1 of 42

Define Derived Demand
Define Marginal Revenue Product (MRP)
Define Marginal Resource Cost (MRC)

Bring Textbook to begin PS 5

1

Homework

Objectives

2 of 42

Objectives and Homework

Finish notes from yesterday

Work (mostly in class):
Read Ch 27 pp.532-546 and
Do Key Questions #2-5 on p. 548

2

3 of 42

Objectives and Homework

Finish notes from yesterday

Work (mostly in class):
Read Ch 27 pp.532-546 and
Do Key Questions #2-5 on p. 548

3

4 of 42

Define Derived Demand
Define Marginal Revenue Product (MRP)
Define Marginal Resource Cost (MRC)

Read Ch 27 pp.532-546
Problem Set #1

4

Homework

Objectives

5 of 42

Unit 5: The Resource Market

5

(aka: The Factor Market or Input Market)

6 of 42

Unit 5: The Resource Market

6

Length: 2 Weeks

Chapters: 27 and 28

Assignments: Problem Set #5

Good News:

Only two new graphs to learn
Application of things we have already learned.
Basically just Supply and Demand

7 of 42

7

Producers Supply

Households Demand

Product Market

8 of 42

8

Producers Demand

Households Supply

Resource Market

9 of 42

9

10 of 42

Perfectly Competitive Labor Market

Characteristics:

Many small firms are hiring workers

No one firm is large enough to manipulate the market.

Many workers with identical skills
Wage is constant
Workers are wage takers

Firms can hire as many workers as they want at a wage set by the industry

10

Perfect

Competition

Monopsony

Resource Markets

11 of 42

Perfectly Competitive Labor Market and Firm

S_L

D_L

?

Wage

Q

Wage

Q

5000

$10

Industry

Firm

12 of 42

Resource Demand

Example 1:

If there was a significant increase in the demand for pizza, how would this affect the demand for cheese?
Cows? Milking Machines? Veterinarians? Vet Schools? Etc.

Example 2:

An increase in the demand for cars increases the demand for…

Derived Demand-

The demand for resources is determined (derived) by the products they help produce.

12

13 of 42

Push-Up Machine

13

14 of 42

14

Mr. Clifford is the inventor of a new generator that converts human push ups into safe and clean electrical energy.
Each push up generative $1 worth of energy.
Supply and demand in the labor market has resulted in an equilibrium wage of $5

(MRC = $5).

The supply curve for the firm is perfectly elastic at $5…how much will you work for?
Assuming identical skills, hire the first worker (do push ups in a 4ft x 7ft box).

The Push-Up Machine

15 of 42

15

The additional cost of an additional resource (worker).

In perfectly competitive labor markets the MRC equals the wage set by the market and is constant.

Ex: The MRC of an unskilled worker is $8.75.

Another way to calculate MRC is:

Marginal

Resource

Cost

=

Change in

Total Cost

Change in

Inputs

Marginal Resource Cost (MRC)

16 of 42

16

The additional revenue generated by an additional worker (resource).

In perfectly competitive product markets the MRP equals the marginal product of the resource times the price of the product.

Ex: If the Marginal Product of the 3^rd worker is 5 and the price of the good is constant at $20 the MRP is…….

$100

Another way to calculate MRP is:

Marginal

Revenue

Product

=

Change in

Total Revenue

Change in

Inputs

Marginal Revenue Product

17 of 42

Calculate MP and MRP

The Push-Up Machine

Quantity Labor	Total Product	Marginal Product	MRP @ $1 Price

18 of 42

Supply

Supply and demand in the INDUSTRY GRAPH has resulted in a equilibrium wage of $5.
How much MUST each worker work for?
Why not ask for more? Why not less?

Demand

If each push up generates $1 worth of energy what is the MRP for each worker?
How much is each worker worth to the firm?

The Push-Up Machine

19 of 42

Why does the MRP eventually fall?

Diminishing Marginal Returns.
Fixed resources means each worker will eventually add less than the previous workers.

The MRP determines the demand for labor

The firm is willing and able to pay each worker up to the amount they generate.
Each worker is worth the amount of money they generate for the firm.

The Push-Up Machine

20 of 42

Graph the firm’s labor demand curve

Read Ch 27 pp.532-546
begin PS 5 #1 & 2
RQ 5-1 Friday, bring books for problem set time tomorrow

20

Homework

Objectives

21 of 42

21

22 of 42

22

Continue to hire until…

MRP = MRC

How do you know how many resources (workers) to employ?

23 of 42

Calculate MP and MRP

The Push-Up Machine

Quantity Labor	Total Product	Marginal Product	MRP @ $1 Price
0	0	-	-
1	35	35	35
2	65	30	30
3	73	8	8
4	76	3	3
5	60	-16	-16
6

MRC @ $5 Price
$5
$5
$5
$5
$5
$5
$5

24 of 42

Perfectly Competitive Labor Market and Firm

D_L

?

Wage

Q

Wage

Q

Q_E

W_E

Industry

Firm

S_L

25 of 42

S_L

D_L

Wage

Q

Wage

Q

Industry

Firm

Q_E

W_E

Q_e

D_L=MRP

S_L=MRC

Side-by-side graph showing Market and Firm

26 of 42

Industry Graph

26

27 of 42

DEMAND RE-DEFINED

What is Demand for Labor?

Demand is the different quantities of workers that businesses are willing and able to hire at different wages.

What is the Law of Demand for Labor?

There is an INVERSE relationship between wage and quantity of labor demanded.

What is Supply for Labor?

