chapter 9. the market for factors of production 1. perfect markets supply of labour demand for...

Chapter 9Chapter 9

THE MARKET FORTHE MARKET FORFACTORS OF PRODUCTIONFACTORS OF PRODUCTION

• 1. Perfect markets

• Supply of Labour

• Demand for labour

• Distribution of Income when Markets are competitive

• Imperfect competition in factor markets

• 1. Perfect markets

• Supply of Labour

• Demand for labour

• Distribution of Income when Markets are competitive

• Imperfect competition in factor markets

The circular flow of incomes and expenditureThe circular flow of incomes and expenditure

FIRMSFIRMS(suppliers of goods and services,(suppliers of goods and services,

demanders of factor services)demanders of factor services)

HOUSEHOLDSHOUSEHOLDS(demanders of goods and (demanders of goods and

services,services,suppliers of factor services)suppliers of factor services)

P

Q

££

££ (1) Goods(1) Goods demanddemand

O

D1


P

Q

££

££

Goods

Goods

(1) Goods(1) Goods demanddemand

(2) Goods(2) Goods supplysupply

O

D1

S


P

Q

££

££

Goods

Goods



P1

O Q1

D1

S


P

Q

P

Q

££ ££

££££

Goods

Goods


(3) Factor(3) Factor demanddemand


P1

OO Q1

D1

S


D1

P

Q

P

Q

££ ££

££££

Factorservices

Goods

GoodsFactor

services


(4) Factor(4) Factor supplysupply



P1

O Q1O

D1

SS


D1

P

Q

P

Q

££ ££

££££

Factorservices

Goods

GoodsFactor

services





P1

Q1O

PF1

QF1O

D1

SS


D1

P

Q

P

Q

££ ££

££££

Factorservices

Goods

GoodsFactor

services

S S

D1 D1





P1

Q1OO

PF1

QF1

D2


P

Q

P

Q

££ ££

££££

Factorservices

Goods

GoodsFactor

services

S S

D1 D1





P1

Q1OO

P2

Q2

PF1

QF1

D2


P

Q

P

Q

££ ££

££££

Factorservices

Goods

GoodsFactor

services

S S

D1 D1





P1

Q1OO

P2

Q2

PF1

QF1

D2 D2


P

Q

P

Q

££ ££

££££

Factorservices

Goods

GoodsFactor

services

S S

D1 D1





P1

Q1OO

D2

P2

Q2

D2

PF1

QF1

PF2

QF2



• Perfectly competitive factor markets

• Everyone is a price taker, worker, firm, and suppliers of capital and land.

• Freedom of Entry and Exit

• Factors are homogeneous – Same level of skill and motivation

• Perfect Knowledge– Know the contract, conditions and alternatives

– How good is your worker

• Perfectly competitive factor markets

• Everyone is a price taker, worker, firm, and suppliers of capital and land.

• Freedom of Entry and Exit

• Factors are homogeneous – Same level of skill and motivation

• Perfect Knowledge– Know the contract, conditions and alternatives

– How good is your worker


• Perfectly Competitive Labour markets– assumptions of a perfect factor market

– determination of factor prices

• Perfectly Competitive Labour markets– assumptions of a perfect factor market

– determination of factor prices

A labour market: Whole marketA labour market: Whole market

O

Labour hours

Ho

urly

wa

ge

Sall workers

in the market

Dall firms

in the market

O

Labour hours

Ho

urly

wa

ge

Wm

Sall workers

in the market

Dall firms

in the market

A labour market: Whole marketA labour market: Whole market

A labour market: Individual employerA labour market: Individual employer

O

Labour hours

Ho

urly

wa

ge

Wm

Slabour


O

Labour hours

Ho

urly

wa

ge

Wm

Slabour

Dindividual employer

O

Labour hours

Ho

urly

wa

ge

Q1

Wm

Slabour

Dindividual employer


A labour market: Individual workerA labour market: Individual worker

O

Labour hours

Ho

urly

wa

ge

Wm

Dlabour


O

Labour hours

Ho

urly

wa

ge

Wm

Sindividual worker

Dlabour

O

Labour hours

Ho

urly

wa

ge

Q2

Wm

Sindividual worker

Dlabour


WAGE DETERMINATIONWAGE DETERMINATIONUNDER PERFECT COMPETITIONUNDER PERFECT COMPETITION

• The supply of labour

– the supply of hours by an individual worker


– the supply of hours by an individual worker

0

10

20

30

0 5 10 15 20 25 30

Un

its o

f CO

NS

UM

PT

ION

I1

Consumption Versus WorkConsumption Versus Worka

Like Consumption

Don’t like work

What are our indifference curves

shaped like?

Hours worked

0

10

20

30

0 5 10 15 20 25 30

Un

its o

f CO

NS

UM

PT

ION

I1

Consumption Versus WorkConsumption Versus Work

a

Any point to the North west is better

and any point to the South East is

worse.

