Chapter 14
Markets for
Factor Inputs
Chapter 14 Slide 2
Topics to be Discussed
Competitive Factor Markets
Equilibrium in a Competitive Factor
Market
Factor Markets with Monopsony Power
Factor Markets with Monopoly Power
Chapter 14 Slide 3
Competitive Factor Markets
Characteristics
1) Large number of sellers of the factor
of production
2) Large number of buyers of the factor
of production
3) The buyers and sellers of the factor
of production are price takers
Chapter 14 Slide 4
Competitive Factor Markets
Demand for a Factor Input When Only
One Input Is Variable
Demand for factor inputs is a derived
demand…
derived from factor cost and output
demand
Chapter 14 Slide 5
Competitive Factor Markets
Assume
Two inputs,Capital (K) and Labor (L)
Cost of K is r and the cost of labor is w
K is fixed and L is variable
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 6
Competitive Factor Markets
Problem
How much labor to hire
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 7
Competitive Factor Markets
Measuring the Value of a Worker’s
Output
Marginal Revenue Product of Labor
(MRPL)
MRPL = (MPL)(MR)
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 8
Competitive Factor Markets
Assume perfect competition in the
product market
Then MR = P
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 9
Competitive Factor Markets
Question
What will happen to the value of MRPL
when more workers are hired?
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 10
Marginal Revenue Product
Hours of Work
Wages
($ per
hour)
MRPL = MPLx P
Competitive Output Market (P = MR)
MRPL = MPL x MR
Monopolistic
Output Market
(P < MR)
Chapter 14 Slide 11
Competitive Factor Markets
Choosing the profit-maximizing amount
of labor
If MRPL > w (the marginal cost of hiring a
worker),hire the worker
If MRPL < w,hire less labor
If MRPL = w,profit maximizing amount of
labor
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 12
w* SL
In a competitive labor market,a
firm faces a perfectly elastic supply of labor
and can hire as many workers as it wants at w*.
Hiring by a Firm in the
Labor Market (with Capital Fixed)
Quantity of Labor
Price of
Labor
Why not hire fewer
or more workers than L*.
MRPL = DL
L*
The profit maximizing firm will
hire L* units of labor at the point
where the marginal revenue product
of labor is equal to the wage rate.
Chapter 14 Slide 13
Competitive Factor Markets
If the market supply of labor increased
relative to demand (baby boomers or
female entry),a surplus of labor would
exist and the wage rate would fall.
Question
How would this impact the quantity
demanded for labor?
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 14
A Shift in the Supply of Labor
Quantity of Labor
Price of
Labor
w1 S1
MRPL = DL
L1
w2
L2
S2
Chapter 14 Slide 15
Competitive Factor Markets
Comparing Input and Output Markets
p ro d u c t i o n of MC MP
MP MR
M R ))((M P
M R P w o rk e rsofn u m b e r
m a x i m i z i n gp ro f i t a t a n d
M R ))(MP(M R P
L
L
L
L
LL
w
w
w
w
Chapter 14 Slide 16
Competitive Factor Markets
Comparing Input and Output Markets
In both markets,input and output choices
occur where MR = MC
MR from the sale of the output
MC from the purchase of the input
Chapter 14 Slide 17
Competitive Factor Markets
Scenario
Producing farm equipment with two
variable inputs:
Labor
Assembly-line machinery
Assume the wage rate falls
Demand for a Factor Input When
Several Inputs Are Variable
Chapter 14 Slide 18
Competitive Factor Markets
Question
How will the decrease in the wage rate
impact the demand for labor?
Demand for a Factor Input When
Several Inputs Are Variable
Chapter 14 Slide 19
MRPL1 MRPL2
When two or more inputs are
variable,a firm’s demand for one input
depends on the marginal revenue
product of both inputs.
Firm’s Demand Curve for Labor
(with Variable Capital)
Hours of Work
Wages
($ per
hour)
0
5
10
15
20
40 80 120 160
When the wage rate is $20,A
represents one point on the firm’s
demand for labor curve.
When the wage rate falls to $15,the
MRP curve shifts,generating a new
point C on the firm’s demand for
labor curve,Thus A and C are
on the demand for labor curve,but
B is not.
DL
A
B
C
Chapter 14 Slide 20
Assume that all firms respond to a lower
wage
All firms would hire more workers.
Market supply would increase.
The market price will fall,
The quantity demanded for labor by the
firm will be smaller.
Competitive Factor Markets
Industry Demand for Labor
MRPL1
The Industry Demand for Labor
Labor
(worker-hours)
Labor
(worker-hours)
Wage
($ per
hour)
Wage
($ per
hour)
0
5
10
15
0
5
10
15
50 100 150 L0 L2
DL1
Horizontal sum if
product price
unchanged
120
MRPL2
L1
Industry
Demand
Curve DL2
Firm Industry
Chapter 14 Slide 22
The Industry Demand for Labor
Question
How would a change to a non-competitive
market impact the derivation of the market
demand for labor?
