PowerPoint to accompany Chapter 10 The Markets for Labour and other Factors of Production.

PowerPoint

to accompany

Chapter 10

The Markets for Labour and

other Factors of Production

Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

1. Explain how firms choose the profit-maximising quantity of workers to employ.

2. Explain how people choose the quantity of labour to supply.

3. Explain how equilibrium wages are determined in labour markets.

Learning Objectives


4. Use demand and supply analysis to explain why compensating differentials, discrimination, and trade unions cause wages to differ.

5. Discuss the role personnel economics can play in helping firms deal with human resources issues.

6. Show how equilibrium prices are determined in the markets for capital and natural resources.

Learning Objectives


Most successful soccer players from Australia play for overseas clubs where they are offered lucrative contracts.

Those clubs generate large revenues from ticket and memorabilia sales, TV rights, etc.. They compete for the best players and can afford to pay huge salaries.

Why does Liverpool Football Club pay Harry Kewell $150 000 a week?


The markets for labour and other factors of production

Factors of production: Labour, capital, natural resources, and other inputs used to produce goods and services.


The demand for labour

LEARNING OBJECTIVE 1

The demand for labour is a derived demand.

Derived demand: The demand for a factor of production that is derived from the demand for the good or service the factor produces.

The labour demand curve is downward sloping and shows the relationship between the wage rate and quantity of labour demanded.




Marginal product of labour: The additional output a firm produces as a result of hiring one more worker.

The law of diminishing returns states that the marginal product of labour declines as more workers are hired, (assuming capital is fixed).




Marginal revenue product of labour (MRP): The change in the firm’s total revenue as a result of hiring one more worker.

When a firms is deciding how many workers to hire, it is not interested in how much output will increase, but in how much revenue will increase, as it hires another worker.




The marginal revenue product of labour curve is the demand curve for labour.

The market demand curve for labour is determined by adding up the quantity demanded of labour by each firm at each wage (W), (other variables held constant).

The marginal revenue product of labour and the demand for labour: Figure 10.1



The relationship between the marginal revenue product of labour and the wage: Table 10.1

When … then the firm …

MRP > W, should hire more workers to increase profits.




MRP < W,should hire fewer workers to increase profits.





MRP < W,should hire fewer workers to increase profits.

MRP = W,is hiring the optimal number of workers, and is maximising profits.



Hiring decisions by a firm that is a price maker


Wandoo didgeridoos is small business in Western Australia specialising in crafting didgeridoos. Wandoo is a price-maker, since it has to lower its prices to increase sales. Suppose the firm faces the situation shown in the following table.

Fill in the blanks and then determine the profit-maximising number of craftsmen for Wandoo to hire.

Briefly explain why hiring this number of workers is profit maximising.




(1)

Quantity of

labour

(2)

Output of didgeridoos

per f/n

(3)

Marginal production of labour

(4)

Product price

(5)

Total revenue

(6)

Marginal revenue product

of labour

(7)

Wage

(8)

Additional profit from hiring one

additional worker

0 0 — — $0

1 7 7 400 1300

2 13 6 380 1300

3 18 5 350 1300

4 22 4 320 1300

5 25 3 280 1300




STEP 1: Review the chapter material. This problem is about determining the profit-maximising quantity of labour for a firm to hire, so you may want to review the section ‘The demand for labour’.

STEP 2: Fill in the blanks in the table. As Wandoo hires more craftsmen, it sells more didgeridoos and earns more revenue. We can calculate how revenue increases by multiplying the number of didgeridoos crafted – shown in column 2 – by the price – shown in column 4.

Then, we can calculate MRP as the change in revenue as each additional craftsman is hired. Finally, additional profit from hiring one more craftsman is calculated:

MRP - Wage (7)




(1)

Quantity of labour

(2)

Output of didgeridoos

per f/n

(3)

Marginal production of labour

(4)

Product price

(5)

Total revenue

(6)

Marginal revenue

product of labour

(7)

Wage

(8)

Additional profit from hiring one

additional worker

0 0 — — $0 — $0 —

1 7 7 400 $2800 $2800 1300 $1500

2 13 6 380 4940 2140 1300 840

3 18 5 350 6300 1360 1300 60

4 22 4 320 7040 740 1300 –560

5 25 3 280 7000 –40 1300 –1340




STEP 3: Use the information in the table to determine the profit-maximising quantity of craftsmen to hire.

