Micro test 3

In labor markets supply:

determine wage. Supply curve is workers supplying their labor/hours

In labor markets Demand…

Determines quantity of employment. Demand curve is firms demanding workers.

Labor supply curve is…

UPWARD sloping. It reflects that as wages increase, more workers are willing to supply their labor.

Labor demand curve is…

DOWNWARD sloping. It shows that as wages decrease, firms are willing to hire more workers.

What are the 3 possible conditions in an equilibrium labor market?

Qd = Qs = Q* at current price

Qd > Qs at current price

Qd < Qs at current price

Marginal produce of labor

The additional output generated by adding one more unit of labor, holding other inputs constant.

Marginal revenue product of labor

The additional revenue generated from employing one more unit of labor, calculated as the marginal product of labor multiplied by the price of the output.

What is the cost of an extra worker?

The marginal cost of labor, which includes wages and any additional benefits associated with hiring the worker.

What is the rational rule for employers?

Firms should hire another worker if the marginal revenue product of labor is greater than or equal to the marginal cost of labor.

The law of Demand

a firm’s labor demand curve is downward sloping (as W falls, Q of workers demanded increases) because of diminishing marginal product of labor

Labor demand is…

Derived demand: As with usual demand, a change in wage results in a movement along the demand curve (i.e., a change in quantity demanded), but it does not result in a change in labor demand (i.e., the demand curve shifting)

Shifts in labor demand

•Increase in labor demand (hire more workers at every wage) ⇒ demand curve shifts right
• Decrease in labor demand (hire less workers at every wage) ⇒ demand curve shifts left

Several things do cause the demand curve to shift (meaning that a firm would hire a different amount of workers at a given wage)

1. (Right shift) Change in demand for the firm’s product, which changes the price of the product
2. (Right or Left shift) Changes in labor productivity
3. (Left shift) Changes in nonwage costs of workers

How do robots/tech work in the labor market?

• Higher wages create an incentive firm to invest in capital (substitute away from labor)
• New technology helps owners of robots at the expense of workers
• Technology leads to the end of some jobs and the creation of others

Labor supply - thinking like a …?

Worker

Labor demand - thinking like a…?

Firm

What is leisure?

• Labor + leisure = ? hours

•The cost of working for another hour is the marginal benefit (MB) of another hour of leisure (whatever you would have been doing if not working)
•The benefit of working for another hour is the wage

What is the rational rule for workers? Workers should work another hour if…

…the marginal benefit (MB) of working that additional hour, which is represented by the wage they would earn, is greater than or equal to the marginal cost (MC) of forgoing leisure time.

In simpler terms, if the extra income from working that hour exceeds the value of the leisure activities they are giving up, it makes rational sense for them to work.

There are two effects from higher wage rates:

1. Substitution effect – higher wages make work more attractive
2. Income effect – higher income makes leisure more attractive

If income effect dominates substitution effect, how does this affect slope of labor supply curve?

the labor supply curve may become backward-bending.

This means that at higher wage rates, workers may choose to work fewer hours because they can achieve their desired income with less labor, valuing leisure time more than additional income. This results in a decrease in the quantity of labor supplied as wages increase beyond a certain point.

The substitution effect is often larger than the income effect, leading the market labor supply curve to be upward sloping. Evidence?

• Higher wages induce people to enter labor market.
• Existing workers are likely to increase hours.
• Some people may switch occupations (i.e., if increase teacher salaries, number of
education majors will increase)

(Note that if the income effect dominates the substitution effect, the labor supply curve is backward bending)

The extensive margin: choosing whether or not to work

• Benefits of working
• Costs of working
• Higher wages lead more people to enter the workforce

Choosing your occupation

• Benefits of a job
• Costs of a job

A change in the wage rate results in a movement along the labor…

supply curve—we simply from one point on our labor supply curve to another point on the labor supply curve. It does not result in labor supply/a shift in the supply curve.

Shifts in labor supply

• Increase in labor supply (supply more at every wage) – supply curve shifts right
• Decrease in labor supply (supply less at every wage) – supply curve shifts left

Several things do cause the labor supply curve to shift (a worker will work more/less for a given wage).

1. Changes in wages in other occupations
2. Changes in population (number of potential workers, for example immigration)
3. Changes in benefits of not working
4. Changes in nonwage benefits and costs

Who controls the labor demand market?

Employers/Firms

Human Capital

refers to the economic value of an individual's skills, knowledge, experience, and attributes that contribute to their productivity in the workplace. It encompasses education, training, and health

What is the relationship between productivity and wages?