Chapter 14 Slide 23
The Demand for Jet Fuel
Observations
Jet fuel is a factor (input) cost
Cost of jet fuel
1971--Jet fuel cost equaled 12.4% of
total operating cost
1980--Jet fuel cost equaled 30.0% of
total operating cost
1990’s--Jet fuel cost equaled 15.0% of
total operating cost
Chapter 14 Slide 24
The Demand for Jet Fuel
Observations
Airlines responded to higher prices in the
1970’s by reducing the quantity of jet fuel
used
Ton-miles increased by 29.6% & jet fuel
consumed rose by 8.8%
Chapter 14 Slide 25
The Demand for Jet Fuel
Observations
The demand for jet fuel impacts the airlines
and refineries alike
The short-run price elasticity of demand for
jet-fuel is very inelastic
Chapter 14 Slide 26
Short-run Price Elasticity
of Demand for Jet Fuel
American -.06 Delta -.15
Continental -.09 TWA -.10
Northwest -.07 United -.10
Airline Elasticity Airline Elasticity
Chapter 14 Slide 27
The Demand for Jet Fuel
Question
How would the long-run price elasticity of
demand compare to the short-run?
Chapter 14 Slide 28
The Short- and Long-Run
Demand for Jet Fuel
Quantity of Jet Fuel
Price
MRPLRMRPSR
Chapter 14 Slide 29
Competitive Factor Markets
The Supply of Inputs to a Firm
Determining how much of an input to
purchase
Assume a perfectly competitive factor
market
SMarket Supply
of fabric
A Firm’s Input Supply in a
Competitive Factor Market
Yards of
Fabric (thousands)
Yards of
Fabric (thousands)
Price
($ per
yard)
Price
($ per
yard)
D
Market Demand
for fabric
100
ME = AE
10 10
Supply of
Fabric Facing Firm
50
Demand
for Fabric
MRP
Observations
1) The firm is a price taker at $10.
2) S = AE = ME = $10
3) ME = MRP @ 50 units
Chapter 14 Slide 31
Competitive Factor Markets
The Market Supply of Inputs
The market supply for physical inputs is
upward sloping
Examples,jet fuel,fabric,steel
The market supply for labor may be
upward sloping and backward bending
Chapter 14 Slide 32
Competitive Factor Markets
The Supply of Labor
The choice to supply labor is based on
utility maximization
Leisure competes with labor for utility
Wage rate measures the price of leisure
Higher wage rate causes the price of
leisure to increase
Chapter 14 Slide 33
Competitive Factor Markets
The Supply of Labor
Higher wages encourage workers to
substitute work for leisure (i.e,the
substitution effect)
Higher wages allow the worker to purchase
more goods,including leisure which
reduces work hours (i.e,the income effect)
Chapter 14 Slide 34
Competitive Factor Markets
The Supply of Labor
If the income effect exceeds the
substitution effect the supply curve is
backward bending
Chapter 14 Slide 35
Income Effect <
Substitution Effect
Income Effect >
Substitution Effect
Backward-Bending Supply of Labor
Hours of Work per Day
Wage
($ per
hour) Supply of Labor
12
C
Worker chooses point A:
16 hours leisure,8 hour work
Income = $80
16
Q
P
A
w = $10
Substitution and Income
Effects of a Wage Increase
Hours of Leisure
Income
($ per
day)
0
240
8 24
480
20
B
w = $20
Suppose wages increase to $20
Substitution effect
Income effect
Increase wage to $20 worker chooses:
20 hour leisure,4 hours work
income = $80
Chapter 14 Slide 37
Labor Supply for One- and
Two-Earner Households
Female Percent of Labor Force
1950 -- 29%
1999 -- 60%
Elasticities of Labor Supply (Hours Worked)
Head’s Hours Spouse’s Hours Head’s Hours
with Respect to with Respect to with Respect to
Group Head’s Wage Spouse’s Wage Spouse’s Wage
Unmarried males,026
(no children)
Unmarried females,106
(with children)
Unmarried females,011
(no children)
One-earner family -.078
(with children)
One-earner family,007
(no children)
Two-earner family -.002 -.086 -.004
(with children)
Two-earner family -.107 -.028 -.059
(no children)
Chapter 14 Slide 39
Equilibrium in a
Competitive Factor Market
A competitive factor market is in
equilibrium when the price of the input
equates the quantity demanded to the
quantity supplied.
SL = AE
SL = AE
DL = MRPL DL = MRPL
P * MPL
Labor Market Equilibrium
Number of Workers Number of Workers
Wage WageCompetitive Output Market Monopolistic Output Market
wC
LC
wM
LM
vM
A B
Chapter 14 Slide 41
Labor Market Equilibrium
Equilibrium in a
Competitive Output
Market
DL(MRPL) = SL
wC = MRPL
MRPL = (P)(MPL)
Markets are efficient
Equilibrium in a
Monopolistic Output
Market
MR < P
MRP = (MR)(MPL)
Hire LM at wage wM
vM = marginal benefit to
consumers
wM = marginal cost to the
firm
Chapter 14 Slide 42
Labor Market Equilibrium
Equilibrium in a
Competitive Output
Market
DL(MRPL) = SL
wC = MRPL
MRPL = (P)(MPL)
Markets are efficient
Equilibrium in a
Monopolistic Output
Market
Profits maximized
Using less than the
efficient level of input
Chapter 14 Slide 43
Economic Rent
For a factor market,economic rent is the
difference between the payments made to
a factor of production and the minimum
amount that must be spent to obtain the
use of that factor.
