Download Chapter 12 The analysis of factor markets: labour

Week 7
Issues in Microeconomics
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The labour market
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Demand for factors in the long run
• The optimum mix of capital and labour depends on
the relative prices of these factors
– This helps to explain why more labour-intensive means of
production are used in some countries where labour is
relatively abundant.
• A change in the price of one factor will have both
output and substitution effects
• A rise in the wage rate leads to
– substitution towards more capital-intensive techniques
– but also leads to lower total output
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The demand for labour in the short run
The marginal value product of labour is the
revenue obtained by selling the output produced
by an extra worker
• Under perfect competition,
with diminishing marginal
productivity:
• the firm maximizes profit
when the marginal cost of
employing an extra worker
equals the MVPL...
W0
MVPL
Employment
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The demand for labour in the short run
E
W0
MVPL
…this occurs at E
where wage = MVPL.
Employment is L*.
Below L*, extra employment
adds more to revenue than
to labour costs.
Above L*, the reverse is so.
This decision is consistent
with the MR = SMC rule for
maximizing profit under
perfect competition.
L* Employment
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The supply of labour
• The LABOUR FORCE:
– all individuals in work or seeking employment
• Labour supply
– for an individual, the decision on how many hours
to offer to work depends on the real wage
– an individual’s attitude towards leisure and income
determines if more or less hours of work are
supplied at a higher real wage rate.
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Labour supply in aggregate
• If we consider the economy as a whole,
or an industry
• a higher real wage rate also encourages
a higher participation rate
• so labour supply is likely to be upwardsloping
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Labour market equilibrium for an industry
SL
DL
• The industry supply curve
SLSL slopes up
– higher wages are needed to
attract workers into the
industry
W0
DL
SL
• For a given output demand
curve, industry demand for
labour slopes down
• Equilibrium is W0, L0.
L0
Quantity
of labour
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A shift in product demand
SL
DL
D'L
Beginning in equilibrium,
a fall in demand for the
product also shifts the
derived demand for labour
to D'L
W0
W1
DL
SL
D'L
L 1 L0
The new equilibrium is
at W1, L1.
Quantity
of labour
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A change in wages in another industry
S'L
SL
DL
Again starting in equilibrium,
An increase in wages in
another industry attracts
labour,
W2
W0
so industry supply shifts
to the left –
S'L
DL
SL
L2 L0
The new equilibrium is
at W2, L2.
Quantity
of labour
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The information economy
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Welfare indicators by country group
Business use of the
internet 2003
Business use of the
internet 1997
1500
6
£bn
4
£bn
2
0
1000
500
0
1997
Business to business
Business to consumer
2003
Business to business
Business to consumer
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e-products
• An e-product:
– can be digitally encoded then transmitted
rapidly, accurately and cheaply
e.g. music, films, books, sport …
• Fixed costs of producing e-products are
huge …
• … but marginal costs of distribution are
tiny
• implying vast economies of scale
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Network externalities
Suppose D1 represents the
demand curve for a product
exhibiting network externalities
£
D
With price at P1, demand is
limited.
P1
If price is reduced to P2, more
people find the network attractive
so not only is there a move along
the demand curve, but there is
a shift in demand.
P2
D1
Q1
Q2
D2
D
Long-run demand is more
elastic (DD).
Quantity
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Information: the supply
side
• Given substantial economies of scale,
we expect monopoly suppliers of
information products:
• Dominant firm with competitive fringe
e.g. Microsoft
• Niche market monopolies
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Pricing information products
• Strategies for pricing information products:
– two-part tariff
• an annual charge to cover fixed costs, and a small price
per unit related to marginal costs
– versioning
• the deliberate creation of different qualities to facilitate
price discrimination
– bundling
• the joint supply of more than one product to reduce the
need for price discrimination
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Competition vs. collaboration
• A strategic alliance is a blend of cooperation and competition, in which a
group of suppliers provide a range of
products that partly complement one
another
– e.g. Microsoft and Intel
– airline alliances: One World, Star
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Understanding the eeconomy
• 1 The information revolution is
changing our lives
– but few of its activities or market
tactics are unprecedented
• 2 The revolution in technology has not
required a corresponding revolution in
economic theory
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Government spending and
Revenue
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Government spending
The scale of government activity has grown steadily in
industrial countries since 1880
% of national income
60
50
Japan
USA
Germany
UK
France
Sweden
40
30
20
10
0
1880
1929
1960
2001
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Private and public goods
• A private good
– if consumed by one person, cannot be consumed
by another person.
e.g. dental treatment
• A public good
– even if consumed by one person, can still be
consumed by other people.
e.g. street lighting
The strong externalities associated with public goods, mean
that government intervention may be justified to ensure
appropriate provision.
