Econ Unit 12: Factor Markets

Derived demand

• firm’s demand for a factor

Demand for labour

• how much labour will a firm wish to hire?

Marginal product (MP_L)

• change in output resulting from incremental change in quantity of labour

• MP_L = ΔQ / ΔL

Marginal revenue product (MRP_L)

• change in revenue resulting from an incremental change in quantity of labour

• MRP_L = ΔR / ΔL

• measures the benefit of that extra unit of labour

  L	Q	MPL	R	MRPL
  0	0	-	0	-
  1	8	8	32	32
  2	14	6	56	24
  3	19	5	76	20
  4	22	3	88	12
  5	23	1	92	4

P = $4

MRP_L = MP_L (P)

• if the firm operates in a perfectly competitive output market MRP_L = P (MP_L)

  • in general MRP_L = MR (MP_L)

  • MRP_L is a downward sloping curve

Photo 1 from dec 4

Marginal factor cost (MFC_L)

• change in total costs resulting from an incremental change in quantity of labour

• MFC_L = ΔC / ΔL = w

• w = wage rate

The hiring rule

• firm should continue to hire additional units of labour as long as the MRP_L > MFC

• firm stops when MRP_L = MFC

L	MRPL
0	-
1	32
2	24
3	20
4	12
5	4

MRP_L = w = 12 @ L = 4

w = 12

w = 12

L = 2

The supply of labour

photo 2 of dec 4

• households choose number of hours of labour to offer

• household choose between two activities

  1. labour (market activity)

  2. leisure (non-market activity)

     • price of leisure? wage rate

       → for the price of leisure we use opportunity cost

2 different effects resulting from change in quantity supplied of labour when wage rate changes

1. substitution effect

   • as wage rate increases, price of leisure increases

   • people substitute away from leisure

   • as wages increase, quantity supplied of labour increases

2. income effect

   • as wage rates increase, income increases

   • as income increases, consumers wish to consume more normal goods

   • leisure is normal good

   • as wages increase, quantity supplied of labour decreases

photo 3 dec 4

Factors that determine wage rate

1. productivity

2. skill set

3. time with firm and experience

4. location

5. necessity of the good/service

6. union vs. nonunion

7. competitiveness of the Labour Market

8. Regulations

Hedonic wages

• suppose a job has a 1/1000 chance of death

  • W_job = W_{riskless job} + 5,000

• suppose there are 1000 workers

  Total increased wage

  = (1000) (5000) = 5 000 000

• value of a human life = $5 000 000

Free market response

Group 1 has MRP₁ = MRP^*

Group 2 has MRP₂ = MRP*

• but W₁ > W₂

  → increase in demand for group 2 → W₂ increases

  → decrease in demand for group 1 → W₁ decreases

Evidence:

• explanation for difference in wages paid to different genders

  1. women tend to work in lower wage occupations

  2. other issues, productivity, experience,…

  3. gender discrimination

Monopsony

• market where there is only one buyer

• monopsonist faces an upward sloping market supply curve since the monopsonist is the market

• graph photo dec 6

• MRP_L^M - W_monop = monopsonistic explanation

Capital

• equipment that lasts over several periods

• compare MFC (today) vs. the present value of MRP (over time)