Equilibrium in a
Competitive Factor Market
Chapter 14 Slide 44
Total expenditure (wage) paid
is 0w* x AL*Economic Rent
Economic rent is ABW*
B
Economic Rent
Number of Workers
Wage
SL = AE
DL = MRPL
w*
L*
A
0
The economic rent associated with the
employment of labor is the excess of wages
paid above the minimum amount needed
to hire workers.
Chapter 14 Slide 45
Economic Rent
Question
What would be the economic rent if SL is
perfectly elastic or perfectly inelastic?
Chapter 14 Slide 46
Land,A Perfectly Inelastic Supply
With land inelastically supplied,its price is
determined entirely by demand,at least in
the short run.
Equilibrium in a
Competitive Factor Market
Chapter 14 Slide 47
Economic
Rent
s1
Economic
Rent
s2
Land Rent
Number of Acres
Price
($ per
acre)
Supply of Land
D2
D1
Chapter 14 Slide 48
Pay in the Military
During the Civil War 90% of the armed
forces were unskilled workers involved
in ground combat.
Today,only 16% are unskilled workers
involved in ground combat.
Chapter 14 Slide 49
Pay in the Military
Shortages of skilled personnel has
occurred? Why?
Hint,If there is a shortage,the wage must
be below the…?
Chapter 14 Slide 50
The Shortage of
Skilled Military Personnel
Number of Skilled Workers
Wage S
L
DL = MRPL
w*
w0
Shortage
Chapter 14 Slide 51
Pay in the Military
Military pay is based on years of service
not MRP.
MRP increases and the private sector
pay is greater than military pay.
Many leave the military.
Chapter 14 Slide 52
Pay in the Military
Solution
Selective reenlistment bonuses
Base pay on MRP
Chapter 14 Slide 53
Factor Markets with Monopsony Power
Assume
The output market is perfectly competitive.
Input market is pure monopsony.
Chapter 14 Slide 54
SL = Average
Expenditure (AE)
Marginal
Expenditure (ME)
Why is marginal expenditure
greater than SL?
D = MRPL
Marginal and Average Expenditure
Units of Input
Price
(per unit
of input)
0 1 2 3 4 65
5
10
15
20
w* = 13
L*
wc
Lc
C
Chapter 14 Slide 55
Factor Markets with Monopsony Power
Examples of Monopsony Power
Government
Soldiers
Missiles
B2 Bombers
NASA
Astronauts
Company town
Chapter 14 Slide 56
Monopsony Power in
the Market for Baseball Players
Baseball owners created a
monopsonistic cartel
Reserve clause prevented competition for
players
1975--Free agency after six years
1969--Average salary was $42,000
($200,000 in 1999 dollars)
1997--Average salary was $1,383,578
Chapter 14 Slide 57
Baseball owners created a monopolistic
cartel
1975 salaries were 25% of team
expenditures
1980 salaries were 40% of team
expenditures
Monopsony Power in
the Market for Baseball Players
Chapter 14 Slide 58
Teenage Labor Markets
and the Minimum Wage
When the minimum wage rose in New
Jersey in 1992 from $4.25 to $5.05,a
survey conducted found a 13%
increase in employment.
Chapter 14 Slide 59
Explanations
Reduction in fringe benefits
Lower pay for more productive workers
Monopsony market
Teenage Labor Markets
and the Minimum Wage
Chapter 14 Slide 60
Findings
None of the explanations are validated by
the survey results
Indicates of the need for further study
Teenage Labor Markets
and the Minimum Wage
Chapter 14 Slide 61
Factor Markets with Monopoly Power
Just as buyers of inputs can have
monopsony power,sellers of inputs can
have monopoly power.
The most important example of
monopoly power in factor markets
involves labor unions.
Chapter 14 Slide 62
SL
DL
MR
When a labor union is a monopolist,it
chooses among points on the buyer’s
demand for labor curve.
Monopoly Power of Sellers of Labor
Number of Workers
Wage
per
worker
A
L*
w*
The seller can maximize the number of workers
hired,at L*,by agreeing that workers will
work at wage w*.
Chapter 14 Slide 63
Economic
Rent
w1
L1
The quantity of labor L1 that maximizes
the rent that employees earn is determined
by the intersection of the marginal revenue
and supply or labor curves; union members
receive a wage rate of w1.
SL
DL
MR
Monopoly Power of Sellers of Labor
Number of Workers
Wage
per
worker
A
L2
w2
Finally,if the union wishes to maximize total
wages paid to workers,it should allow L2
union members to be employed at a wage
rate of w2 because the marginal revenue
to the union will then be zero.