C Up

Work down

C down

Work Up

Consider point a

Hours worked

0

10

20

30

0 5 10 15 20 25 30

Un

its o

f CO

NS

UM

PT

ION

I1


a

So any indifference curve must lie to the North East or

South West

BETTER

WORSE

Hours worked

0

10

20

30

0 5 10 15 20 25 30

Un

its o

f CO

NS

UM

PT

ION

I1


U0U1

U2

C Up, Work down,

U rising

Hours worked

0

10

20

30

0 5 10 15 20 25 30

Un

its o

f CO

NS

UM

PT

ION

Constraint & OptimumConstraint & Optimum

Hours worked

24 Hours work @50p

=£12

U0

U1

U2

W∙24=Cmax

Budget Constraint:

C=W∙L

24 hours

0

10

20

30

0 5 10 15 20 25 30

Un

its o

f CO

NS

UM

PT

ION

Hours worked

Suppose now wages rise

24 Hours work @$1.00p =£24

U0

U1

U2U3

The supply of hours workedThe supply of hours worked

O

Hours worked

Ho

urly

wa

ge

S

L0L1

w0

w1

Backward-bending supply curve of labourBackward-bending supply curve of labour

S

WI

Ho

urly

wa

ge

HoursO



– the supply of hours by an individual workermarginal disutility of work

the shape of the individual’s supply curve of labour

– the supply of labour to an individual employerElastic from the perspective of the employer

– the market supply of a given type of labourGenerally upward sloping


– the supply of hours by an individual workermarginal disutility of work

the shape of the individual’s supply curve of labour

– the supply of labour to an individual employerElastic from the perspective of the employer

– the market supply of a given type of labourGenerally upward sloping


• The demand for labour: marginal productivity theory

– the marginal revenue product of labour ( MRPL )

• What is the additional output a firm can get from hiring one more worker?

• How much will they get for that output





The marginal revenue product of labour ( MRPL )





dL

dQMPPorMP LL

dL

dQMRMRPL




dL

dQPMRPL

•How much will they get for that output UNDER PERFERCT COMPETTITON

dL

dQMPPorMP LL


• How much will they get for that output• How much will they get for that output

dL

dQPMRPL

How much does it cost them to hire that worker?

W

Therefore hire workers until:

LL MCWdL

dQPMRP

Marginal physical product of labour curveMarginal physical product of labour curve

O

Out

put

MPPL

Q of labour

OQ of labour

Out

put

MPPL

x

Marginal physical product of labour curveMarginal physical product of labour curve

The profit-maximising level of employmentThe profit-maximising level of employment

O

£

MRPL

x

Q of labour

O

£

MRPL

x

Wm MCL= W

Q of labour


O

£

MRPL

x

Wm MCL= W

QeQ of labour





– derivation of the firm's demand curve for labour



– derivation of the firm's demand curve for labour

Deriving the firm’s demand curve for labourDeriving the firm’s demand curve for labour

O

Q of labour

£

MRPL

W1 MCL1

Q1

a

O

Q of labour

£

W1 MCL1

Q1

MCL2W2

Q2

a

b

MRPL


O

Q of labour

£

W1 MCL1

Q1

MCL2

MCL3

W2

W3

Q2 Q3

a

b

c

MRPL


So Firm’s demand Curve is the MRPL

= LD

WAGE DETERMINATIONWAGE DETERMINATIONIN IMPERFECT MARKETSIN IMPERFECT MARKETS

• Factor market power: Monopsony

• A firm which is a monopoly purchaser of a factor

– E.g. Single Employer in a Town

– Government

• A Monopolist restricts Quantity sold to keep price up

• A Monopsonist restricts quantity purchased to keep price down!!!….WHY?

• Factor market power: Monopsony

• A firm which is a monopoly purchaser of a factor

– E.g. Single Employer in a Town

– Government

• A Monopolist restricts Quantity sold to keep price up

• A Monopsonist restricts quantity purchased to keep price down!!!….WHY?

MonopsonyMonopsony

O

Q of labour

£

MRPL

ACL W (supply curve)

O

Q of labour

£

MRPL


MCL

MonopsonyMonopsony


Firms with monopsony power in employing labour

– MCL > W (where MCL is equal to MRPL)

Under Perf. Competition, workers get their MRPL.

With a monopsony, they are being paid less…

– effects on wages and employment

Firms with monopsony power in employing labour

– MCL > W (where MCL is equal to MRPL)

Under Perf. Competition, workers get their MRPL.

With a monopsony, they are being paid less…

– effects on wages and employment

O

Q of labour

£

MRPL


Q1

MCL

MonopsonyMonopsony

O

Q of labour

£

MRPL

W1


Q1

MCL

MonopsonyMonopsony

O

Q of labour

£

MRPL

W1


Q1 Q2

W2

MCL

MonopsonyMonopsony


• Firms with monopsony power in employing labour– MCL > W– effects on wages and employment

• Monopsony implies Wages and Employment Down compared to a perfectly competitive labour market.

• Firms with monopsony power in employing labour– MCL > W– effects on wages and employment

• Monopsony implies Wages and Employment Down compared to a perfectly competitive labour market.

chapter 9. the market for factors of production 1. perfect markets supply of labour demand for...

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factor demand demand

goods demand demand

goods supply supply

supply of hours

market slide

p q p q goods

expenditure slide

expenditure d1d1 slide