CRC Microeconomics 1

04/11/23 CRC Microeconomics 2

What did you study last time?

what is meant by an oligopoly? what is meant by a duopoly? how game theory is applied to

oligopoly? how governments deal with

oligopoly?

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Do you know …

what determines your wages and salaries?

what determines the rent paid to landowners?

what determines the interest paid to capital owners?

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A. What determines your wages and salaries?

Your wages and salaries are determined in the market for your labor service.

The demand for labor The supply of labor The equilibrium in the labor market

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1. The demand for labor

The demand for labor is a derived demand.• A firm’s demand for labor (a factor of

production) is derived from its decision to supply a good in another market.

Labor is the most important factor of production, for workers receive most of the total income earned in the U.S. economy.

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1. The demand for labor

a. A derived demandb. Assumptionsc. The production function and marginal

product of labor (MPL)

d. The value of marginal product (VMP) and the demand for labor (DL)

e. Output supply (Q*) and input demand (L*)f. What causes the labor demand curve to

shift?

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a. A derived demand

The market for apples(an output market)

Q apples

The market for apple pickers(an input market)

P apples

D

S

P

Q

D

S

P

Q Q applepickers

W apple pickers

The demand for apple pickers depends on (is derived from)the supply of apples.

From To

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b. Assumptions

The firm is competitive (i.e. a price taker) in both the output market and the input market.

The firm is profit-maximizing.

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c. Production function and MPL

L

Labor

0

1

2

3

4

5

Q

Output

0

100

180

240

280

300

MPL

Marginalproduct

oflabor

?

?

?

?

?

VMPL

Valueof

marginalproduct

W

Wage

$500

M

Marginal profit

VMP-W

?

?

?

?

?

$500

$500

$500

$500

?

?

?

?

?

Replace the ?’s with correct values. Assume that P = $10.

100

80

60

40

20

$1,000

$800

$600

$400

$200

$500

$300

$100

-$100

-$300

Decision

Yes/No

?

?

?

?

?

Yes

Yes

Yes

No

No

What are the firm’s profit-maximizing output and labor input levels?

Q* = 240 at L* = 3, where VMPL >= W

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c. Production function and MPL

The production function is the relationship between the quantity of inputs used to make a good and the quantity of output of that good.

Q = f (L, l, K) where L = labor, l = land, and K = capital

In the short run: Q = f (L), l & K are fixed

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c. Production function and MPL

As the quantity of input increases, the production function gets flatter, reflecting the property of diminishing marginal product.

MPL is the increase in the amount of output from an additional unit of labor.

MPL = Q / L

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Graph

Q

L

Production function

0

The production function becomesflatter as L increases, reflecting

diminishing MPL. (MPL is the slope of the production function.)

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d. VMPL & the demand for labor DL

The value of marginal product, VMP, is the marginal product of an input times the price of the output.

VMP = MP x P For a competitive firm, the VMP is

also the firm’s demand for labor used to produce that product.

i.e. VMPL = DL.

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Graph

VMPL

L0

Market wageW

VMPL = DL

L*

Profit-maximizingquantity of L

A competitive, profit-maximizing firm hires workers up to the pointwhere VMPL = W

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e. Output supply (Q*) & input demand (L*)

A competitive firm produces its profit-maximizing Q* in the output market where:

(P = AR) = MR = MC or P = MC = TVC / Q (1) Multiplying both sides of (1) by MPL = (Q /

L)P x MPL = MC x MPL

= (TVC / Q) x (Q / L) = TVC / L = (W x L) / L

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e. Output supply (Q*) & input demand (L*)

In a competitive labor (input) market W is fixed.

So VMPL = MPL x P = TVC / L = W

Or VMPL = W (2)

P = MR = MC (in a competitive output market)

is the same as VMPL = W (in a competitive labor market)

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e. Output supply (Q*) & input demand (L*)

The profit-maximizing output Q* is determined where MR = MC.

The profit-maximizing input L* is determined where VMPL = W.

They are just two sides of the same coin.

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f. What shifts DL?

VMPL = MPL x P = DL

So VMPL = DL shifts due to changes in:• P (the output price),

• MPL (marginal product of labor), as a result of technological change, and

• the supply of other factors

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2. The supply of labor

The tradeoff between work and leisure

What causes the labor supply curve to shift?

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GraphW/hr

Hrs/day0

$300

$100

8 10 12 14

$200

$400

$550

$900

$1,000

$1,100Suppose that your wage is initially $100/hr, and you work 8 hours a day.Do you work more if your wage goes up to $200? $400? $550? $900? $1,100?

This section of the labor supply curve isupward-sloping. Workers work more

when their wages increase.

This section of the labor supply curve isbackward-bending. Workers work less

when their wages increase.

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a. The tradeoff between work and leisure

The labor supply curve reflects how workers decide about the labor-leisure tradeoff.

An increase in wages increases the opportunity cost of leisure, (i.e. leisure time becomes more expensive.)

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a. The tradeoff between work and leisure

If workers respond by enjoying:• less leisure, they work more, the

supply of labor slopes upward.• more leisure, they work less, the

supply of labor slopes downward. It is backward-bending.

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a. The tradeoff between work and leisure

For now, assume that the labor supply curve is upward sloping.

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b. What shifts SL?

SL shifts due to changes in:• tastes or attitudes toward

work/leisure,• alternative opportunities in other

labor markets, and• immigration/emigration.

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3. Equilibrium in the labor market

Key facts Equilibrium in the labor market Shifts in SL

Shifts in DL

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a. Key facts

The market wage adjusts to balance the supply of labor SL and demand for labor DL.

At equilibrium in the labor market:W = VMPL

Any event that changes SL or DL must change W and VMP by the same amount, because they must always be equal.

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b. Equilibrium in the labor market

W

QL0

We

DL

E

SL

At equilibrium workers receive the value of their marginal contribution to theproduction of G&S (VMP).

Qe

PL

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c. Shifts in SL

W

QL0

W1

DL

E1

S1

The diagram shows the original situation in a labor market.

Q1

S2

E2

Q2

W2

1. An increase in SL

2. reduces the wage ..

3. and raise employment.

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c. Shifts in DL

W

QL0

W1

D1

E1

S1

Q1

E2

Q2

W2

1. An increase in DL

2. raises the wage ..

3. and raise employment.

D2

The diagram shows the original situation in a labor market.

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B. Other factor markets

The market for land The market for capital Linkages among factors of

production

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a. The market for land

Rent

Ql0

Pe

Dl

E

Sl

Supply and demand determine the compensation paid to the owners of land.The demand for land depends on the VMP of land.

Qe

Pl

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a. The market for capital

Rent

QK0

Pe

DK

E

SK

Supply and demand determine the compensation paid to the owners of capital.The demand for capital depends on the VMP of capital.

Qe

PK

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c. Linkages among factors

Because of diminishing MP, • a factor in abundant supply has a

low MP and thus a low price.• a factor in scarce supply has a high

MP and thus a high price. When the supply of a factor falls, its equilibrium price rises.

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c. Linkages among factors

An event that changes the supply of any one factor can alter the earnings of all the factors.

The change in earnings of any factor can be found by analyzing the impact of the event on the VMP of that factor.

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Conclusion

The neoclassical theory of distribution The amount earned by a factor

depends on supply and demand. The demand for a factor depends

on its marginal productivity. In equilibrium, each factor earns

the value of its marginal product.

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Now you know …

what determines your wages and salaries.

what determines the rent paid to landowners.

what determines the interest paid to capital owners.

CRC Microeconomics 37

What will you study next?

Why do people’s earnings differ? What is discrimination?

CRC Microeconomics 38