Higher productivity means workers can produce more, often leading to higher wages because employers want to reward increased output.

signaling

is when individuals or companies show their skills or qualities to prove they are good candidates for jobs or contracts.

Two reasons people with education get paid more:

• Education increases human capital
• Education also serve as a signal of ability

When employers pay workers more to encourage higher worker productivity. Why would they do this and what can it lead to?

Employers pay higher wages to motivate workers to work harder. This can lead to better job performance, less employee turnover, and attracting better candidates.

In certain markets such as movie actors, athletes, and singers, there are some superstars that do much better than the average person in their industry. Why?

Superstars usually earn more because they have unique talent and a strong public presence. Their exceptional skills attract more attention and audiences, which leads to higher earnings compared to average performers.

Winner-take-all markets

These are markets where a few top performers earn a lot more than everyone else. In these markets, having unique talent or strong popularity can lead to much higher earnings compared to average performers.

Compensating Differential

Higher wages paid to attract workers to less desirable jobs with negative aspects, such as risks or unpleasant conditions.

Institutional factors that explain why wages vary

1. Government regulation

2. Unions

3. Monopsony

Occupational licensing laws - Increase or decrease supply? how do they affect wages?

Regulations that require individuals to obtain a license to practice in certain professions, such as medicine, law, and cosmetology.

-These laws can decrease the supply of workers

-Licensing often leads to higher wages in those occupations due to reduced competition

Minimum wage laws

Laws setting the floor wage

Unions increase bargaining power of members and increase wages (by effectively
shifting the supply curve up/left). How does this affect wage?

Increases

Monopsony

is a market structure where there is only one buyer, typically a firm, who has market power over the sellers, often workers in the labor market. This allows the monopsonist to pay workers a wage that is lower than the competitive market wage.

Market Structure – Characteristics of a market (number of firms, uniformity of product, ease of entry/exit)

1. Perfect competition
2. Monopoly
3. Oligopoly
4. Monopolistic competition

Perfect Competition

1. All firms maximize profits

2. Entry and exit to the market are free (i.e., no barriers to entry or exit)

3. All firms sell entirely identical (i.e., homogenous) goods

4. There are no consumer preferences.

is rare, imperfect competition is more common

Monopolistic Competition

1. All firms are profit-maximizing

2. Entry and exit to the market are free (i.e., no barriers to entry or exit)

3. Firms sell differentiated products

4. Consumers may prefer one product over the other (however, they are still very close substitutes).

Oligopoly

1. All firms maximize profits

2. Oligopolies can set prices (i.e., they are price-makers)

3. Barriers to entry and exit exist in the market

4. Products may be homogeneous or differentiated

5. Only a few firms dominate the market.

Monopoly

1. The monopolist is profit-maximizing

2. It can set the price (i.e., it is the price-maker)

3. There are high barriers to entry and exit

4. Only one firm dominates the entire industry.

is rare, imperfect competition is more common

Imperfect competition

Firms face some competition but sell products that differ from its competitors. Imperfect competition groups monopolistic competition and oligopoly together

Market power (pricing power)

A company's ability to influence the price of products by manipulating supply, demand, or both. It allows companies to increase profit margins and create barriers to entry for other firms.

Most to Least Market Power

Monopoly → Oligopoly → Monopolistic Competition → Perfection Competition

source of market power?

market power comes from having control over resources, creating loyal customers, being bigger than competitors, or having some advantage like special knowledge or government help.

In perfect competition, a price taker is a…

firm or individual that has no control over the market price and must accept the price determined by supply and demand in the market

Insights into imperfect competition

1. The more competitors you have the less market power you have.

2. Market power allows firms to pursue independent pricing strategies.

   >As stated above, perfectly competitive firms (which have no market power) are price takers and use the market price

   >But firms with market power can choose their optimal P, Q combination

3. There is a tradeoff between raising the price and selling a smaller quantity (because the demand curve is downward-sloping)

4. The more you can differentiate your product the more market power you have (advertising).

5. Imperfect competition among buyers gives them market power

6. When there are few firms (oligopoly), your best choice depends on actions of competitors

(In)efficiency

1. There is a market failure/deadweight loss with firms with market power.

2. Compared to perfect competition, market power leads to:
   o Underproduction (lower quantity)
   o Higher prices
   o Deadweight loss
   o Larger economic profits
   o Inefficient businesses can survive

What are patents?

a government authority or license conferring a right or title for a set period, especially the sole right to exclude others from making, using, or selling an invention.

