Slide #1.

Resource Markets
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Slide #2.

Remember that the following terms are just different words for the same things. Resources Inputs Factors of Production Whichever they’re called, they are things that are used to produce output.
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Slide #3.

Input and output markets can be perfectly competitive or not. So there are four possibilities. Output Market Perfectly competitive Input Market Perfectly competitive Not Perfectly competitive Not Perfectly competitive
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Slide #4.

A firm uses inputs to produce outputs. So there are four possibilities. Output Market Perfectly competitive Input Market Perfectly competitive Not Perfectly competitive Perfectly competitive in both input & output markets Not Perfectly competitive
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Slide #5.

A firm uses inputs to produce outputs. So there are four possibilities. Output Market Perfectly competitive Perfectly competitive Input Market Not Perfectly competitive Not Perfectly competitive Perfectly competitive in both input & output markets Perfectly competitive in neither input nor output market
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Slide #6.

A firm uses inputs to produce outputs. So there are four possibilities. Output Market Perfectly competitive Input Market Not Perfectly competitive Perfectly competitive Not Perfectly competitive Perfectly competitive in both input & output markets Perfectly competitive in input but not output market Perfectly competitive in neither input nor output market
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Slide #7.

A firm uses inputs to produce outputs. So there are four possibilities. Output Market Perfectly competitive Input Market Perfectly competitive Not Perfectly competitive Perfectly competitive in both input & output markets Perfectly competitive in input but not output market Perfectly Not Perfectly competitive in competitive output but not input market Perfectly competitive in neither input nor output market
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Slide #8.

Input Market Possibilities • Perfect Competition – many buyers of the input with no influence on the input price • Monopsony – one buyer of the input • Oligopsony – a few buyers of the input • Monopsonistic Competition – many buyers but with some influence over input price Perfect Competitors have a horizontal input supply curve. Monopsonists, oligopsonists, & monopsonistic competitors face an upward sloping input supply curve.
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Slide #9.

Output or Product P Industry P* D S P* Q* Input or Labor P Perfectly Competitive Firm W D Q Q W S W* W* S D L* L L
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Slide #10.

Derived Demand Because the demand for an input is derived from the demand for the output that it is used to produce, the demand for an input is called a derived demand.
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Slide #11.

To determine how much input a firm will use, we need a few concepts.
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Slide #12.

If a firm hires all workers at the same wage, then the total resource cost (TRC) or total cost of labor (TC L) is the wage per unit of labor times the amount of labor hired. TRC = TCL = W•L
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Slide #13.

Marginal Resource Cost (MRC) the change in total variable cost that results from the employment of an additional unit of an input. MRC = TVC / L = dTVC/dL
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Slide #14.

Average Resource Cost (ARC) the total variable cost per unit of input ARC = TCL / L If the firm hires all workers at the same wage, then ACL or ARC = TCL / L = (W•L)/L = W
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Slide #15.

Marginal Physical Product (MPP) or Marginal Product (MP) the change in the quantity of output that results from the employment of an additional unit of an input. MPP = Q /L = dQ/dL
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Slide #16.

Marginal Revenue Product (MRP) the change in total revenue that results from the employment of an additional unit of an input. MRP = TR /L = dTR/dL
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Slide #17.

What is the difference between MPP & MRP? Suppose your company produces chairs. The MPP tells how many more chairs you can make if you hire another worker. The MRP tells how much more revenue you can make from the additional chairs produced by the additional worker.
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Slide #18.

Alternative formula for MRP MRP = TR = TR Q L L Q = TR Q  Q L = MR . MPP So, MRP = MR . MPP
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Slide #19.

Sales Value of the Marginal Product (SVMP) or Value of the Marginal Product (VMP) the price of the output multiplied by the marginal physical product of the input. VMP = P . MPP
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Slide #20.

Sometimes MRP = VMP, but not always.
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Slide #21.

Recall: If a firm is a perfect competitor in the product market, marginal revenue is equal to the price of the output (MR = P). Then, MRP = MR . MPP = P . MPP = VMP So, MRP = VMP for a firm that is a perfect competitor in the product market.
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Slide #22.

Recall: If a firm is a not perfect competitor in the product market, marginal revenue is less than the price of the output (MR < P). Since MRP = MR . MPP and VMP = P . MPP, MRP < VMP, for a firm that is not a perfect competitor in the product market.
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Slide #23.

If a firm is perfectly competitive in the product market, then MRP = VMP. If a firm is not perfectly competitive in the product market, then MRP < VMP.
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Slide #24.

Example: A firm sells its shirts in a perfectly competitive product market for $10 each. L 0 10 20 30 40 50 60 70 Q 0 70 130 180 220 250 270 280
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Slide #25.