L*
w*
Chapter 14 Slide 64
The primary determinant of controlling
wage and economic rent is controlling
the supply of labor
Factor Markets with Monopoly Power
Chapter 14 Slide 65
A Two-Sector Model of Labor
Employment
Union monopoly power impacts the
nonunionized part of the economy.
Factor Markets with Monopoly Power
Chapter 14 Slide 66
Wage Determination in
Unionized and Nonunionized Sectors
Number of Workers
Wage
per
worker
DU DNU DL
SL
w*
UL?
wU
When a monopolistic union
raises the wage rate in the
unionized sector of the
economy from w* to wU,
employment in that
sector falls.
For the total supply of labor to
remain unchanged,the wage in
the nonunionized sector
must fall from w* to wNU..
MUL?
wNU
Chapter 14 Slide 67
Bilateral Monopoly
Market in which a monopolist sells to a
monopsonist.
Factor Markets with Monopoly Power
Chapter 14 Slide 68
Bilateral Monopoly
Number
of Workers
Wage
per
worker
DL = MRPL
MR
5
10
15
20
25
10 20 40
SL = AE
ME
25
19
Wage
Possibilities
wC
Chapter 14 Slide 69
Bilateral Monopoly
Number
of Workers
Wage
per
worker
DL = MRPL
MR
5
10
15
20
25
10 20 40
SL = (AE)
ME
25
19
wC
Observations
Hiring without union
monopoly power
MRP = ME at 20
workers and w =
$10/hr
Union’s objective
MR = MC at 25
workers and w =
$19/hr
Chapter 14 Slide 70
Bilateral Monopoly
Who Will Win?
The union will if its threat to strike is
credible.
The firm will if its threat to hire non-union
workers is credible.
If both make credible threats the wage will
be at wc.
Chapter 14 Slide 71
The Decline of Private Sector Unionism
Observations
Union membership and monopoly power
has been declining.
Initially,during the 1970’s,union wages
relative to nonunion wages fell.
Chapter 14 Slide 72
Observations
In the 1980’s union wages stabilized
relative to non-union wages.
In the 1990’s membership has been falling
and wage differential has remained stable.
The Decline of Private Sector Unionism
Chapter 14 Slide 73
Explanation
The unions have been attempting to
maximize the individual wage rate instead
of total wages paid.
The demand for unionized employees has
probably become increasingly elastic as
firms find it easier to substitute capital for
skilled labor.
The Decline of Private Sector Unionism
Chapter 14 Slide 74
Wage Inequality--Have
Computers Changed the Labor Market?
1950 - 1980
Relative wage of college graduates to high-
school graduates hardly changed
1980-1995
The relative wage grew rapidly
Chapter 14 Slide 75
Wage Inequality--Have
Computers Changed the Labor Market?
In 1984,25.1% of all workers used
computers
1993 -- 46.6%
1999 -- nearly 60%
Chapter 14 Slide 76
Wage Inequality--Have
Computers Changed the Labor Market?
Percent change in use of computers
College degrees
1984 - 1993 -- 42 to 70%
Less than high school degree
5 to 10%
With high school degree
19 to 35%
Chapter 14 Slide 77
Wage Inequality--Have
Computers Changed the Labor Market?
Growth in wages -- 1983 - 1994
College graduates using computers - 11%
Non-computer users -- less than 4%
Chapter 14 Slide 78
Wage Inequality--Have
Computers Changed the Labor Market?
1993 - 1997
High school dropouts out of school less
than 10 years earned 29% less than high
school graduates
1963 -- The differential was only 19%
Chapter 14 Slide 79
Wage Inequality--Have
Computers Changed the Labor Market?
1993 - 1997
Average weekly wage for college
graduates (out of school less than 10
years) was 96% higher than high school
graduates.
College graduation premium has more
than doubled.
Chapter 14 Slide 80
Summary
In a competitive input market,the
demand for an input is given by the
MRP,the product of the firm’s marginal
revenue,and the marginal product of
the input.
A firm in a competitive labor market will
hire workers to the point at which the
marginal revenue product of labor is
equal to the wage rate.
Chapter 14 Slide 81
Summary
The market demand for an input is the
horizontal sum of the industry demands
for the input.
When factor markets are competitive,
the buyer of an input assumes that its
purchase will have no effect on the price
of the input.
Chapter 14 Slide 82
Summary
The market supply of a factor such as
labor need not be upward sloping.
Economic rent is the difference between
the payments to factors of production
and the minimum payment that would
be needed to employ those factors.
Chapter 14 Slide 83
Summary
When a buyer of an input has monopsony
power,the marginal expenditure curve lies
above the average expenditure curve.
When the input seller is a monopolist such as
a labor union,the seller chooses the point on
the marginal revenue product curve that best
suits its objective.
Chapter 14 Slide 84
Summary
When a monopolistic union bargains
with a monopsonistic employer,the
wage rate depends on the nature of the
bargaining process.
