Transcript Chapter 14

Chapter 14
Markets for Factor Inputs
Topics to be Discussed
 Competitive Factor Markets
 Equilibrium in a Competitive Factor
Market
 Factor Markets with Monopsony Power
 Factor Markets with Monopoly Power
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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
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Competitive Factor Markets
 Demand for a Factor Input When Only
One Input Is Variable
Factor demands are derived demand
 Demand
for an input that depends on, and is
derived from, both the firm’s level of output and
the cost of inputs.
 Demand for computer programmers derived
from how much software Microsoft expects to
sell
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Factor Input Demand – One
Variable Input
 Assume firm produces output using two
inputs:
Capital (K) and Labor (L)
Hired at prices r (rental cost of capital) and
the w (wage rate)
K is fixed (short run analysis) and L is
variable
Firm must decide how much labor to hire
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Factor Input Demand – One
Variable Input
 How does a firm decide if its profitable to
hire another worker?
If the additional revenue from the output of
hiring another worker is greater than its cost
Marginal Revenue Product of Labor (MPRL)
 Additional
revenue resulting from the sale of
output created by the use of one additional unit
of an input
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Factor Input Demand – One
Variable Input
 The incremental cost of a unit of labor is
the wage rate, w
 Profitable to hire more labor if the MRPL
is at least as large as the wage rate, w
 Must measure the MRPL
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Factor Input Demand – One
Variable Input
 MRPL is the additional output obtained
from the additional unit of labor,
multiplied by the additional revenue from
an extra unit of output
 Additional output is given by MPL and
additional revenue is MR
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Factor Input Demand – One
Variable Input
R
MRPL 
w hereR is revenue and L is labor
L
Q
R
MPL 
and MR 
L
Q
R R  Q 



L Q  L 
MRPL  ( MPL )(MR)
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Factor Input Demand – One
Variable Input
 In a competitive market MR = P
 This means, for a competitive market
MRPL  ( MPL )(P )
 Graphically, diminishing marginal returns,
MPL falls as L increases
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Marginal Revenue Product
Wages
($ per
hour)
Competitive Output Market (P = MR)
Monopolistic
Output Market
(P < MR)
MRPL = MPLx P
MRPL = MPL x MR
Hours of Work
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Factor Input Demand – One
Variable Input
 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
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Hiring by a Firm in the Labor
Market
Price of
Labor
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*.
w*
SL
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.
MRPL = DL
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Quantity of Labor
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Factor Input Demand – One
Variable Input
 Quantity of labor demand changes in
response to the wage rate
 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.
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A Shift in the Supply of Labor
Price of
Labor
w1
S1
w2
S2
MRPL = DL
L1
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L2
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Quantity of Labor
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Factor Input Demand – One
Variable Input
 Comparing Input and Output Markets
MRPL  (MPL )(MR)
and at profit maximizing
number of workers MRPL  w
(MPL )(MR)  w
MR  w MPL
w MPL  MC of production
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Factor Input Demand – One
Variable Input
 Both the hiring and output choices of the
firm follow the same rule
Inputs or outputs are chosen so that
marginal revenue from the sale of output is
equal to marginal cost from the purchase of
inputs
True for both competitive and noncompetitive
markets
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Factor Input Demand – Many
Inputs
 In choosing more than one variable input,
a change in the price of one input
changes the demand for the others.
 Scenario
Producing farm equipment with two variable
inputs:
 Labor
 Assembly-line
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machinery
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Factor Input Demand – Many
Inputs
 If the wage rate falls
More labor will be demanded even if amount
of machinery does not change
MC of producing farm equipment falls
Profitable for firm to increase output
Will invest in additional machinery to expand
production
MRPL will shift right, quantity of labor
demanded increases
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Factor Input Demand – Many
Inputs
 If wage rate is $20/hr, firm hires 100 worker
hours – point A
 Wage rate falls to $15/hr
 MRPL > W, form demands more labor
 MRPL1 is demand for labor w/machinery fixed
 Increased labor causes MPK to rise
encouraging the firm to rent more machinery
 MPL increases
 MRPL curve shifts right, firm uses 140 hrs labor
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Factor Input Demand – Many
Inputs
Wages
($ per
hour)
When the wage rate falls to $15, the
MRP curve shifts, generating a new
point C on the firm’s demand for
labor curve.
Thus A and C are on the demand for
labor curve, but B is not.
A
20
C
15
B
DL
10
MRPL1 MRPL2
5
0
40
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120
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Hours of Work
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Market Demand Curve
 All firms demand for labor vary
substantially
 Assume that all firms respond to a lower
wage
All firms would hire more workers.
Market supply would increase.
The market price of the product will fall.
The quantity demanded for labor by the firm
will be smaller.