Example: A firm sells its shirts in a perfectly competitive product market for $10 each. L 0 0 10 20 30 40 50 60 70 70 130 180 220 250 270 280 Q MPP=Q/L --7 6 5 4 3 2 1
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Slide #26.

Example: A firm sells its shirts in a perfectly competitive product market for $10 each. L Q 0 0 10 20 30 40 50 60 70 70 130 180 220 250 270 280 MPP=Q/L TR=PQ --0 700 7 1300 6 1800 5 2200 4 3 2500 2 2700 1 2800
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Slide #27.

Example: A firm sells its shirts in a perfectly competitive product market for $10 each. L 0 10 0 70 20 30 40 50 60 70 130 180 220 250 270 280 Q MPP=Q/L TR=PQ MR =TR/Q 0 --700 10 6 1300 5 1800 10 4 2200 10 3 2500 2 2700 10 1 2800 10 10 10 --7
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Slide #28.

Example: A firm sells its shirts in a perfectly competitive product market for $10 each. L Q 0 10 20 30 40 50 60 70 0 70 130 180 220 250 270 280 MRP =TR/L MPP=Q/L TR=PQ MR =TR/Q MRP= MR•MPP --0 ----7 700 10 70 6 1300 10 60 5 1800 10 50 4 2200 10 40 3 2500 10 30 2 2700 10 20 1 2800 10 10
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Slide #29.

Focusing on the first and last columns of the previous table, we have the MRP schedule. L 0 10 20 30 40 50 60 70 MRP --70 60 50 40 30 20 10
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Slide #30.

Plotting points we have a graph of the MRP curve. MRP 70 60 50 40 30 20 10 0 MRP 10 20 30 40 50 60 70 labor
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Slide #31.

Suppose we want to maximize our profits. How much input we should use? MRP > MRC MRP < MRC MRP = MRC employ more input cut back employment profit-maximizing employment level
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Slide #32.

profit-maximizing condition for input usage: MRP = MRC
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Slide #33.

The Perfectly Competitive Labor Market Firm Each time a firm hires another unit of labor, its cost increases by the price of the labor (W). So for a firm in a perfectly competitive labor market, MRC = W . (If a firm is not in a perfectly competitive labor market, this isn’t true.) Also, remember that the supply curve of labor for a firm that is perfectly competitive in the labor market is a horizontal line at the going wage W. Recall that for a firm that hires all workers at the same wage, ARC = W. So for a firm that is perfectly W competitive in the labor SL = MRC = ARC market, MRC, ARC, and SL are all the same horizontal L line at the wage W.
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Slide #34.

Suppose the firm in the example we considered earlier is also perfectly competitive in the labor market. So the MRC is the same as the price of labor or the market wage. Let’s see what the demand curve for labor is for this firm. Let’s first assume that other inputs are fixed. What we need to know is how many workers will be hired at various wage levels.
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Slide #35.

Remember: You hire workers as long as they add at least as much to revenues as they add to cost. L 0 10 20 30 40 50 60 70 MRP --70 60 50 40 30 20 10 Suppose the market wage is $70. workers will you hire? 10 Suppose the market wage is $60. workers will you hire? 20 Suppose the market wage is $50. workers will you hire? 30 Suppose the market wage is $40. workers will you hire? 40 How many How many How many How many
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Slide #36.

Remember we have been trying to determine what the demand curve for labor looks like for this firm. All of our demand curve points have been points on the MRP curve. The demand curve for labor by the firm is just (the downward sloping part of) the MRP curve.
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Slide #37.

A Firm’s Demand Curve for Labor $ 70 60 50 40 30 20 10 0 demand curve for labor 10 20 30 40 50 60 70 labor
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Slide #38.

In the last few slides, we were assuming that inputs other than labor were fixed. Suppose now that all inputs are variable; we are in a long run situation. When the wage decreases, firms will adjust their usage of other inputs, such as capital. When the wage dropped, the cost of production fell. So the firm would probably produce more and would therefore need more capital. However, they may use less capital, substituting the now less expensive labor input. So, when the price of an input drops, the amount used of other inputs may increase, decrease, or remain the same.
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Slide #39.

Suppose that when the wage falls from W 1 to W2, the amount of capital used increases from K1 to K2. When labor has more capital with which to work, labor is more productive. So the MRPL is greater. Therefore, the demand curve is derived from parts of different MRP Ls. When capital can not be changed, the quantity of labor demanded (in response to the wage drop) only increases from L 1 to L’. When capital can be changed, the quantity of labor demanded increases to L 2. $ W1 W2 DL MRPL2 (amt of capital is K2) MRPL1 (amt of capital is K1) L1 L’ L2 labor
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Slide #40.