To determine the profit-maximising quantity of craftsmen to hire, we need to compare the marginal revenue product of labour with the wage. Column 8 does this by subtracting the wage from the marginal revenue product. As long as values in column 8 are positive, the firm should continue to hire workers. Hiring a third craftsman adds $60 to profit, whereas hiring a fourth craftsman reduces profit by $560.

Therefore, Wandoo will maximise its profit by hiring three didgeridoo craftsmen.




Factors that shift the labour demand curve

1. Increases in human capital.

Human capital: The accumulated knowledge and skills that workers acquire from education and training or from their life experiences.

2. Changes in technology.

3. Changes in the price of the product.

4. Changes in the quantity of other inputs.

5. Changes in the number of firms in the market.


The supply of labour


The labour supply curve shows the relationship between the wage rate and quantity of labour supplied.

The labour supply curve for most people is upward sloping.

The opportunity cost of leisure is the wage

The higher the wage the greater the opportunity cost of leisure

Substitution effect: higher wages cause workers to substitute work for leisure

Wage (dollars

per hour)

Quantity of labour0


Labour supply

The labour supply curve: Figure 10.2


The supply of labourLEARNING OBJECTIVE 2

The backward bending labour supply curve

At very high wage levels the labour supply curve for an individual may become backward bending.

Higher wages may result in a smaller quantity of labour supplied.

According to the income effect, because leisure is a normal good, higher wages will cause a worker to devote less time to working and more time to leisure.

The backward bending labour supply curve occurs when the income effect is greater than the substitution effect.

Wage (dollars

per hour)

Quantity of labour0


Labour supply

A backward bending labour supply curve: Figure 10.3


Factors that shift the labour supply curve

1. Increases in population.

2. Changing demographics.

Low birth rate and aging populations may decrease the supply of labour over time.

3. Changing alternatives.

expansion or contraction of particular industries.

availability and level of unemployment benefits and other government transfers.


The Supply of Labour

Wage (dollars

per hour)

Quantity of labour0


Labour supply

Equilibrium in the labour market: Figure 10.4

Labour demand

Equilibrium wage

Equilibrium employment

Wage (dollars

per hour)

Quantity of labour0


Labour supply

The effect of an increase in labour demand: Figure 10.5

Labour demand1

W1

L1

Labour demand2

L2

W2

1. An increase in labour productivity causes

labour demand to shift to the right …

3. …and also increasing the

equilibrium level of employment.

2. …increasing the equilibrium

wage…

Wage (dollars

per hour)

Quantity of labour0


Labour demand

W1

L1

Labour supply2

L2

W2

1. An increase in population causes

labour supply to shift to the right …

3. …and increasing the equilibrium level

of employment.

2. …decreasing the equilibrium

wage…

The effect of an increase in labour supply: Figure 10.6

Labour supply1


How does a university degree affect your future earnings?

MAKING THE CONNECTION10.1


Explaining differences in wages


As shown, equilibrium wage = marginal revenue product (MRP) of labour.

The more productive workers are, and/or the higher workers’ output can be sold for, the higher the wages will be.

Example: Football players and university lecturers

The MRP of football players is higher than the MRP of university lecturers.

Wage (dollars per

year)

Quantity of labour

0


Supply of football players

Football players are paid more than university lecturers: Figure 10.7

$300 000

300

Demand for football

players

75 000

Demand for university lecturers

Supply of university lecturers

40 000




Compensating differentials: Higher wages that compensate workers for unpleasant aspects of a job.

Economic discrimination: Paying a person a lower wage or excluding a person from an occupation on the basis of an irrelevant characteristic such as race or gender.




Discrimination

Is it discrimination, or other factors?

1. Differences in education.

2. Differences in experience.

3. Differing preferences for jobs.

Although it is difficult to determine, the majority of economists believe that the difference in wages in Australia is due to factors other than discrimination.




Does it pay to discriminate?

Employers who discriminate face an economic penalty

If a firm discriminates, it was have a reduced supply of labour, forcing up wages and increasing costs. Its prices will rise and the quantity demanded will fall.

A non-discriminating firm will have an increase in the supply of labour, reducing wages and decreasing costs. Its prices will fall and the quantity demanded will rise.

Discrimination and wages: Figure 10.8




Does it pay to discriminate?

Why will competition not eliminate all economic discrimination?

1) Worker discrimination.

2) Customer discrimination.

3) Negative feedback loops.




Trade unions

Trade union: An organisation of employees that has the legal right to bargain with employers about wages and working conditions.

Do unions increase wages for their members?

Difficult to determine as many unionised industries have a high MRP, so wages may be high even if they were not unionised.


