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Economics of Public Policy – Labor Market Equilibrium – Economics of Health Care – Public Goods 1 Labor Market Equilibrium Understand the relationship between wages and the marginal productivity of workers Analyze how wages and employment are determined in competitive labor markets 2 The Labor Market • Marginal product of labor (MP) – The additional output a firm gets by employing one additional unit of labor • Value of marginal product of labor (VMP) – The dollar value of the additional output a firm gets by employing one additional unit of labor • In a competitive market, wage = VMP 3 Adiron Woodworking Company • Makes cutting boards from free scrap wood – Price of a cutting board is $20 • Going wage is $350 per week # of Workers Output 0 0 1 2 3 4 5 30 55 76 94 108 MP VMP 30 $600 25 500 21 420 18 360 14 280 4 Adiron Woodworking Company • The company will hire workers until the value of the marginal product of the last worker is equal to the wage – Cost-Benefit Principle – Workers earn $350 per week • Adiron will hire four # of Workers VMP workers 1 $600 – The fifth worker costs 2 500 more ($350) than the 3 420 benefits he delivers ($280) 4 360 5 280 5 Firm 1 12 D1 = VMP1 12 D = VMP1 + VMP2 6 100 150 Wage ($/hour) Market 12 Firm 2 Wage ($/hour) Wage ($/hour) Demand for Labor 6 D2 = VMP2 6 150 250 Total Employment 50 100 Work hours/day 6 Individual Labor Supply • Individuals trade-off income and leisure – More work hours means more income AND less leisure • Suppose the wage increases – Substitution effect: work more • Leisure is more expensive – Income effect: work less • Purchasing power increases for a given work schedule – A higher wage may increase or decrease the quantity of labor supplied by the individual 7 Labor Supply of Programmers S Wage ($/hour) • Labor supply for a single profession has a positive slope – Higher wages attract workers from other careers • An increase in wages from W1 to W2 increases quantity of labor supplied from L1 to L2 – Movement along the labor supply curve W2 W1 L1 L2 Employment of programmers (work-hours/year) 8 Equilibrium in the Labor Market of Programmers • Demand for programmers increases from D1 to D2 – Initial impact is a shortage of programmers at W1 – In the short-run, wages are bid up to W3 • In the long run – Movement up the supply curve and down the demand curve – Quantity of labor supplied increases from L1 to L2 – Wages settle at W2 W3 S W2 W1 D2 D1 L1 L2 Employment of programmers (work-hours/year) 9 Health Care Delivery • Health care spending has grown faster than income – Up from 4% of national income in 1940 to 14% in 2005 – Part of the increase is due to improved quality of tests, procedures, drugs, etc. – Part is due to the third-party payment system • Growth in use of insurance for payments – Employer-provided and government-provided 10 Health Care Delivery • Cost-benefit test assures efficient allocation of health care – Perform a service only if the benefit exceeds the cost • Costs are easy to measure • Benefits are complicated – Usual measure is willingness to pay marginal cost • Some patients are unable to pay for basic services – Society assumes some responsibility via government-provided insurance – Confused by third-party payment system 11 • Price of hospital room is $300 per day – If David pays, MC to him is $300 – David equates marginal cost and marginal benefit and stays one day – If insurance pays, MC to David is zero • He stays 3 days Price ($/day) The Demand for Hospital Care 300 D 1 3 Length of hospital stay (days) 12 Full Insurance Coverage Creates Waste • If David pays, stay is 1 day • If insurance pays, stay is 3 days – Extra benefit of 2nd and 3rd day to David is $300 – Extra cost is 2 days times $300 per day = $600 – $300 surplus lost Alternative Coverage Scheme Price ($/day) • Insurance company pays 300 David $700 – Insurance company saves $200 compared D to a 3-day stay 1 3 • David stays 1 day Length of hospital stay (days) – Pays hospital $300 – David keeps $400 • The $300 benefit he would get from staying 3 days PLUS $100 pure surplus • Total surplus increases $300 Policy Implications • Research shows that when individuals pay for their health care, they consume less • An more efficient system can be designed – Adopt a system of high deductible health insurance – Use stipend payments for the poor • An efficient policy will increase the size of the health care pie Public Goods • Government is the only organization with the power to compel actions – Taxes – Military service – Imprison people • All other institutions – family, business, charitable organizations, etc. – rely on voluntary transactions • Government decisions can be analyzed using economic principles Public Goods • Public good is a good that is both nonrival and nonexcludable – A nonrival good is one whose consumption by one person does not diminish its availability to others • National defense ; Economics lectures – A non-excludable good is one that is difficult or costly to exclude non-payers from consuming • Over-the-air broadcasts; Fireworks displays • A pure public good is, to a high degree, both nonrival and nonexcludable. Public Goods and Government • A collective good is a good or service that, to at least some degree, is nonrival but excludable – Sometimes provided by government • A good is a pure private good if – Non-payers can easily be excluded and – Each unit consumed by one person means one less unit available for others • A pure commons good is a rival good that is nonexcludable Fish in open water Types of Goods Paying for Public Goods • Not everyone benefits equally from a public good or service. • Example – Prentice and Wilson have adjacent properties • Fighting zebra mussel infestation • New device to control mussels is $1,000 to serve both properties • Wilson's income is higher and value device at $800 • Prentice values device at $400 Paying for Public Goods • Equal sharing of costs with a head tax • A head tax is a tax that collects the same amount from every taxpayer • Result: no new device – $500 is more than Prentice's reservation price • Prentice vetoes device • A regressive tax has a tax rate that varies inversely with income • A proportional income tax requires all taxpayers to pay the same proportion of their incomes in taxes • A progressive tax takes a larger share of higher incomes as tax