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Merit goods and bads
• Merit goods (bads)
– goods (bads) that society thinks everyone
ought to have (ought not to have)
regardless of whether they are wanted by
each individual.
e.g. Education, health services, cigarettes
– The government may spend money on compulsory
education or compulsory vaccination because it
recognizes that otherwise individuals act in a way
they will subsequently regret.
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Varieties of taxes
• Direct taxes
– taxes on earnings from labour, rents,
dividends and interest.
e.g. income tax, corporation tax
• Indirect taxes
– taxes levied on expenditures on goods and
services
e.g. VAT, duty on alcohol
• Wealth taxes
– capital transfer tax, tax on property
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A tax on wages
With no tax, the labour
SS' market is in equilibrium
at wage W, hours L.
SS
With a tax, labour supply
is effectively at SS',
workers receive W'',
but firms pay W', the
difference being the tax.
W'
W
W''
DD
L' L
Hours worked
Employers pay the blue
area, and workers the green.
The orange area is a welfare
loss for society.
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The incidence of a tax
• Who pays a tax depends upon the
elasticity of demand and supply for the
product.
• This also affects the size of distortion
caused by the imposition of a tax.
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The Laffer curve
shows how much tax revenue is raised at each
possible tax rate. Beyond t*, higher tax rates reduce
revenue because of disincentive effects.
t*
Tax rate
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100%
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Industrial policy and
competition policy
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Industrial policy and
Competition Policy
• Competition policy
– aims to enhance economic efficiency by
promoting or safeguarding competition
between firms
• Industrial policy
– aims to offset externalities that affect
production decisions by firms
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Industrial policy
• Inventions and the patent system
– designed to provide a sufficient incentive
for invention without suppressing
competition for ever
• Research and Development (R&D)
– the social return on risky projects may
exceed the private return
• Dynamic change
– coping with sunset and sunrise industries
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Consumer surplus
Consider the demand curve D
and suppose price is at P with
quantity demanded being Q.
A
P
P represents the value placed
on the good by the marginal
consumer
E
D
Q
Quantity
so D can be seen to
represent marginal social
benefit
With all consumers paying the same price P for the good, the
triangle APE represents consumer surplus – benefit received
by consumers in excess of the amount they need to pay.
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Producer surplus
Producer surplus is the
excess of total revenue
over total costs
P
LAC = LMC
– as shown by the
rectangle.
D
Q
Quantity
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The social cost of monopoly:
comparing perfect competition and monopoly
For simplicity, suppose as
industry with horizontal
long-run average and
marginal costs.
LAC = LMC
Pc
D
Qc
Quantity
Under perfect competition,
long-run equilibrium would
be with industry output
Qc selling at price Pc.
Consumer surplus is
the area of the big
green triangle.
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The social cost of monopoly:
comparing perfect competition and monopoly
If taken over by a monopolist, profit
maximization is at the lower output
Qm and higher price Pm.
Consumer surplus is now
the smaller green triangle.
Pm
LAC = LMC
Pc
MR
Qm
D
Qc
Quantity
The monopoly receives
producer surplus (profit)
of the blue rectangle.
and the red triangle shows
the welfare loss – the
social cost of monopoly
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Perfect competition and monopoly
under differing cost conditions
Suppose that monopoly
enjoys lower cost
conditions than under
perfect competition
Pm
Under perfect competition
equilibrium is at Pc, Qc.
LRSSpc
Pc
LAC = LMC
Compared with Pm, Qm
under monopoly
MR
D
Qm
Qc
Quantity
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Welfare implications
• In comparing the two situations, the
loss of consumer surplus under
monopoly (the red triangle)
• must be balanced against the gains
from efficiency (the blue rectangle)
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Counting the cost of
monopoly
• The size of the social cost of monopoly is difficult to
evaluate
– in part it depends upon the elasticity of demand
– which influences the size of the ‘red triangle’ of welfare loss
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