End of Chapter 14
Markets for
Factor Inputs
Markets for
Factor Inputs
Chapter 14 Slide 2
Topics to be Discussed
Competitive Factor Markets
Equilibrium in a Competitive Factor
Market
Factor Markets with Monopsony Power
Factor Markets with Monopoly Power
Chapter 14 Slide 3
Competitive Factor Markets
Characteristics
1) Large number of sellers of the factor
of production
2) Large number of buyers of the factor
of production
3) The buyers and sellers of the factor
of production are price takers
Chapter 14 Slide 4
Competitive Factor Markets
Demand for a Factor Input When Only
One Input Is Variable
Demand for factor inputs is a derived
demand…
derived from factor cost and output
demand
Chapter 14 Slide 5
Competitive Factor Markets
Assume
Two inputs,Capital (K) and Labor (L)
Cost of K is r and the cost of labor is w
K is fixed and L is variable
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 6
Competitive Factor Markets
Problem
How much labor to hire
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 7
Competitive Factor Markets
Measuring the Value of a Worker’s
Output
Marginal Revenue Product of Labor
(MRPL)
MRPL = (MPL)(MR)
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 8
Competitive Factor Markets
Assume perfect competition in the
product market
Then MR = P
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 9
Competitive Factor Markets
Question
What will happen to the value of MRPL
when more workers are hired?
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 10
Marginal Revenue Product
Hours of Work
Wages
($ per
hour)
MRPL = MPLx P
Competitive Output Market (P = MR)
MRPL = MPL x MR
Monopolistic
Output Market
(P < MR)
Chapter 14 Slide 11
Competitive Factor Markets
Choosing the profit-maximizing amount
of labor
If MRPL > w (the marginal cost of hiring a
worker),hire the worker
If MRPL < w,hire less labor
If MRPL = w,profit maximizing amount of
labor
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 12
w* SL
In a competitive labor market,a
firm faces a perfectly elastic supply of labor
and can hire as many workers as it wants at w*.
Hiring by a Firm in the
Labor Market (with Capital Fixed)
Quantity of Labor
Price of
Labor
Why not hire fewer
or more workers than L*.
MRPL = DL
L*
The profit maximizing firm will
hire L* units of labor at the point
where the marginal revenue product
of labor is equal to the wage rate.
Chapter 14 Slide 13
Competitive Factor Markets
If the market supply of labor increased
relative to demand (baby boomers or
female entry),a surplus of labor would
exist and the wage rate would fall.
Question
How would this impact the quantity
demanded for labor?
Demand for a Factor Input When
Only One Input Is Variable
Chapter 14 Slide 14
A Shift in the Supply of Labor
Quantity of Labor
Price of
Labor
w1 S1
MRPL = DL
L1
w2
L2
S2
Chapter 14 Slide 15
Competitive Factor Markets
Comparing Input and Output Markets
p ro d u c t i o n of MC MP
MP MR
M R ))((M P
M R P w o rk e rsofn u m b e r
m a x i m i z i n gp ro f i t a t a n d
M R ))(MP(M R P
L
L
L
L
LL
w
w
w
w
Chapter 14 Slide 16
Competitive Factor Markets
Comparing Input and Output Markets
In both markets,input and output choices
occur where MR = MC
MR from the sale of the output
MC from the purchase of the input
Chapter 14 Slide 17
Competitive Factor Markets
Scenario
Producing farm equipment with two
variable inputs:
Labor
Assembly-line machinery
Assume the wage rate falls
Demand for a Factor Input When
Several Inputs Are Variable
Chapter 14 Slide 18
Competitive Factor Markets
Question
How will the decrease in the wage rate
impact the demand for labor?
Demand for a Factor Input When
Several Inputs Are Variable
Chapter 14 Slide 19
MRPL1 MRPL2
When two or more inputs are
variable,a firm’s demand for one input
depends on the marginal revenue
product of both inputs.
Firm’s Demand Curve for Labor
(with Variable Capital)
Hours of Work
Wages
($ per
hour)
0
5
10
15
20
40 80 120 160
When the wage rate is $20,A
represents one point on the firm’s
demand for labor curve.
When the wage rate falls to $15,the
MRP curve shifts,generating a new
point C on the firm’s demand for
labor curve,Thus A and C are
on the demand for labor curve,but
B is not.
DL
A
B
C
Chapter 14 Slide 20
Assume that all firms respond to a lower
wage
All firms would hire more workers.
Market supply would increase.
The market price will fall,
The quantity demanded for labor by the
firm will be smaller.
Competitive Factor Markets
Industry Demand for Labor
MRPL1
The Industry Demand for Labor
Labor
(worker-hours)
Labor
(worker-hours)
Wage
($ per
hour)
Wage
($ per
hour)
0
5
10
15
0
5
10
15
50 100 150 L0 L2
DL1
Horizontal sum if
product price
unchanged
120
MRPL2
L1
Industry
Demand
Curve DL2
Firm Industry
Chapter 14 Slide 22
The Industry Demand for Labor
Question
How would a change to a non-competitive
market impact the derivation of the market
demand for labor?