Supply is the different quantities of individuals that are willing and able to sell their labor at different wages.

What is the Law of Supply for Labor?

There is a DIRECT (or positive) relationship between wage and quantity of labor supplied.

Workers have trade-offs between work and leisure

27

28 of 42

Where do you get the Market Demand?

Q

McDonalds

Wage	Q_LDem
$12	1
$10	2
$8	3
$6	5
$4	7

Burger King

Other Firms

Wage	Q_LDem
$12	0
$10	1
$8	2
$6	3
$4	5

Wage	Q_LDem
$12	9
$10	17
$8	25
$6	42
$4	68

Wage	Q_LDem
$12	10
$10	20
$8	30
$6	50
$4	80

Market

3

P

Q

2

P

Q

25

P

Q

30

P

$8

D

29 of 42

Who demands labor?

FIRMS demand labor.
Demand for labor shows the quantities of workers that firms will hire at different wage rates.
Market Demand for Labor is the sum of each firm’s MRP.

DL

Quantity of Workers

Wage

As wage falls, Qd increases.
As wage increases, Qd falls.

29

30 of 42

Who supplies labor?

Individuals supply labor.
Supply of labor is the number of workers that are willing to work at different wage rates.
Higher wages give workers incentives to leave other industries or give up leisure activities.

Quantity of Workers

Wage

As wage increases, Qs increases.
As wage decreases, Qs decreases.

Labor Supply

30

31 of 42

Equilibrium

Wage (the price of labor) is set by the market.

EX: Supply and Demand for Carpenters

Quantity of Workers

Wage

Labor Supply

Labor Demand =

MRP

$30hr

31

32 of 42

Individual Firms

32

Wage

Q

Q_e

D_L=MRP

S_L=MRC

33 of 42

33

Example:

You hire workers to mow lawns. The wage for each worker is set at $100 a day.
Each lawn mowed earns your firm $50.
If you hire one worker, he can mow 4 lawns per day.
If you hire two workers, they can mow 5 lawns per day together.
What is the MRC for each worker?
What is the first worker’s MRP?
What is the second worker’s MRP?
How many workers will you hire?
How much are you willing to pay the first worker?
How much will you actually pay the first worker?
What must happen to the wage in the market for you to hire the second worker?

$100/day

$200

$50

1

$200

$100

It must drop to $50

34 of 42

You’re the Boss

You and your partner own a business.
Assume the you are selling the goods in a perfectly competitive PRODUCT market so the price is constant at $10.
Assume that you are hiring workers in a perfectly competitive RESOURCE market so the wage is constant at $20.
Also assume the wage is the ONLY cost.

To maximize profit how many workers should you hire?

34

35 of 42

Workers

Total

Product

(Output)

Use the following data:

0

1

2

3

4

5

6

7

0

7

17

24

27

29

30

27

*Hint*

How much is each worker worth?

Wage = $20

Price = $10

35

36 of 42

Units of

Labor

Total

Product

(Output)

Use the following data:

0

1

2

3

4

5

6

7

0

7

17

24

27

29

30

27

What is happening to Total Product?

Why does this occur?

Where are the three stages?

Wage = $20

Price = $10

36

37 of 42

Units of

Labor

Total

Product

(Output)

Use the following data:

0

1

2

3

4

5

6

7

0

7

17

24

27

29

30

27

Wage = $20

Price = $10

Marginal

Product

(MP)

-

7

10

7

3

2

1

-3

This shows the PRODUCTIVITY of each worker.

Why does productivity decrease?

37

38 of 42

Units of

Labor

Total

Product

(Output)

Use the following data:

0

1

2

3

4

5

6

7

0

7

17

24

27

29

30

27

Wage = $20

Price = $10

Marginal

Product

(MP)

-

7

10

7

3

2

1

-3

Product

Price

0

10

Price is constant because we are in a perfectly competitive market.

38

39 of 42

Units of

Labor

Total

Product

(Output)

Use the following data:

0

1

2

3

4

5

6

7

0

7

17

24

27

29

30

27

Wage = $20

Price = $10

Marginal

Product

(MP)

-

7

10

7

3

2

1

-3

Product

Price

0

10

Marginal Revenue Product

0

70

100

70

30

20

10

-30

This shows how much each worker is worth

39

40 of 42

Units of

Labor

Total

Product

(Output)

Use the following data:

0

1

2

3

4

5

6

7

0

7

17

24

27

29

30

27

Wage = $20

Price = $10

Marginal

Product

(MP)

-

7

10

7

3

2

1

-3

Product

Price

0

10

0

70

100

70

30

20

10

-30

Marginal Resource Cost

0

20

How many workers should you hire?

40

Marginal Revenue Product

41 of 42

The Connection Between Input Demand & Output Supply

Recall: marginal cost (MC)

= cost of producing an additional unit of output

= ∆TC/∆Q, where TC = total cost

Suppose W = $2500, MP_L = 500 bushels of corn
If Farmer Jack hires another worker, � ∆TC = $2500, ∆Q = 500 bushels

MC = $2500/500 = $5 per bushel

In general: MC = W/MP_L

CHAPTER 18 THE MARKETS FOR THE FACTORS OF PRODUCTION

42 of 42

In general: MC = W/MP_L
Notice:

To produce additional output, hire more labor.
As Q_L rises, MP_L falls…
causing W/MP_L to rise…
causing MC to rise.

Hence, diminishing marginal product and increasing marginal cost are two sides of the same coin.

CHAPTER 18 THE MARKETS FOR THE FACTORS OF PRODUCTION

The Connection Between Input Demand & Output Supply