishing marginal returns).
Investment will increase until the rate of return on capital
investment is equal to the interest rate for borrowed funds.
Similarly, if the rate of return on capital investment was less than
the interest rate for borrowed funds, investors would be losing
money by making capital investments.
Investment will be cut back until the rate of return on capital
investment again equals the interest rate for borrowed funds.
There is a tendency for capital to be allocated across firms
and industries so that the rate of return is equal. Why?
If the rate of return is higher in one particular industry,
owners of capital will move to that industry.
That will cause output in that industry to expand and
price to fall until the industry earns a normal profit and
the rate of return is the same as in other industries.
Similarly, if the rate of return is lower in one particular
industry, owners of capital will leave that industry.
Output will fall and price will rise until the industry
earns a normal profit and the rate of return is the same
as in other industries.
When we add the demand for investment funds and the
demand for funds for consumption, we get the demand
for loanable funds.
We combine this with the
supply of loanable funds
interest
to get the market for
rate
loanable funds.
S
As usual, the equilibrium
interest rate and
i*
equilibrium quantity of
loanable funds occurs at
D
the intersection of the
supply and demand
Q* loanable funds
curves.
Why do Interest Rates Differ?
•
•
•
•
Difference in risk
Differences in the duration of the loan
Differences in costs of processing
Differences in tax treatment