Technology and the earnings of “superstars”

Why does Cate Blanchett earn more today relative to the typical actor than stars did in the 1940s?



Personnel Economics


Personnel economics: The application of economic analysis to human resources issues.

Analyses the link between differences between jobs and differences in the way workers are paid.


Personnel Economics


Should workers’ pay depend on how much they work or on how much they produce?

Straight salary or commission?

Straight salary provides certainty for employees, but commission based on productivity increases work incentive.

Compensation received per

week

Cars sold per week

0


Compensation of salesperson on

commission

$800

4

Paying care salespeople by salary or commission: Figure 10.9

Compensation of salesperson on

salary


Personnel Economics


Other considerations in setting compensation schemes.

Firms may choose a salary system for several reasons:

Difficulty in measuring output.

Concerns about quality.

Worker dislike of risk.


Raising pay, productivity and profits at Sefelite AutoGlass


A piece-rate system at Safelite AutoGlass led to increases in workers’ wages and the firm’s profits.


The Markets for Capital and Natural Resources


The market for capital – machines, buildings and equipment

Demand for capital is a derived demand.

The marginal revenue product of capital is also the demand curve for capital, and is downward sloping.

The supply curve for capital is upward sloping, as firms producing capital goods face increasing marginal costs.

Rental price of capital

Quantity of capital

0


Supply

Demand

Equilibrium rental price

Equilibrium quantity of capital

Equilibrium in the market for capital: Figure 10.10




The market for natural resources

Demand for natural resources is a derived demand.

The marginal revenue product of a natural resource is also the demand curve for the natural resource, and is downward sloping.




The market for natural resources

In most cases, the supply of natural resources is fixed.

However, in many cases, the quantity supplied still responds to the price, therefore the supply curve for many natural resources is upward sloping.




The market for natural resources In some cases, the supply of a natural

resource is fixed, eg: land, and supply will not change as price changes.

The supply curve will be vertical – perfectly inelastic.

Economic rent (or pure rent): The price of a factor of production that is in fixed supply.

(b) The market for a natural resource with a vertical supply curve

0

(a) The market for a natural resource with an upward-sloping supply curve

Quantity of natural resource

Supply

Demand

Pe

Equilibrium in the market for natural resources: Figure 10.11

Qe

Price of natural

resource

Price of natural

resource

Quantity of natural resource

0 Qe

Pe


Demand

Supply




Monopsony: The sole buyer of a factor of production.

A firm that has a monopsony in a factor market will restrict the quantity of the factor demanded to force the price down, to increase profits.

Marginal productivity theory of income distribution: The theory that the distribution of income is determined by the marginal productivity of the factors of production that individuals own.


An Inside Look

Football Federation Australia facing uphill task to get top coach down under


An Inside LookFigure 1: The high salaries of coaches are determined by an increase in demand and an inelastic supply

Insert Figure 1 from page 316, as large as possible

while retaining clarity


Key Terms Compensating

differentials

Derived demand

Economic discrimination

Economic rent (or pure rent)

Factors of production

Human capital

Marginal product of labour

Marginal productivity theory of income distribution

Marginal revenue product of labour (MRP)

Monopsony

Personnel economics

Trade unions.


Get Thinking!

The gap between salaries of ordinary staff members and CEOs of large companies have been dramatically rising over the past decade.

1) Why do you think this has occurred?

2) Recent failures of US and global financial market giants, e.g. Lehman Brothers, Merrill Lynch, AIG, etc. have raised discussion whether enormous pay packages of executives are justified. What do you think?

3) What, if anything, can be done to make compensation ‘fairer’?

http://www.msnbc.msn.com/id/26963309/


Check Your Knowledge

Q1. Let MRP equal the marginal revenue product of labor and W the wage. When should a firm hire more workers in order to increase profit?

a. When MRP > W.

b. When MRP < W.

c. When MRP = W.

d. When MRP = 0



Q2. What is the definition of economic rent?

a. The price of a resource when that price is strictly determined by supply.

b. The marginal revenue product of natural resources.

c. The price received by a factor of production that is in fixed supply, in excess of its opportunity cost.

d. The earnings of a landlord.



Q3. Which of the following is caused by the existence of a firm with a monopsony in the labour market?

a. More workers will be hired at higher wages.

b. More workers will be hired at lower wages.

c. Fewer workers will be hired at higher wages.

d. Fewer workers will be hired at lower wages.

PowerPoint to accompany Chapter 10 The Markets for Labour and other Factors of Production.

Documents

Transcript of PowerPoint to accompany Chapter 10 The Markets for Labour and other Factors of Production.