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Chapters 16.1-16.5, 17.1-17.4, 18.1, 18.2: Input & Labor Markets, Wages & Rent 1 Input Demand Curve of a Competitive Firm • Input demand shows the total quantity of the input that will be demanded at various prices • Input demand will depend on the marginal value product (MVP), which is the extra revenue a competitive firm receives by selling the additional output generated when employment of an input is increased by 1 unit – For a competitive firm, MVP = MPL * P (this is b/c output price is constant for a competitive firm) – It makes sense for a firm to hire to the point where MVP = w, w = MPL*P and therefore w/MPL = P 2 Competitive Firms Demand for Labor: All Inputs Variable • When all inputs are variable, an input’s MVP curve shifts with changes in the employment of other inputs – A lower wage rate causes the firm to substitute toward labor and away from capital • Input demand is a “derived demand” reflecting the fact that industry demand for an input ultimately derives from consumers’ demand for the final product produced by that input Dollars Capital per unit A1 A 12 A’ 10 MC New expansion path E E2 E P3 E2 E1 IQ2 E1 MC’ IQ1 0 20 26 30 Z’ Substitution Effect Output Effect Z1 Labor 0 q1 q2 Output 3 Competitive Industry Demand for Labor The firm The market Wage Wage $300 = w A $300 = w B $200 = w’ C $200 = w’ d(P = $100) A’ B’ C’ ∑ d(P = $100) ∑ d’(P = $80) d’(P = $80) D 0 20 27 30 Labor 0 2,000 2,700 3,000 Labor 4 Elasticity of an Industry’s Demand Curve for an Input • Elasticity of input demand is the sensitivity of input demand to changes in input cost = (%input demand)/(%input cost) • Four major determinants of the elasticity of an industry’s demand for an input 1. 2. 3. 4. Elasticity of the final product The substitutability of one input for another in production The supply of other inputs Time period 5 Supply of Inputs Wage S w2 w1 Wage S w2 w1 0 L1 Labor (in all (100,000,000) industries) 0 L1 (5,000) L2 Labor (in software (15,000) programming industry) 6 Equilibrium in Input Markets The Equilibrium Wage and Employment Level for a Competitive Industry The firm Input Price Equalization Across Industries Aerospace industry The industry Wage Wage SSA SS’A Wage Telecommunications industry Wage SST SS’T S $400 = wA s $300 =w $350 = w’A $300 = w $250 = w1 l (500) Labor D 0 s $300 = wT d 0 $350 = w’T L0 L L1 Labor (6,000) (10,000) (12,000) DA 0 LA L’A (500) (700) Labor DT 0 LT L’T (800) (1,000) 7 Labor Income Leisure Choice of the Worker Weekly Income A Y2 $800 = Y1 B E U3 U2 G $20 U1 F 1 hr. 8 Supply of Hours of Work Weekly Income A’ H $25 1 hr. $25 1 hr. A E’ $20 1 hr. E1 U2 E U1 L3 L2 L1 0 I H’ Z Leisure S TE 9 A Backward Bending Labor Supply Curve? Weekly income Hourly wage A’’ $30 E’’ $30 1 hr. A’ $25 1 hr. E’ A $20 E’’ E’ $25 1 hr. E 0 L2 L3 L1 $20 Z Leisure E ZL3 ZL1 ZL2 Labor 10 Why Do Wages Differ? • If wage rates differ across occupations and there is free entry and exit from/into occupations, shouldn’t we see individuals leave the low wage occupation (shifting supply to the left) and enter the high wage occupation (shifting supply to the right), equalizing wages across occupations. So why do wages differ across individuals and occupations? 1. Compensating wage differentials 2. Differences in human capital 3. Differences in ability 11 Minimum Wages S Wage S Wage $5.15 $6.00 $4.00 $5.15 D D 0 L2 L1 L3 Unskilled Labor 0 L2 L1 L3 Unskilled Labor 12 Burden of Social Security Tax • Social security is financed by a payroll tax composed of two equal-rate levies, one collected from employers and one collected from employees (about 7.6% on each for the first $80K of income), so who really pays for this tax? Wage Wage S S $10.50 = w’’ $10.00 = w $10 = w Total revenue $8 = w’ $8.50 = w’ $2 $2 D D D’ = D - T 0 L1 Labor D’ = D - T 0 L1 Labor 13