Day 12 Review: Micro

Factor Market (Short Run & Long Run)

MRP=MRC

Perfectly Competitive Factor Market (Labor)

Imperfectly Competitive Factor Market (Labor)

Monopsony

Derived Demand

Long Run: Least-Cost Rule

Factor Demand

• The factors of production are
• Land
• Labor
• Capital
• Entrepreneurship
• Producers demand the factors of production in order to supply goods and services in the product market.
• In order to understand factor demand we will focus on the demand for labor.

Rules to Remember

• Profit Maximizing
• Marginal Benefit = Marginal Cost (MB=MC)
• Marginal Revenue = Marginal Cost (MR=MC)

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• New:
• Marginal Revenue Product = Marginal Resource Cost
• (MRP = MRC)

The Perfectly Competitive Firm’s Market for Labor

• Marginal Revenue Product (MRP)

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• MRP = ^{∆ Total Revenue} / _{∆ Input}

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• MRP = MR*MP_L=P * MP_L

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• MRP = Demand for Labor

• Marginal Resource Cost (MRC)

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• MRC = ^{∆ Total Resource Cost} / _{∆ Input}

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• MRC = Wage

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• MRC = Supply of Labor to a competitive firm

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MRP=MRC

• To maximize profit, a firm should hire additional units of a specific resource as long as each successive unit adds more to the firm's total revenue than it adds to total cost, up to the point where the marginal revenue product is equal to the marginal resource cost (wage rate for labor).

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• WHY?

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• Simple: If hiring one more unit of labor only costs me $10/hour (the market wage rate), yet that worker generates $15/hour of revenue, then I SHOULD HIRE HIM/HER!

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• However: If hiring one more unit of labor costs me $10/hour, yet that worker generates only $7/hour of revenue, clearly, I would be losing money if I hire him/her.

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• SO: I should hire workers up to the point where the MRC (the cost of hiring the last worker) = MRP (the additional revenue the last worker generates).

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Short Run & Long Run

• Short Run: at least one variable is fixed (capital).
• Law of Diminishing Returns.
• Profit Maximizing: MRP=MRC
• Long Run: all inputs are variable.
• Capital
• Labor
• Least-Cost for a certain output (think budget and marginal utility for a maximizing consumer).
• Profit Maximizing: MRP=MRC=1

The Perfectly Competitive Firm’s Market for Labor (Draw)

Price of Labor

Quantity of Labor

MRC = Wage = Supply of Labor

MRP_L= Demand for Labor

Q

w

Determinants of Resource Demand

• Product Demand (creates Derived Demand)
• Productivity of Labor
• Access to physical capital (natural resources)
• Increased technology (machines)
• Improvements in human capital (training and education)
• Price of other resources
• Substitute Resource
• Substitution effect (Capital (machines) vs. Labor)
• Output effect (lower costs = increase in output = more demand for resources)
• Complementary resources (capital and labor working together. Ex, computers P↓, output effect, D workers↑).

Determinants of Resource Demand:�

• Changes in product demand creates Derived Demand will shift the demand for the resources that produce it (in the same direction).

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• Changes in Productivity: If a resource becomes more productive, demand for it will increase (shift in the same direction).

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• Factors that could increase productivity:
• ·Quantities of other resources: give a worker more tools, the worker will become more productive
• ·Technological advance: give a worker better technology, the worker will become more productive
• ·Quality of variable resource: give the workers better education and skills, the workers will become more productive

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• Explains why average wages are higher in industrially advanced nations. Strong Demand: Workers are better educated and trained, work with larger amounts of capital goods (machines and natural resources).
• Supply: scarce supply for the best educated and trained = higher wages.
• Developing nations: more unskilled workers and not as much capital = lower wages.

Labor Market (Draw)

Price of Labor

Quantity of Labor

Supply of Labor

Q

w

Demand for Labor

Change in Resource Demand (Draw)

Price of Labor

Quantity of Labor

MRC

MRP_L

Q

w

Assume the price (P) of a competitive firm’s product increases. Because MRP_L = P * MP_L .: MRP_L will increase… P↑ .: MRP_L↑ .: Quantity of labor employed ↑

→

MRP_L1

Q₁

Perfectly Competitive Labor Market diagram (Draw): �

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·Supply of labor is upward sloping since at higher wages households supply more labor.

·Demand is downward sloping because at lower wages, firms want to employ more labor.

• ·Supply as seen by the individual firm is perfectly elastic at the equilibrium wage rate. The firm is a "wage-taker", meaning it can employ as few or as many workers it wants at the market wage rate.
• ·The profit maximizing firm will employ workers up the point at which the MRP=the MRC (up to Q_ef)

Perfect Comp.