Substitution & Output Effects of a change in wage Suppose that at the initial wage, the firm is operating at point A, the tangency of isocost 1 and isoquant 1. The slope of an isocost is –PL / PK = -W / PK , so when the wage falls, the isocosts become flatter. Capital expansion path Isocost 1 C A Isoquant 2 Isocost 2a B Isocost 2b Isoquant 1 Labor The firm moves to point B, the tangency of isoquant1 with the flatter isocost2a, substituting away from capital and toward labor. Then since production has become less costly, the firm moves out to point C. It has moved out along the expansion path to the tangency between isoquant2 and isocost2b (which is parallel to isocost2a).
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Slide #41.

Substitution & Output Effects of a change in wage The movement from A to B represents the substitution effect. The firm uses more labor and less capital, since labor has become relatively cheaper. The movement from B to C is Capital expansion path Isocost 1 C A Isoquant 2 Isocost 2a B Isocost 2b Isoquant 1 Labor the output effect. The firm uses more labor and more capital, at C than at B, since it has expanded production in response to the drop in the cost of production. The combined effect is to use more labor in response to the wage drop. In this particular graph, the combined effect on capital is to use slightly more capital. (C is higher than A.)
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Slide #42.

However, in response to a drop in the wage, the amount of capital used may Capital expansion path Isocost 1 C A Isoquant 2 Isocost 2a B Isocost 2b Isoquant 1 Labor increase if the output effect is larger than the substitution effect, decrease if the output effect is smaller than the substitution effect, or remain the same if the output effect is the same size as the substitution effect.
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Slide #43.

A perfectly competitive industry’s demand for labor Let’s start with the DL and a wage of W1. (Suppose the price of the product is 100.) When the wage (or price of an input) falls, firms increase production. The increase in industry supply drives down the price of the product (perhaps to 80). This reduces VMPL = P·MPPL which is also DL = MRPL = MR·MPPL. So the DL decreases or shifts leftward. So instead of just adding up the individual firms’ D Ls, the industry demand curve for labor consists of points from different ΣDLs. wage wage The Firm The Industry DL W1 W1 ΣDL1 (P = 100) DL1 (P = 100) W2 W2 ΣDL2 (P = 80) DL2 (P = 80) L1 L2 labor L1 L2 labor
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Slide #44.

4 major determinants of an industry’s elasticity of demand for labor with respect to its wage 1. Price elasticity of demand for the product. 2. Ease of substitution of one input for another in the production process. 3. Elasticity of supply of other inputs. 4. The amount of time allowed for adjustment to the change in wage.
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Slide #45.

1. Price elasticity of demand for the product. Suppose the wage increases. That will drive up the price of the product. If the demand for the product is very responsive (or elastic) to price increases, the quantity demanded of the product will decrease considerably. The quantity demanded of labor will therefore also decrease considerably. So the more elastic the demand for the product is with respect to its price, the more elastic the demand for labor will be with respect to its wage.
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Slide #46.

2. Ease of substitution of one input for another in the production process. Again suppose the wage increases. If it is easy to substitute another input for the labor whose wage has increased, firms will reduce considerably the quantity of labor whose wage has gone up. So the easier substitution is, the greater the elasticity of demand for labor with respect to its wage will be.
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Slide #47.

3. Elasticity of supply of other inputs. Again suppose the wage increases. Suppose also that the supply of other inputs is very responsive (elastic) to the prices of those inputs. Then when firms start looking for alternative inputs to substitute for the labor that has become more expensive, it won’t take a very large increase in the price of the alternative inputs to bring about a large increase in the supply of those inputs. So it will not be very costly to switch to other inputs and the firms will be able to cut back on the labor quite a bit. So the greater the elasticity of supply of alternative inputs, the greater the elasticity of demand for labor.
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Slide #48.

4. The amount of time allowed for adjustment to the change in wage. One more time, suppose the wage increases. When firms have more time to adjust to the change, more options may become available. For example, new machines may be developed to do the work that the now more expensive labor is doing. So firms will be able to cut back more on their labor usage. So the more time allowed for adjustment, the greater the elasticity of demand for labor.
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Slide #49.

Market demand for labor (accountants, for example) To determine the demand curve for accountants, we just horizontally sum the various industry demand curves for all the industries that hire accountants.
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Slide #50.

The shape of the supply curve of an input depends on the specific case. The supply curve to one industry will be flatter (more elastic) than the supply curve to the economy as a whole. The smaller the share of the total market accounted for by a particular industry, the more elastic its input supply curve. The supply curve to an individual firm in a perfectly competitive input market will be horizontal (perfectly elastic).
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Slide #51.