Chapter 14 Slide 23
The Demand for Jet Fuel
Observations
Jet fuel is a factor (input) cost
Cost of jet fuel
1971--Jet fuel cost equaled 12.4% of
total operating cost
1980--Jet fuel cost equaled 30.0% of
total operating cost
1990’s--Jet fuel cost equaled 15.0% of
total operating cost
Chapter 14 Slide 24
The Demand for Jet Fuel
Observations
Airlines responded to higher prices in the
1970’s by reducing the quantity of jet fuel
used
Ton-miles increased by 29.6% & jet fuel
consumed rose by 8.8%
Chapter 14 Slide 25
The Demand for Jet Fuel
Observations
The demand for jet fuel impacts the airlines
and refineries alike
The short-run price elasticity of demand for
jet-fuel is very inelastic
Chapter 14 Slide 26
Short-run Price Elasticity
of Demand for Jet Fuel
American -.06 Delta -.15
Continental -.09 TWA -.10
Northwest -.07 United -.10
Airline Elasticity Airline Elasticity
Chapter 14 Slide 27
The Demand for Jet Fuel
Question
How would the long-run price elasticity of
demand compare to the short-run?
Chapter 14 Slide 28
The Short- and Long-Run
Demand for Jet Fuel
Quantity of Jet Fuel
Price
MRPLRMRPSR
Chapter 14 Slide 29
Competitive Factor Markets
The Supply of Inputs to a Firm
Determining how much of an input to
purchase
Assume a perfectly competitive factor
market
SMarket Supply
of fabric
A Firm’s Input Supply in a
Competitive Factor Market
Yards of
Fabric (thousands)
Yards of
Fabric (thousands)
Price
($ per
yard)
Price
($ per
yard)
D
Market Demand
for fabric
100
ME = AE
10 10
Supply of
Fabric Facing Firm
50
Demand
for Fabric
MRP
Observations
1) The firm is a price taker at $10.
2) S = AE = ME = $10
3) ME = MRP @ 50 units
Chapter 14 Slide 31
Competitive Factor Markets
The Market Supply of Inputs
The market supply for physical inputs is
upward sloping
Examples,jet fuel,fabric,steel
The market supply for labor may be
upward sloping and backward bending
Chapter 14 Slide 32
Competitive Factor Markets
The Supply of Labor
The choice to supply labor is based on
utility maximization
Leisure competes with labor for utility
Wage rate measures the price of leisure
Higher wage rate causes the price of
leisure to increase
Chapter 14 Slide 33
Competitive Factor Markets
The Supply of Labor
Higher wages encourage workers to
substitute work for leisure (i.e,the
substitution effect)
Higher wages allow the worker to purchase
more goods,including leisure which
reduces work hours (i.e,the income effect)
Chapter 14 Slide 34
Competitive Factor Markets
The Supply of Labor
If the income effect exceeds the
substitution effect the supply curve is
backward bending
Chapter 14 Slide 35
Income Effect <
Substitution Effect
Income Effect >
Substitution Effect
Backward-Bending Supply of Labor
Hours of Work per Day
Wage
($ per
hour) Supply of Labor
12
C
Worker chooses point A:
16 hours leisure,8 hour work
Income = $80
16
Q
P
A
w = $10
Substitution and Income
Effects of a Wage Increase
Hours of Leisure
Income
($ per
day)
0
240
8 24
480
20
B
w = $20
Suppose wages increase to $20
Substitution effect
Income effect
Increase wage to $20 worker chooses:
20 hour leisure,4 hours work
income = $80
Chapter 14 Slide 37
Labor Supply for One- and
Two-Earner Households
Female Percent of Labor Force
1950 -- 29%
1999 -- 60%
Elasticities of Labor Supply (Hours Worked)
Head’s Hours Spouse’s Hours Head’s Hours
with Respect to with Respect to with Respect to
Group Head’s Wage Spouse’s Wage Spouse’s Wage
Unmarried males,026
(no children)
Unmarried females,106
(with children)
Unmarried females,011
(no children)
One-earner family -.078
(with children)
One-earner family,007
(no children)
Two-earner family -.002 -.086 -.004
(with children)
Two-earner family -.107 -.028 -.059
(no children)
Chapter 14 Slide 39
Equilibrium in a
Competitive Factor Market
A competitive factor market is in
equilibrium when the price of the input
equates the quantity demanded to the
quantity supplied.
SL = AE
SL = AE
DL = MRPL DL = MRPL
P * MPL
Labor Market Equilibrium
Number of Workers Number of Workers
Wage WageCompetitive Output Market Monopolistic Output Market
wC
LC
wM
LM
vM
A B
Chapter 14 Slide 41
Labor Market Equilibrium
Equilibrium in a
Competitive Output
Market
DL(MRPL) = SL
wC = MRPL
MRPL = (P)(MPL)
Markets are efficient
Equilibrium in a
Monopolistic Output
Market
MR < P
MRP = (MR)(MPL)
Hire LM at wage wM
vM = marginal benefit to
consumers
wM = marginal cost to the
firm
Chapter 14 Slide 42
Labor Market Equilibrium
Equilibrium in a
Competitive Output
Market
DL(MRPL) = SL
wC = MRPL
MRPL = (P)(MPL)
Markets are efficient
Equilibrium in a
Monopolistic Output
Market
Profits maximized
Using less than the
efficient level of input
Chapter 14 Slide 43
Economic Rent
For a factor market,economic rent is the
difference between the payments made to
a factor of production and the minimum
amount that must be spent to obtain the
use of that factor.
