Wages and Employment in Perfect Competition
The end of labor is to gain leisure.
-AristotleSlide 1 of 28
Resources are used to produce goods and services
Natural Resources such as Land Entrepreneurialism
Labor Capital
In studying resources, we’ll focus on this one…it is the largest of the four,
making up 70% of all of our income.
Resources can be grouped into these
four categories.
When they are used to make goods and services, they earn
income.
Slide 2 of 28
In this module, we’ll analyze labor markets
We’ll start by discussing the value of labor…we’ll call that the
Marginal Revenue Product (MRP).
We’ll then discuss the cost of labor…we’ll call that Marginal
Factor Cost (MFC).
We’ll then use these two metrics to determine how many employees a
firm will hire…that is called the “hiring decision”
But first, let’s set up an assumptions….
MRP
MFC
Slide 3 of 28
Assume we have a perfectly competitive labor market
Let’s first assume that firms demanding resources are competing in a perfectly
competitive market.
That means the firms demanding resources have no impact on price
or quantity in that market.
Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly
In other words, just because you hire someone, that doesn’t affect the wages of all of those employees.
A good example of this might be cashiers. I think it is safe to say that
they all generally make the same wage.
In the next module, we’ll get rid of this assumption… and analyze an imperfectly competitive labor
market.Slide 4 of 28
The rule for employing resources
Much like everything else we have studied, resources are demanded (or “hired”) to the extent that their benefit
outweighs their cost.
In technical terms, we say that any resource for which Marginal Revenue
Product (MRP) exceeds Marginal Factor Cost (MFC) will be hired.
Rule for hiring resource:
Continue to hire them as long as MRP>MFC
So what are MRP and MFC? Let’s explore them on the next set of slides…Slide 5 of 28
Marginal Revenue Product is comprised of two things
The productivity of that resource in helping to make a good or service1
The market value (price) of the good or service that the resource helps produce2
This concept refers to Marginal Product (MP)
This concept refers to Marginal Revenue (MR)
A resource that is highly productive in contributing to a highly valued product
will be in great demand!
2011 earnings: $195 million!
U2 has been highly productive at producing a highly demanded good. As such, they command a huge wage.
Slide 6 of 28
Other examples of resources that are highly productive in producing a valuable product
Professional athletes
Oil Rigs Mad Scientists!?!
Slide 7 of 28
Combining the MP and MR concepts help determine how much of a resource is demanded
These concepts can be analyzed in conjunction by
looking at a resource’s Marginal Revenue Product
For these examples, we’ll discuss labor resources, but this could be any
resource (land, capital, etc)
Slide 8 of 28
Calculating MRP
That means the first unit of labor hired has an MRP of $14
In other words, the first hired employee adds $14 to revenues
They produce 7 units (MP) and each unit sells for $2
The second unit of labor hired has an MRP of $12
As we have studied, diminishing marginal returns has set in!
Each successive employee hired brings in less revenue.
Note that the first person hired can make 7 units.
Also note that those units can sell for $2 each.
That is not because these extra people are poor workers…it is because diminishing marginal returns is
occurring.
Perhaps, after a certain point, the workplace runs out of tools (or space)
and successive employees stand around waiting for their turn.
Slide 9 of 28
MRP data, seen graphically
This curve is downward sloping because of
Diminishing Marginal Returns
Slide 10 of 28
Recall, the rule for hiring resources: Continue as long as MRP>MFC
Employers decide to add (hire) an additional resource if that resource adds more to revenue than it does to costs.
In other words, they hire any resource where that resource’s MRP is greater than its Marginal Factor Cost (MFC)
Again, for these examples, we’ll discuss labor resources, but this could
be any resource (land, capital, etc).
On the next slide, we’ll calculate the MFC in a perfectly competitive labor market…
Slide 11 of 28
Marginal resource costs are determined by each resource’s wage
Note that the first unit of labor hired cost $6/hr.
Each successive unit of labor also costs $6.
Let’s assume employees cost $6 per hour.
In reality, wages for employees doing the same work may differ slightly. The perfectly competitive
labor market assumption means they do not.
That means that after you hire the first employee, total costs are $6 per hour.
The MFC measures the amount that employee has INCREASED total
costs…in this case, it is $6.
Slide 12 of 28
So how many units of labor should this firm hire?
The first employee has an MRP of $14 and an
MFC of $6. Clearly, she is a good hire.
The second employee also has an MRP of
$12 and an MFC of $6. Clearly, he is a good
hire.
The third employee also has an MRP of $10 and costs $6.
Clearly, she is a good hire.
The fourth employee also has an MRP of $8 and costs $6. Clearly, he is an attractive hire.
The fifth employee also has an MRP of $6
and costs $6. He is the last attractive hire.Each additional
employee would cost more than they
generate and would not be hired.
It depends on the wage. Let’s assume the market has set the wage at $6
Each employee costs $6/hr. Therefore, the
MFC curve is displayed here.
Slide 13 of 28
We completed this analysis…. the hiring decision
We asked ourselves, “How many
employees should I hire?”
We then compared each employees MRP
and MFC.
After doing so, we determined that the first 5 employees
have an MRP that is greater (or equal to)
MRC.
In this case, we’d hire 5 employees!
Slide 14 of 28
Here we see how a firm makes a decision (how
many people to hire) based on marginal benefits (MRP) and marginal costs (MFC).
That is a key learning outcome!
MRP=Demand
Given this information, we see that if wages are $14, one
employee is hired.
Given this information, we see that if wages are $12, two
employees are hired.
Given this information, we see that if wages are $10, three
employees are hired.
If that is true, then the MRP represents the relationship
between employees demanded and their price.
In other words, the MRP curve represents demand for labor.