>tend to make monopolies

Why do governments grant patents? Whats the trade off?

Governments grant patents to encourage innovation by providing inventors exclusive rights to their inventions, allowing them to profit from their ideas.

The tradeoff is that while patents reward innovation and foster new developments, they also create temporary monopolies.

Ways to restrain market power

1. Anti-collusion laws
2. Merger laws
3. Anti trust
4. Encouraging international trade promotes competition.
5. Price ceilings

Collusion

is a non-competitive, secret, and sometimes illegal agreement between rivals which attempts to disrupt the market's equilibrium.

Merger

occurs when two companies of similar size and value decide to combine into a single entity

Natural Monopoly industry

is a monopoly in an industry or sector with high barriers to entry and start-up costs that prevent any rivals from competing

Water, electricity, or gas companies

Price ceilings

1. Governments sometimes grant monopoly rights to a firm in a natural monopoly industry

2. In natural monopoly industries, price ceilings can be used to increase output and reduce or eliminate DWL.

3. Or the government might decide to instead provide the service in the natural monopoly industry itself.

What is Price Discrimination?

selling strategy that charges customers different prices for the same product or service based on what the seller believes it can get the customer to agree to.

Conditions for price discrimination

1. The firm must have market power

2. The firm must be able to prevent resale

3. The firm must be able to target the right prices to the right customers (and different customers must have different demand)
   o I.e., distinguish between who is willing to pay higher prices and who isn’t

Efficiency of price discrimination

1. Price discrimination increases the quantity sold (compared to a firm with market power
   charging a single price)

2. Price discrimination increases producer surplus

3. Price discrimination may either increase or decrease consumer surplus

Reservation Price

is a limit on the price of a good or a service. It is the highest price that a buyer is willing to pay.

To maximize profits, a firm would like to…

charge a price as close to the buyer’s reservation price as possible. The price also needs to be greater than or equal to the firm’s marginal cost.

Perfect price discrimination

def: is a business practice of pricing units of the same product or service differently to ensure the maximum consumers pay as much as possible for the product.

ex: PPD is efficient, meaning there is no deadweight loss. However, consumers get 0 consumer surplus. Producers capture all of the surplus in the market. Its very rare.

Group pricing

charging different prices to different groups of people

Why do firms use group pricing?

The benefits of group pricing include targeted marketing strategies, rewarding wholesale customers, and running efficient loyalty programs.

(Price method 1) How to segment the market/create groups

1. Choose groups whose demand differs. The more the better.
2. Target groups based on verifiable characteristics.
a. Want to make lying hard
3. Choose groups based on difficult-to-change characteristics

Group pricing method 2: The hurdle method

If it is hard to figure out people’s reservation prices then the firm might use the hurdle method, where people effectively sort themselves into groups.

Charge lower prices to the people (LOW reservation) who are willing to overcome the hurdle.

Types of Hurdles

1. Alternative timing

2. Alternative versions

3. Shopping around

4. Extra Hassle, bad service, and imperfect goods

5. Quantity discounts

Alternative timing

different ways of timing or order in which decisions are made

EX: a decision-maker may choose between two alternatives at different times, and the optimal choice may vary depending on the timing

Alternative Version

A different brand but similar item/service of the current item/service you’re looking for

EX: A radio from sony, a radio from beats

Hurdle: Shopping around

1. Looking for the best deal

2. Price fluctuations

3. Haggling

Hurdle: Extra hassle, bad service, and imperfect goods

1. Extra hassle (like travel time, rewards cards)

2. Coupons and rebates

3. Slightly worse service/quality

4. Imperfect goods

Hurdle: Quantity discounts

1. Per unit price is lower when buy more.
   >Can either be like a buy one get one free
   - Or if you buy something in bulk, like a huge container of ketchup, which might be cheaper per ounce than a small container of ketchup
   > Bundling

Payoff matrix

presents the outcomes based on choices of each player (firm, person, etc.)

How to solve a static game theory problem:

1. Consider all possible outcomes.

2. Break down the “what ifs?”

3. Play your best choice/best response.
   >What is the best response?

4. Put yourself in someone else’s shoes.
   >Basically, repeat the above steps for the other player.

What is Nash Equilibrium?

equilibrium in which the choice that each player makes is a best response
to the choices other players are making

Prisoner’s dilemma

a game where the Nash equilibrium outcome (where they both defect) is worse for both players than is another outcome where they both cooperate

Why do we end up in a prisoner’s dilemma?

Agreements to cooperate are not credible, and each player has an incentive to
cheat.