Imperfect Comp.

Imperfect Competition in the Product Market (Monopoly)�(DRAW)

• For a monopolist in the product market MR<P, so in the factor market MRP_M < MRP_C

Price of Labor

Quantity of Labor

MRC

MRP_C

Q_C

w

MRP_M

Q_M

PC: MRP (demand) curve is downward sloping due to the Law of Diminishing Returns.

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Imperfect: Law of Diminishing Returns and Price falls as output increases.

Imperfect competition results in less output than PC, thus fewer inputs (like labor).

Imperfect Competition in the Factor Market (Monopsony)

• Unlike a monopoly, which is the sole producer of a good or service, a monopsonist is the sole consumer of a good or service. In the factor market this leads to a condition where the MRC > Wage.
• Wage Union?

Price of Labor

Quantity of Labor

Supply of Labor

Q_c

w_c

MRP

MRC

Q_m

w_m

LONG RUN:�Optimal Combination of Resources�

• Two questions are considered:

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• 1.What is the least-cost combination of resources to use in producing any given output?

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• 2.What combination of resources (and output) will maximize a firm’s profits?

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Least Cost (Draw/Write)�

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Two questions are considered when firms decides how much labor and capital to employ:

1. What is the least-cost combination of resources to use in producing any given output?

2. What combination of resources (and output) will maximize a firm’s profits?

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The least-cost rule states that costs are minimized where the marginal product per dollar’s worth of each resource used is the same. PROPORTIONAL FOR A GIVEN OUPUT LEVEL.

MP of labor/labor price = MP of capital/capital price.

In the long-run, all resources are variable, not just labor! How should firms decide how much labor AND capital to employ?

Rationale: The last dollar spent on each resource yields the same marginal product.

Least-cost combination of Labor and Capital: hire L and C up until the point when...

Notes:

1. Long-run cost curves assume that each level of output is being produced with the least-cost combination of inputs.

2. The least-cost production rule is similar to Chapter 7’s Utility-Maximizing combination of goods.

Least-Cost Hiring Rule

• Given a budget constraint, what is the least costly combination of labor and capital that will generate a maximum level of output ?
• MP_L/P_L = MP_K/P_K = MP_L/MP_K = P_L/P_K

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• If MP_L/P_L > MP_K/P_K , then the firm will hire more labor and employ less capital until MP_L/P_L = MP_K/P_K

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• If MP_L/P_L < MP_K/P_K , then the firm will employ more capital and employ less labor until MP_L/P_L = MP_K/P_K

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Profit Maximizing Rule

• The profit‑maximizing rule states that in a competitive market, the price of the resource must equal its marginal revenue product. This rule determines level of employment MRP(labor) / Price(labor) = MRP(capital) / Price(capital) = 1.

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• Simply: MRC=MRP (firm input)
• Like MR=MC (firm output), or MB=MC (individual/society)

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Profit Maximizing (Draw/Write)�

The profit-maximizing rule states that in a competitive market, the price of the resource must equal its marginal revenue product. This rule determines level of employment of labor and capital:

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MRP(labor) / Price(labor) = MRP(capital) / Price(capital) = 1

Remember: MRP = MRC is the profit maximization rule for a single resource.

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·In a purely competitive resource market MRC = Price (wages, interest, rent).

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·therefore, to maximize profits in the long-run, when all resources are variable: MRP_L = P_L and MRP_C = P_C

To maximize its profits in the long-run, a firm should employ capital and labor up to the point where marginal revenue product is equal to its marginal resource cost of all resources.

A firm wishes to maximize its profits. It employs two resources, capital and labor. What should the following firm do to maximize its profits?

·The last worker the firm hired added $15 to its TR, at a wage of $5.

·The last machine the firm employed added $9 to its TR, and it cost the firm$3.

Is this the profit maximizing combination of resources??

MRP_L = 15 P_L = 5

MRP_C = 9 P_C = 3

What should this firm do to maximize profits?

The firm should hire more of both labor and capital, until MRP_L = $5 and MRP_C = $3.

·As the firm hires more workers and capital, the marginal product will decline due to diminishing returns.

·If the firm is an imperfect competitor, it will have to lower the product price as it increases output.

·Lower MP and lower Price mean MRP will fall as output increases.

Optimal Combination of Resources

Multiple Choice Answers

1.e

2.e

3.d

4.c

5.d

6.e

7.c

8.a

9.d

10.a

11.a

12.b

13.e

14.c

15.e

No #. b

16.b

17.a

18.d

19.d

20.b

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21.a

22.c

23.a

24.b

25.c

26 (on last page).b

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End Review Day 12

• Which of the above topics do you need to spend more time studying?

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• What specific steps will you take to study?

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