Slide 15 of 28
MFC=Supply
Given this information, we see that at $6, the employer may hire as many workers as they
want.
This refers to the idea of a perfectly competitive labor
market.
Regardless of how many employees the employer hires,
they will not impact price or quantity in that market.
If that is true, then the MFC represents the relationship
between employees supplied and their price.
In other words, the MFC represents the supply of labor.
We’ll analyze imperfectly competitive labor markets in a future moduleSlide 16 of 28
Once again, we look to supply and demand
If MRP=demand for labor and MFC =
supply of labor, then determining the
number of resources to hire is done by
comparing supply and demand!
Slide 17 of 28
So why do some resources command such huge wages?
Because their Marginal Revenue Product is so high. They generate A LOT of revenue!
Is it fair? Socially, I don’t know, but economically, it is.
Each resource (including you) should be paid at or near your MRP.
Are you?
Each of these resources is very productive at producing a highly demanded product.
Therefore, they command very high wages. Put another way…Their MRP exceeds a very high MFC.
Slide 18 of 28
May 2011-May 2012Floyd Mayweather $85 millionManny Pacquaio $62 million
Tiger Woods $59.4 millionLeBron James $53 millionRoger Federer $52.7 millionKobe Bryant $52.3 million
Phil Mickelson $47.8 millionDavid Beckham $46 million
Cristiano Ronaldo $42.5 millionPeyton Manning $42.4 million
Real world application of High Marginal Revenue Product
Can you
guess
the top five?Top athletes are paid
so much because they
have a very high MRP.
Slide 19 of 28
Individual Exercise
How many employees should be hired? _____________
What do you think your MRP (per day) is where you work?_________
Fill in the blank cells and answer the questions below. Click to see the answers
5
Slide 20 of 28
Over time…things can change!
AS time moves on, demand for a resource can change.
Perhaps that is due to changes in productivity, fashion, or some
other factor.
When these changes occur, it can affect the hiring decision.
Slide 21 of 28
Many factors affect resource demand
As the characteristics of a resource change, it’s
MRP can shift.
Increased demand for a resourceDecreased demand for a resource
The last few slides describes some factors that can affect resource
demand.
In other words, they are ‘determinants of
resource demand”.
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Examples of determinants of demand for resources
• Changes in product demand– An increase in a product’s demand will increase the
demand for resources to make it
• Changes in productivity– An increase in a resource’s productivity will increase
its demand
• Changes in prices of other resources– Results will vary depending on whether the change in
price is for a good that is a substitute or a compliment.
71%
’90-’10
201%
’90-’10
Has the use of ethanol in gas affect prices of
corn products?
Change in employment
As our population ages, we have seen an increase in demand for health care workers.
Change in real spending on equipment and software
As technology has made workers more productive, demand for computers and
software (capital) has escalated.
The next few slides will describe these differences
Slide 23 of 28
Demand for a resource can be affected by prices of substitute resources
MRC
2 3
Since total costs are equal, I suspect that you would be indifferent as to which scenario is better.
MRC
2 3
Demand for labor Demand for capital
Assume you own a landscaping company and these are your alternatives. In each alternative, the same amount of work can be accomplished.
But if the price of labor went up, would you still be indifferent or would the second scenario be more attractive?
Slide 24 of 28
Real world example: the ATM
Originally the ATM was implemented because they can handle transactions at a fourth
the cost of a human teller.
At a lower cost, ATMs were substituted for human tellers.
Eventually, their popularity caught on to the extent that
now banks charge fees.
Slide 25 of 28
Demand for a resource can be affected by prices of complementary resources
MFC
2000 3000
A decrease in computer prices has resulted in an increase in demand for a complimentary
resource (computer programmers)
With declining computer costs, demand for computer
programmers has skyrocketed.
In fact, demand for computer programmers increased 243%
between 1990 and 2010.
Assuming this Marginal Factor Costs, a higher MRP will result in more workers being hired!
Slide 26 of 28
In Summary
Producers employ (hire) resources to the extent that they are beneficial.
This benefit can be measured by analyzing the Marginal Revenue Product
(MRP) and the Marginal Factor Cost (MFC) of a resource.
When the MRP is greater than or equal to the MFC, that resource Is attractive.
Keep in mind however, that over time, changes in a resources MRP or MFC can
occur…changing the hiring decision.
MRPMFC
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Credits
Slide 1: http://www.flickr.com/photos/53558245@N02/4978362207/
Slide 3: http://www.flickr.com/photos/kylemacdonald/5341665045/
Slide 4: http://www.flickr.com/photos/bioversity/8554603872/
Slide 5:http://www.flickr.com/photos/madebytess/276639499/
Slide 6: http://commons.wikimedia.org/wiki/File:2005-11-21_U2_@_MSG_by_ZG.JPG
Slide 7: http://commons.wikimedia.org/wiki/File:LeBron_James_2.jpg, , http://commons.wikimedia.org/wiki/File:Oil_Platform_Emmy_HB_CA_Photo_D_Ramey_Logan.jpg
http://commons.wikimedia.org/wiki/File:Mad_scientist.svg
Slide 17: http://commons.wikimedia.org/wiki/File:Tiger_Woods_2007.jpg, , http://commons.wikimedia.org/wiki/File:Rihanna_5,_2012.jpg
http://commons.wikimedia.org/wiki/File:Alan_Greenspan,_IMF_116greenspan2lg.jpg
Slide 21: http://www.flickr.com/photos/extremeezine/3277771465/
Slide 25: https://commons.wikimedia.org/wiki/File:ATM_750x1300.jpg
Slide 26: http://doctormo.deviantart.com/art/Computer-Programmer-Ink-346207753
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