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Industry Demand for Labor
Firm
Wage
($ per
hour)
15
15
10
10
MRPL2
MRPL1
5
0
5
50
100 120 150 Labor
(worker-hours)
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Industry
Wage
($ per
hour)
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Horizontal sum if
product price
unchanged
Industry
Demand
Curve
L0
DL1
DL2
L1
L2
Labor
(worker-hours)
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The Industry Demand for Labor
 If wage rate falls for all firms in industry,
all firms will demand more labor
 More industry output and supply for
output will rise causing price to fall
 The increase in labor is smaller than if
the product price were fixed
 Adding all labor demand curves in all
industries gives market demand curve for
labor
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The Demand for Jet Fuel
 Jet fuel is a factor (input) for airlines
 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
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The Demand for Jet Fuel
 Airlines responded to higher prices in the
1970’s by reducing the quantity of jet fuel
used.
 Output of airlines (ton-miles) increased
by 29.6% & jet fuel consumed rose by
8.8%.
 Effect of increased fuel costs on airlines
depends on ability to cut fuel usage by
reducing weight
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The Demand for Jet Fuel
 Price elasticity of demand for jet fuel
depends on ability to conserve fuel and
elasticities of demand and supply of
travel
 The demand for jet fuel impacts the
airlines and refineries alike
 The short-run price elasticity of demand
for jet-fuel is very inelastic
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Short-run Price Elasticity
of Demand for Jet Fuel
Airline
Elasticity
American
Continental
Northwest
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-.06
-.09
-.07
Airline
Delta
TWA
United
Chapter 14
Elasticity
-.15
-.10
-.10
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The Demand for Jet Fuel
 There is no good substitute for jet fuel
 Long run elasticity of demand is higher,
however, because airlines can eventually
introduce more energy-efficient airplanes
 Can show short and long-run demands
for jet fuel
MRPSR is much less elastic than long run
demand since it takes time to substitute
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The Short- and Long-Run
Demand for Jet Fuel
Price
MRPSR
MRPLR
Quantity of Jet Fuel
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The Supply of Inputs to a Firm
 In competitive market firm can purchase
as much of an input it wants at the
market price
Determined by supply/demand of input
market
 Input supply to a firm is perfectly elastic
 Firm small part of market so does not
affect market price
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A Firm’s Input Supply in a
Competitive Factor Market
Price
($ per
yard)
Market Supply
of fabric
S
Price
($ per
yard)
Supply of
Fabric Facing Firm
Market Demand
for fabric
10
10
ME = AE
D
100
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Yards of
Fabric (thousands)
Chapter 14
Demand
for Fabric
50
MRP
Yards of
Fabric (thousands)
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The Supply of Inputs to a Firm
 Remember that the supply curve is the
average expenditure curve
Supply curve representing the price per unit
that t firm pays for a good
 Also, marginal expenditure curve
represents the firm’s expenditures on an
additional unit that it buys
Analogous to MR curve in output market
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The Supply of Inputs to a Firm
 When factor market is competitive,
average expenditure and marginal
expenditure are identical horizontal lines
 How much of the input should the firm
purchase?
As long as MRP > ME, profit can be
increased by buying more input
When MRP < ME, benefits lower than costs
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The Supply of Inputs to a Firm
 Profit maximization required the marginal
expenditure to be equal to the marginal
revenue product
ME = MRP
 A special case of competitive output
market showed profit maximization where
ME = w
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The Market Supply of Inputs
 The market supply for factor inputs is
upward sloping
Examples: jet fuel, fabric, steel
 The market supply for labor may be
upward sloping and backward bending
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The Supply of Inputs to a Firm
 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
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The Market Supply of Inputs
 The Supply of Labor
Higher wages encourage workers to
substitute work for leisure
 The
substitution effect
Higher wages allow the worker to purchase
more goods, including leisure which reduces
work hours
 The
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income effect
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Competitive Factor Markets
 The Supply of Labor
If the income effect exceeds the substitution
effect the supply curve is backward bending
By using utility and budget line graph, we can
show how the supply curve can be backward
bending
 Can
show how the income effect can exceed
the substitution effect
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Substitution and Income Effects
of Wage Increase
R
720
Income
($ per
day)
Worker initially chooses point A:
•16 hours leisure, 8 hour work
•Income = $80
w = $30
Wage increases to $30.
New budget line RQ
•19 hours leisure, 5 hours work
•Income = $150
Income effect overrides
substitution effect
240
P
C
w = $10
B
A
Q
0
8
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16
19
24
Substitution effect
Income effect
Hours of
Leisure
40
Backward-Bending Supply of
Labor
Wage
($ per
hour)
Supply of Labor
Income Effect >
Substitution Effect
Income Effect <
Substitution Effect
Hours of Work
per Day
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Labor Supply for One- and
Two-Earner Households
 In twentieth century the percent of females in
labor force has increased
 1950 – 34%
 2001 – 60%
 Compared the work choices of 94 unmarried
females w/work decisions of heads of
households and spouses in 397 families
 Can describe work decisions by calculating elasticity
of supply for labor
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Elasticities of Labor Supply
(Hours Worked)
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Labor Supply for One- and
Two-Earner Households
 When higher wage rate leads to fewer
hours worked
Labor supply curve is backward bending
Income effect outweighs the substitution
effect
Elasticity of labor supply is negative
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Equilibrium in a Competitive
Factor Market
 Competitive factor market is in
equilibrium when the prevailing price
equate quantity supplied and quantity
demanded
 Since workers are well informed, all
received the same wage and generate
identical MRPL when employed
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Equilibrium in a Competitive
Factor Market
 If output market is perfectly competitive,
demand curve for an input measures
benefit consumers place on use of input
in production process
 Wage rate also reflects the cost of the
firm and to society of using additional unit
of input
 At equilibrium, MBL = MCL = wage
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Equilibrium in a Competitive
Factor Market
 When output and input markets are both
perfectly competitive, resources are used
efficiently
Maximize TB – TC
 Efficiency requires MRPL equals the
benefit to consumers of the additional
output, given by (P)(MPL)
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Equilibrium in a Competitive
Factor Market
 If output market is not competitive
MRPL = (P)(MPL) no longer holds
(P)(MPL) > MRPL
At equilibrium number of workers, marginal
cost to firm, wM, is less than marginal benefit
to consumers vM.