Equilibrium in a
Competitive Factor Market
Chapter 14 Slide 44
Total expenditure (wage) paid
is 0w* x AL*Economic Rent
Economic rent is ABW*
B
Economic Rent
Number of Workers
Wage
SL = AE
DL = MRPL
w*
L*
A
0
The economic rent associated with the
employment of labor is the excess of wages
paid above the minimum amount needed
to hire workers.
Chapter 14 Slide 45
Economic Rent
Question
What would be the economic rent if SL is
perfectly elastic or perfectly inelastic?
Chapter 14 Slide 46
Land,A Perfectly Inelastic Supply
With land inelastically supplied,its price is
determined entirely by demand,at least in
the short run.
Equilibrium in a
Competitive Factor Market
Chapter 14 Slide 47
Economic
Rent
s1
Economic
Rent
s2
Land Rent
Number of Acres
Price
($ per
acre)
Supply of Land
D2
D1
Chapter 14 Slide 48
Pay in the Military
During the Civil War 90% of the armed
forces were unskilled workers involved
in ground combat.
Today,only 16% are unskilled workers
involved in ground combat.
Chapter 14 Slide 49
Pay in the Military
Shortages of skilled personnel has
occurred? Why?
Hint,If there is a shortage,the wage must
be below the…?
Chapter 14 Slide 50
The Shortage of
Skilled Military Personnel
Number of Skilled Workers
Wage S
L
DL = MRPL
w*
w0
Shortage
Chapter 14 Slide 51
Pay in the Military
Military pay is based on years of service
not MRP.
MRP increases and the private sector
pay is greater than military pay.
Many leave the military.
Chapter 14 Slide 52
Pay in the Military
Solution
Selective reenlistment bonuses
Base pay on MRP
Chapter 14 Slide 53
Factor Markets with Monopsony Power
Assume
The output market is perfectly competitive.
Input market is pure monopsony.
Chapter 14 Slide 54
SL = Average
Expenditure (AE)
Marginal
Expenditure (ME)
Why is marginal expenditure
greater than SL?
D = MRPL
Marginal and Average Expenditure
Units of Input
Price
(per unit
of input)
0 1 2 3 4 65
5
10
15
20
w* = 13
L*
wc
Lc
C
Chapter 14 Slide 55
Factor Markets with Monopsony Power
Examples of Monopsony Power
Government
Soldiers
Missiles
B2 Bombers
NASA
Astronauts
Company town
Chapter 14 Slide 56
Monopsony Power in
the Market for Baseball Players
Baseball owners created a
monopsonistic cartel
Reserve clause prevented competition for
players
1975--Free agency after six years
1969--Average salary was $42,000
($200,000 in 1999 dollars)
1997--Average salary was $1,383,578
Chapter 14 Slide 57
Baseball owners created a monopolistic
cartel
1975 salaries were 25% of team
expenditures
1980 salaries were 40% of team
expenditures
Monopsony Power in
the Market for Baseball Players
Chapter 14 Slide 58
Teenage Labor Markets
and the Minimum Wage
When the minimum wage rose in New
Jersey in 1992 from $4.25 to $5.05,a
survey conducted found a 13%
increase in employment.
Chapter 14 Slide 59
Explanations
Reduction in fringe benefits
Lower pay for more productive workers
Monopsony market
Teenage Labor Markets
and the Minimum Wage
Chapter 14 Slide 60
Findings
None of the explanations are validated by
the survey results
Indicates of the need for further study
Teenage Labor Markets
and the Minimum Wage
Chapter 14 Slide 61
Factor Markets with Monopoly Power
Just as buyers of inputs can have
monopsony power,sellers of inputs can
have monopoly power.
The most important example of
monopoly power in factor markets
involves labor unions.
Chapter 14 Slide 62
SL
DL
MR
When a labor union is a monopolist,it
chooses among points on the buyer’s
demand for labor curve.
Monopoly Power of Sellers of Labor
Number of Workers
Wage
per
worker
A
L*
w*
The seller can maximize the number of workers
hired,at L*,by agreeing that workers will
work at wage w*.
Chapter 14 Slide 63
Economic
Rent
w1
L1
The quantity of labor L1 that maximizes
the rent that employees earn is determined
by the intersection of the marginal revenue
and supply or labor curves; union members
receive a wage rate of w1.
SL
DL
MR
Monopoly Power of Sellers of Labor
Number of Workers
Wage
per
worker
A
L2
w2
Finally,if the union wishes to maximize total
wages paid to workers,it should allow L2
union members to be employed at a wage
rate of w2 because the marginal revenue
to the union will then be zero.