Suppose a firm is perfectly competitive in both its product market and its input market. Then the firm will take the going wage as given and face a horizontal supply curve at that wage. wage wage The Firm SL W* The Industry SL W* DL DL L* labor L* labor
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Slide #52.

Suppose there are many industries that employ a particular type of input, engineers for example. Then the wage of engineers will tend to be the same across industries. Why? If the engineers in industry A were paid more than the engineers in industry B, engineers would move from B to A. As a result of the reduction in the supply of engineers in industry B, the wage would increase there. As a result of the increase in the supply of engineers in industry A, the wage would fall there. Engineers would continue to move until the wages were the same in the two industries.
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Slide #53.

Input Price Determination in a Multi-Industry Input Market Industry A wage Industry B SLA Total Labor Market wage wage SLT SLB W* W* W* DLB DLA LA* labor LB* labor DLT LT* While the amount of labor hired by different industries may be very different, the wages paid will tend to be the same. labor
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Slide #54.

What happens if there is an increase in demand for the product of one of the industries? Industry A wage Industry B S’LA Total Labor Market wage wage SLT SLB W’ W* SLA W’ W* W’ W* D’LT D’LB DLA DLT DLB LA’ LA* labor LB* LB’ labor LT* LT’ labor The demand for labor in industry B will increase, raising the wage in industry B. Labor will move from A to B in response to the higher wages. As the supply of labor in A drops, the wage in A rises, until the wages are once again equal in the two industries.
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Slide #55.

Monopsony An input market in which a single firm is the only purchaser of the input
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Slide #56.

In monopsony, the supply curve of labor to the firm is the same as the market labor supply curve. So the monopsonist faces an upward sloping labor supply curve SL. The SL curve tells the wage the firm must pay to get a specific amount of labor. wage MRCL = MCL As we found earlier, the wage is the same as the ACL, if the firm pays all workers the same wage. So the SL curve is the same as the ACL curve. SL = ACL Recall that when an average curve is sloping upward the marginal must be above it. So since the SL = ACL slopes upward, the MRCL or MCL must lie above the Labor ACL.
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Slide #57.

Monopsony employment and wage level To determine the profitmaximizing input level, the firm equates MRPL to MRCL. The wage that is paid for that amount of labor, however, is determined by the SL curve. wage MRCL = MCL SL = ACL W* DL = MRPL L* Labor
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Slide #58.

Other firms that are not perfect competitors in the input market (oligopsonists and monopsonistic competitors) face similar input curves to monopsonists. Their SL curves, however, are not the same as the labor market supply curve and are likely to be more elastic. wage MRCL = MCL SL = ACL W* DL = MRPL L* Labor
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Slide #59.

Impact of Minimum Wage Law: Perfectly Competitive Labor Market Case When there is no minimum wage law, the equilibrium wage and employment level are W* and L*. When a minimum wage above the equilibrium wage is imposed, the quantity of labor demanded is lower (Ld) and the quantity supplied of labor is higher (Ls). The Ls – Ld is the difference between the number of people who want to work at that wage and the number of jobs available. wage SL Wm W* DL Ld L* Ls Labor
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Slide #60.

Impact of Minimum Wage Law: Monopsony Case Without the minimum wage law the monopsonist paid W* and hired L* workers. Now suppose the minimum wage Wm is set at the intersection of SL and DL. The new SL curve is a horizontal line at Wm up to the intersection of SL and DL. At that point the SL becomes the same as the old one. The new MCL curve is the three part curve shown. When the firm equates MRPL and MRCL, it hires more workers (L ) at the new higher wage. MRCL = MCL wage SL Wm DL = MRPL W* L* Lm Labor
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Slide #61.

A strong union operating with a monopsonistic employer can have a similar effect. MRCL = MCL wage SL Recall that a freely operating monopsonist would pay W* and hire L* workers. If the union is able to negotiate a wage of W1, it will raise employment (to L1) along with the wage. W1 DL = MRPL W* L* L1 Labor
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Slide #62.

If the wage was increased to W2, employment would be the same as with a freely operating monopsonist (L*=L2) but the wage would be much higher. MRCL = MCL wage SL W2 W1 DL = MRPL W* L*=L2 L1 Labor
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Slide #63.

If the wage was increased to W3, employment would be less than with a freely operating monopsonist (L*) but the wage would be much higher. MRCL = MCL wage SL W3 DL = MRPL W* L3 L* Labor
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Slide #64.

So what is the effect of a minimum wage law on the employment level in a monopsonistic labor market? Depending on how high the minimum wage is set, the new employment level could be higher, lower, or the same as the employment level without the minimum wage law.
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Slide #65.

Example: Consider a firm that is perfectly competitive in the product market, where the going price of the product is $2. The firm is not perfectly competitive in the labor market. Labor Output wage 0 0 --- 10 180 12 20 350 14 30 510 16 40 660 18 50 800 20 60 930 22 70 1050 24 80 1160 26
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Slide #66.

Determine the MPPL for the given employment levels. Recall: MPPL = Q/L Example: For the first 10 workers, MPPL = (180-0)/(10-0) = 18 Labor Output wage MPPL 0 0 --- 10 180 12 20 350 14 30 510 16 40 660 18 50 800 20 60 930 22 70 1050 24 80 1160 26
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Slide #67.

Determine the MPPL for the given employment levels. Recall: MPPL = Q/L Example: For the first 10 workers, MPPL = (180-0)/(10-0) = 18 Labor Output wage MPPL 0 0 --- --- 10 180 12 18 20 350 14 17 30 510 16 16 40 660 18 15 50 800 20 14 60 930 22 13 70 1050 24 12 80 1160 26 11
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Slide #68.

Determine the total cost of labor for the given employment levels. Recall: TCL = W•L Example: For 10 workers, TCL = W•L = (12)(10) = 120 Labor Output wage MPPL 0 0 --- --- 10 180 12 18 20 350 14 17 30 510 16 16 40 660 18 15 50 800 20 14 60 930 22 13 70 1050 24 12 80 1160 26 11 TCL
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Slide #69.

Determine the total cost of labor for the given employment levels. Recall: TCL = W•L Example: For 10 workers, TCL = W•L = (12)(10) = 120 Labor Output wage MPPL TCL 0 0 --- --- 0 10 180 12 18 120 20 350 14 17 280 30 510 16 16 480 40 660 18 15 720 50 800 20 14 1000 60 930 22 13 1320 70 1050 24 12 1680 80 1160 26 11 2080
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Slide #70.

Determine the MRCL or MCL for the given employment levels. Recall: MRCL = TCL/L Example: For the first 10 workers, MRCL = (120-0)/(10-0) = 12 Labor Output wage MPPL TCL 0 0 --- --- 0 10 180 12 18 120 20 350 14 17 280 30 510 16 16 480 40 660 18 15 720 50 800 20 14 1000 60 930 22 13 1320 70 1050 24 12 1680 80 1160 26 11 2080 MRCL or MCL
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Slide #71.

Determine the MRCL or MCL for the given employment levels. Recall: MRCL = TCL/L Example: For the first 10 workers, MRCL = (120-0)/(10-0) = 12 Labor Output wage MPPL TCL MRCL or MCL 0 0 --- --- 0 --- 10 180 12 18 120 12 20 350 14 17 280 16 30 510 16 16 480 20 40 660 18 15 720 24 50 800 20 14 1000 28 60 930 22 13 1320 32 70 1050 24 12 1680 36 80 1160 26 11 2080 40
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Slide #72.

Determine the MRPL for the given employment levels. Recall: MRPL = TR/L = MR•MPPL = P•MPPL (since the firm is perfectly competitive in the product market). Also remember the price of the product is $2. Example: For the first 10 workers, MRPL = (2)(18) = 36 Labor Output wage MPPL TCL MRCL MRPL or MCL 0 0 --- --- 0 --- 10 180 12 18 120 12 20 350 14 17 280 16 30 510 16 16 480 20 40 660 18 15 720 24 50 800 20 14 1000 28 60 930 22 13 1320 32 70 1050 24 12 1680 36 80 1160 26 11 2080 40
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Slide #73.

Determine the MRPL for the given employment levels. Recall: MRPL = TR/L = MR•MPPL = P•MPPL (since the firm is perfectly competitive in the product market). Also remember the price of the product is $2. Example: For the first 10 workers, MRPL = (2)(18) = 36 Labor Output wage MPPL TCL MRCL MRPL or MCL 0 0 --- --- 0 --- --- 10 180 12 18 120 12 36 20 350 14 17 280 16 34 30 510 16 16 480 20 32 40 660 18 15 720 24 30 50 800 20 14 1000 28 28 60 930 22 13 1320 32 26 70 1050 24 12 1680 36 24 80 1160 26 11 2080 40 22
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Slide #74.

What are the profit-maximizing wage and employment level? Recall the -max employment condition is MRPL = MRCL. So 50 workers will be hired at a wage of 20. Labor Output wage MPPL TCL MRCL MRPL or MCL 0 0 --- --- 0 --- --- 10 180 12 18 120 12 36 20 350 14 17 280 16 34 30 510 16 16 480 20 32 40 660 18 15 720 24 30 50 800 20 14 1000 28 28 60 930 22 13 1320 32 26 70 1050 24 12 1680 36 24 80 1160 26 11 2080 40 22
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Slide #75.