L*
w*
Chapter 14 Slide 64
The primary determinant of controlling
wage and economic rent is controlling
the supply of labor
Factor Markets with Monopoly Power
Chapter 14 Slide 65
A Two-Sector Model of Labor
Employment
Union monopoly power impacts the
nonunionized part of the economy.
Factor Markets with Monopoly Power
Chapter 14 Slide 66
Wage Determination in
Unionized and Nonunionized Sectors
Number of Workers
Wage
per
worker
DU DNU DL
SL
w*
UL?
wU
When a monopolistic union
raises the wage rate in the
unionized sector of the
economy from w* to wU,
employment in that
sector falls.
For the total supply of labor to
remain unchanged,the wage in
the nonunionized sector
must fall from w* to wNU..
MUL?
wNU
Chapter 14 Slide 67
Bilateral Monopoly
Market in which a monopolist sells to a
monopsonist.
Factor Markets with Monopoly Power
Chapter 14 Slide 68
Bilateral Monopoly
Number
of Workers
Wage
per
worker
DL = MRPL
MR
5
10
15
20
25
10 20 40
SL = AE
ME
25
19
Wage
Possibilities
wC
Chapter 14 Slide 69
Bilateral Monopoly
Number
of Workers
Wage
per
worker
DL = MRPL
MR
5
10
15
20
25
10 20 40
SL = (AE)
ME
25
19
wC
Observations
Hiring without union
monopoly power
MRP = ME at 20
workers and w =
$10/hr
Union’s objective
MR = MC at 25
workers and w =
$19/hr
Chapter 14 Slide 70
Bilateral Monopoly
Who Will Win?
The union will if its threat to strike is
credible.
The firm will if its threat to hire non-union
workers is credible.
If both make credible threats the wage will
be at wc.
Chapter 14 Slide 71
The Decline of Private Sector Unionism
Observations
Union membership and monopoly power
has been declining.
Initially,during the 1970’s,union wages
relative to nonunion wages fell.
Chapter 14 Slide 72
Observations
In the 1980’s union wages stabilized
relative to non-union wages.
In the 1990’s membership has been falling
and wage differential has remained stable.
The Decline of Private Sector Unionism
Chapter 14 Slide 73
Explanation
The unions have been attempting to
maximize the individual wage rate instead
of total wages paid.
The demand for unionized employees has
probably become increasingly elastic as
firms find it easier to substitute capital for
skilled labor.
The Decline of Private Sector Unionism
Chapter 14 Slide 74
Wage Inequality--Have
Computers Changed the Labor Market?
1950 - 1980
Relative wage of college graduates to high-
school graduates hardly changed
1980-1995
The relative wage grew rapidly
Chapter 14 Slide 75
Wage Inequality--Have
Computers Changed the Labor Market?
In 1984,25.1% of all workers used
computers
1993 -- 46.6%
1999 -- nearly 60%
Chapter 14 Slide 76
Wage Inequality--Have
Computers Changed the Labor Market?
Percent change in use of computers
College degrees
1984 - 1993 -- 42 to 70%
Less than high school degree
5 to 10%
With high school degree
19 to 35%
Chapter 14 Slide 77
Wage Inequality--Have
Computers Changed the Labor Market?
Growth in wages -- 1983 - 1994
College graduates using computers - 11%
Non-computer users -- less than 4%
Chapter 14 Slide 78
Wage Inequality--Have
Computers Changed the Labor Market?
1993 - 1997
High school dropouts out of school less
than 10 years earned 29% less than high
school graduates
1963 -- The differential was only 19%
Chapter 14 Slide 79
Wage Inequality--Have
Computers Changed the Labor Market?
1993 - 1997
Average weekly wage for college
graduates (out of school less than 10
years) was 96% higher than high school
graduates.
College graduation premium has more
than doubled.
Chapter 14 Slide 80
Summary
In a competitive input market,the
demand for an input is given by the
MRP,the product of the firm’s marginal
revenue,and the marginal product of
the input.
A firm in a competitive labor market will
hire workers to the point at which the
marginal revenue product of labor is
equal to the wage rate.
Chapter 14 Slide 81
Summary
The market demand for an input is the
horizontal sum of the industry demands
for the input.
When factor markets are competitive,
the buyer of an input assumes that its
purchase will have no effect on the price
of the input.
Chapter 14 Slide 82
Summary
The market supply of a factor such as
labor need not be upward sloping.
Economic rent is the difference between
the payments to factors of production
and the minimum payment that would
be needed to employ those factors.
Chapter 14 Slide 83
Summary
When a buyer of an input has monopsony
power,the marginal expenditure curve lies
above the average expenditure curve.
When the input seller is a monopolist such as
a labor union,the seller chooses the point on
the marginal revenue product curve that best
suits its objective.
Chapter 14 Slide 84
Summary
When a monopolistic union bargains
with a monopsonistic employer,the
wage rate depends on the nature of the
bargaining process.
End of Chapter 14
Markets for
Factor Inputs