Next, suppose a minimum wage of $24 is imposed. Indicate the wage for the given employment levels. Labor Output wage MPPL TCL MRCL MRPL or MCL 0 0 --- --- 0 --- --- 10 180 12 18 120 12 36 20 350 14 17 280 16 34 30 510 16 16 480 20 32 40 660 18 15 720 24 30 50 800 20 14 1000 28 28 60 930 22 13 1320 32 26 70 1050 24 12 1680 36 24 80 1160 26 11 2080 40 22 Wage (with min wage=24)
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Slide #76.

Next, suppose a minimum wage of $24 is imposed. Indicate the wage for the given employment levels. Labor Output wage MPPL TCL MRCL MRPL or MCL Wage (with min wage=24) 0 0 --- --- 0 --- --- 24 10 180 12 18 120 12 36 24 20 350 14 17 280 16 34 24 30 510 16 16 480 20 32 24 40 660 18 15 720 24 30 24 50 800 20 14 1000 28 28 24 60 930 22 13 1320 32 26 24 70 1050 24 12 1680 36 24 24 80 1160 26 11 2080 40 22 26
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Slide #77.

Determine the total cost of labor for the given employment levels, under the minimum wage of $24. TCL is still equal to W•L. Example: For the first 10 workers, TCL = 24•10 = 240 Labor Output wage MPPL TCL MRCL MRPL or MCL TCL Wage (with min (with min wage=24) wage=24) 0 0 --- --- 0 --- --- 24 10 180 12 18 120 12 36 24 20 350 14 17 280 16 34 24 30 510 16 16 480 20 32 24 40 660 18 15 720 24 30 24 50 800 20 14 1000 28 28 24 60 930 22 13 1320 32 26 24 70 1050 24 12 1680 36 24 24 80 1160 26 11 2080 40 22 26
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Slide #78.

Determine the total cost of labor for the given employment levels, under the minimum wage of $24. TCL is still equal to W•L. Example: For the first 10 workers, TCL = 24•10 = 240 Labor Output wage MPPL TCL MRCL MRPL or MCL TCL Wage (with min (with min wage=24) wage=24) 0 0 --- --- 0 --- --- 24 --- 10 180 12 18 120 12 36 24 240 20 350 14 17 280 16 34 24 480 30 510 16 16 480 20 32 24 720 40 660 18 15 720 24 30 24 960 50 800 20 14 1000 28 28 24 1200 60 930 22 13 1320 32 26 24 1440 70 1050 24 12 1680 36 24 24 1680 80 1160 26 11 2080 40 22 26 2080
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Slide #79.

Determine the MRCL under the minimum wage of $24. MRCL is still equal to TCL/L. Example: For the first 10 workers, MRCL = (240-0)/(10-0) = 24 Labor Output wage MPPL TCL MRCL MRPL or MCL TCL Wage (with min (with min wage=24) wage=24) 0 0 --- --- 0 --- --- 24 --- 10 180 12 18 120 12 36 24 240 20 350 14 17 280 16 34 24 480 30 510 16 16 480 20 32 24 720 40 660 18 15 720 24 30 24 960 50 800 20 14 1000 28 28 24 1200 60 930 22 13 1320 32 26 24 1440 70 1050 24 12 1680 36 24 24 1680 80 1160 26 11 2080 40 22 26 2080 MRCL (with min wage=24)
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Slide #80.

Determine the MRCL under the minimum wage of $24. MRCL is still equal to TCL/L. Example: For the first 10 workers, MRCL = (240-0)/(10-0) = 24 Labor Output wage MPPL TCL MRCL MRPL or MCL TCL Wage (with min (with min wage=24) wage=24) MRCL (with min wage=24) 0 0 --- --- 0 --- --- 24 --- 24 10 180 12 18 120 12 36 24 240 24 20 350 14 17 280 16 34 24 480 24 30 510 16 16 480 20 32 24 720 24 40 660 18 15 720 24 30 24 960 24 50 800 20 14 1000 28 28 24 1200 24 60 930 22 13 1320 32 26 24 1440 24 70 1050 24 12 1680 36 24 24 1680 24 80 1160 26 11 2080 40 22 26 2080 40
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Slide #81.

What are the -max. wage and employment level under the minimum wage law? Recall the -max employment condition is still MRPL = MRCL. So 70 workers will be hired at a wage of 24. Notice that there is more employment at a higher wage than before, when 50 workers were hired at a wage of 20. Labor Output wage MPPL TCL MRCL MRPL or MCL TCL Wage (with min (with min wage=24) wage=24) MRCL (with min wage=24) 0 0 --- --- 0 --- --- 24 --- 24 10 180 12 18 120 12 36 24 240 24 20 350 14 17 280 16 34 24 480 24 30 510 16 16 480 20 32 24 720 24 40 660 18 15 720 24 30 24 960 24 50 800 20 14 1000 28 28 24 1200 24 60 930 22 13 1320 32 26 24 1440 24 70 1050 24 12 1680 36 24 24 1680 24 80 1160 26 11 2080 40 22 26 2080 40
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Slide #82.

Another Monopsony Example Suppose that for a monopsonistic labor market, the equation of the supply curve of labor or average cost of labor is ACL = W = 160 + 3L, where L is the amount of labor used per day and W is the wage per day. Suppose the marginal revenue product of labor is MRPL = 240 – 2L.
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Slide #83.

Graph the supply of labor or ACL = W = 160 + 3L curve and the MRPL = 240 – 2L curve. $ 240 SL = ACL MRPL 160 Labor
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Slide #84.

Determine the intersection of ACL = W = 160 + 3L and MRPL= 240 – 2L. ACL = MRPL 160 + 3L = 240 – 2L 5L = 80 wage SL = ACL 240 L = 16 Then ACL = W = 160 + 3L = 160 + 3(16) = 208 or MRPL = 240 – 2L = 240 – 2(16) = 208 208 160 MRPL 16 Labor
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Slide #85.

Given our average cost of labor equation ACL = W = 160 + 3L, determine the equations for the total cost of labor TCL and the marginal cost of labor MCL (or marginal resource cost of labor). TCL = ACL(L) = (160 + 3L) L = 160L + 3L2. MCL = dTCL/dL = 160 + 6L.
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Slide #86.

Graph the MCL = 160 + 6L curve. wage MRCL = MCL 240 SL = ACL 208 160 MRPL 16 Labor
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Slide #87.

Determine the profit-maximizing employment level and the profit-maximizing wage level. We knew MRPL = 240 – 2L and we found MCL = 160 + 6L. For profit-maximization, MRPL = MCL. So 240 – 2L = 160 + 6L 80 = 8L 10 = L MCL = 160 + 6L = 160 + 6(10) = 220 Given SL, we have W = 160 + 3L = 160 + 3(10) = 190. wage MRCL = MCL 240 SL = ACL 220 208 190 160 MRPL 10 16 Labor
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Slide #88.

If a minimum wage of $208 per day were imposed, what would the new employment level be? At that minimum wage, the new supply curve is the purple line. The new MCL curve is the gray line. wage MRCL = MCL 240 SL = ACL 220 Equating MRPL to MCL, we find L = 16. 208 At that employment level, the new supply curve shows that the wage is 208. 160 190 MRPL 10 16 Labor
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Slide #89.

If a minimum wage of $220 per day were imposed, what would the new employment level be? At that minimum wage, the new supply curve is the purple line. The new MCL curve is the gray line. MRCL = MCL wage 240 SL = ACL 220 Equating MRPL to MCL, we find L = 10. 208 At that employment level, the new supply curve shows that the wage is 220. 160 190 MRPL 10 16 Labor
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Slide #90.

Individuals’ Labor Supply Decisions When individuals decide to work more hours in the labor market, they are trading non-labor time for money to buy goods.
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Slide #91.

An individual’s non-market time is generally believed to be a normal good. That is, when you have more money, you want to purchase more of all normal goods, including your own time.
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Slide #92.

When wages increase, the response of individuals involves income and substitution effects. The income effect is the response to having more income to spend. The substitution effect is the response to changes in relative prices.
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Slide #93.

The Income Effect of a Wage Increase When the wage increases, the individual earns more money. He/she therefore feels richer and consumes more of all normal goods, including his/her own time. He/she therefore works less as a result of the income effect.
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Slide #94.

The Substitution Effect of a Wage Increase When the wage increases, the price of one’s non-labor time increases relative to the price of other goods. The individual, therefore, consumes less nonlabor time and more of other goods. He/she therefore works more as a result of the substitution effect.
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Slide #95.

So for a wage increase, the income effect is to work less, and the substitution effect is to work more. If the substitution effect is greater than the income effect, the individual will work more when his/her wage increases. If the income effect is greater than the substitution effect, the individual will work less when his/her wage increases.
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Slide #96.

At lower wage levels, the substitution effect is usually larger than the income effect, but there may be a level at which the income effect dominates. As the wage increases wage fromW1 to W2, hours S worked per week increases W from L1 to L2. W However, when the wage increases from W2 to W3, W hours worked per week decrease from L2 to L3. As a result, an individual’s L L L hours worked per week labor supply curve bends backward. L 3 2 1 1 3 2
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Slide #97.

To determine the market supply curve, we need only horizontally sum the individual labor supply curves. Theoretically, the market supply curve could slope upward, downward, or a combination of both. Empirical evidence suggests that it slopes upward.
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Slide #98.

Why do wages differ? 1. Differences in human capital investment. People who have invested more in education and training tend to earn more. 2. Differences in ability. Some people have inherited greater abilities. 3. Compensating wage differentials. Less pleasant or more dangerous jobs pay more. 4. Discrimination. People may earn less because of characteristics unrelated to their productivity. They may be discriminated against on the basis of their gender, race, ethnicity, disability, religion, sexual orientation, etc.
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Slide #99.

Borrowing, Lending, and the Interest Rate
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Slide #100.

Interest rate • The price paid by borrowers for the use of funds • The rate of return earned by capital as an input in the production process
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Slide #101.

The rate of return earned by capital is the interest rate that equates the present value of the cost and the present value of the returns for the investment in the capital. For example, suppose the cost (C) of an investment is incurred now and the returns (R1, R2, and R3) are received over the next three years. Then the present value of the returns is R1 / (1 + i)1 + R2 / (1 +i)2 + R3 / (1 + i)3 Since the cost is incurred now, its present value is just the amount of that cost C. So, the rate of return earned by the capital is the value of i such that C = R1 / (1 + i)1 + R2 / (1 +i)2 + R3 / (1 + i)3
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Slide #102.

Investment and the Marginal Productivity of Capital Gross marginal productivity – the total addition to productivity that capital investment contributes Net marginal productivity – the total addition to productivity that capital investment contributes, less the cost of capital
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Slide #103.

Example: If Robinson Crusoe fishes by hand, he can catch 20 fish each week. If he takes a week off to make a net, he can then catch 25 fish a week with the net until it wears out in 10 weeks. In order to avoid starving during the week that he is weaving the net, he can borrow 10 fish from Friday, on the condition that he pays back the 10 fish plus an extra 5 fish. The cost of the net is the 20 fish that he gave up by not fishing for a week plus the 5 extra fish paid to Friday, or 25 fish. The gross marginal productivity of the net (the total addition to productivity that it contributes) is (5 fish per week)•(10 weeks) = 50 fish. The net marginal productivity of the net (the total addition to productivity that it contributes, less its cost) is (50 fish) – (25 fish) = 25 fish.
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Slide #104.

Recall that the law of diminishing marginal returns implies that each additional dollar of capital adds less to total output. So, as the quantity of investment increases, the rate of return r on the investment decreases. A firm will only be willing to pay an interest rate i to borrow money to make an investment if the interest rate is less than the rate of return on the investment (i < r). So, the quantity demanded of funds for investment is inversely related to the interest rate and the curve representing the demand for investment slopes downward. Demand for Investment Curve interest rate i2 i1 DI I2 I1 investment
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Slide #105.

Why does the rate of return on capital investment tend to equal the interest rate for borrowed funds? Suppose that the rate of return on capital investment was greater than the interest rate for borrowed funds. Then investors would benefit by borrowing funds and investing in capital. So the level of investment will increase, and as it does the rate of return declines (due to diminishing marginal returns). Investment will increase until the rate of return on capital investment is equal to the interest rate for borrowed funds. Similarly, if the rate of return on capital investment was less than the interest rate for borrowed funds, investors would be losing money by making capital investments. Investment will be cut back until the rate of return on capital investment again equals the interest rate for borrowed funds.
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Slide #106.

There is a tendency for capital to be allocated across firms and industries so that the rate of return is equal. Why? If the rate of return is higher in one particular industry, owners of capital will move to that industry. That will cause output in that industry to expand and price to fall until the industry earns a normal profit and the rate of return is the same as in other industries. Similarly, if the rate of return is lower in one particular industry, owners of capital will leave that industry. Output will fall and price will rise until the industry earns a normal profit and the rate of return is the same as in other industries.
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Slide #107.

When we add the demand for investment funds and the demand for funds for consumption, we get the demand for loanable funds. We combine this with the supply of loanable funds interest to get the market for rate loanable funds. S As usual, the equilibrium interest rate and i* equilibrium quantity of loanable funds occurs at D the intersection of the supply and demand Q* loanable funds curves.
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Slide #108.

Why do Interest Rates Differ? • • • • Difference in risk Differences in the duration of the loan Differences in costs of processing Differences in tax treatment
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