Although firm maximizes profits, output is
below efficient level and uses less than
efficient level of output
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Equilibrium in a Competitive
Factor Market
 If output market is not competitive
Although firm maximizes profits, output is
below efficient level and uses less than
efficient level of output
Economic efficiency would be increased if
more laborers were hired and more output
produced
 Gains
to consumers would outweigh firm’s lost
profit
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Labor Market Equilibrium
Monopolistic Output Market
Competitive Output Market
Wage
Wage
SL = AE
SL = AE
wC
A
vM
wM
B
P * MPL
DL = MRPL
LC
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Number of Workers
Chapter 14
DL = MRPL
LM
Number of Workers
50
Equilibrium in a
Competitive Factor Market
 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.
The economic rent associated with the
employment of labor is the excess of wages
paid above the minimum amount needed to
hire workers
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Economic Rent
Wage
SL = AE
A
Total expenditure (wage) paid
is 0w* x AL*
w*
Economic Rent
DL = MRPL
B
Economic rent is ABW*
0
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Equilibrium in a
Competitive Factor Market
 Land: A Perfectly Inelastic Supply
Occurs when land for housing or agriculture
is fixed, as least in short run
Its price is determined entirely by demand
When demand increases, rental value per
unit increases and total land rent increases
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Land Rent
Price
($ per
acre)
Supply of Land
When demand increases,
price and economic rent
increase.
s2
s1
D2
Economic
Rent
D1
Number of Acres
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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.
 Lead to severe shortages in skilled
workers
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Pay in the Military
 Rank structure has stayed the same
Pay increases determined primarily by years
of service
Similarly, officers with differing skill levels
often paid similar salaries
Many skilled workers leave the army since
salaries in private sector much higher
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The Shortage of
Skilled Military Personnel
Wage
SL
w*
w0
Shortage
DL = MRPL
Number of Skilled Workers
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Pay in the Military
 Solution
Selective reenlistment bonuses targeted at
skilled jobs where there are shortages
With increases in demand for skilled military
jobs, we should expect the military increase
reenlistment bonuses and other market
based incentives
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Factor Markets with Monopsony
Power
 We showed before that many firms have
monopsony buying power
US automobile companies as buyers of parts
and components
 Assume
The output market is perfectly competitive.
Input market is pure monopsony.
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Factor Markets with Monopsony
Power
 Marginal and Average Expenditure
When choosing to purchase a good, increase
amount purchased until the marginal value
equals marginal expenditure
Price paid for good is average expenditure
and is equal to marginal expenditure
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Factor Markets with Monopsony
Power
 Since a monopsonist pays the same price for
each unit, the supply curve is the average
expenditure curve
 Upward sloping since deciding to buy an extra
unit raises price must pay for all units
 For profit maximizing firm, marginal expenditure
curve lies above the average expenditure curve
 Firm must pay all units the higher price, not just
last unit hired
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Marginal and Average
Expenditure
Marginal
Expenditure (ME)
Price 20
(per unit
of input)
C
15
wc
SL = Average
Expenditure (AE)
w* = 13
10
D = MRPL
•Hires where ME = MRP
5
0
•LC is competitive market level
1
2
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3
4
L*
5
6 Units of Input
Lc
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Factor Markets with Monopsony
Power
 Examples of Monopsony Power
Government
 Soldiers
 Missiles
 B2
Bombers
NASA
 Astronauts
Company town
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Monopsony Power in the Market
for Baseball Players
 Baseball owners operate a monopsonistic
cartel
Reserve clause prevented competition for
players
Each player tied to one team for life
Once drafted, could not play for another team
unless rights were sold
Baseball owners has monopsony power in
negotiating new contracts
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Monopsony Power in the Market
for Baseball Players
 During 1960’s and 70’s, players’ salaries
were far below market value of MP
 If competitive market
Players receiving $42,000 in 1969 would
have instead received a salary of $300,000 in
1969 dollars.
 Strike in 1972 followed by lawsuit
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Monopsony Power in
the Market for Baseball Players
 In 1975, players could become free agents after
playing for a team for six years
 Reserve clause no longer in effect
 Market became more competitive
 From 1975 to 1980, expenditures on player’s
contract went from 25% of team expenditures to
40%
 Average player salary doubled in real terms
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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.
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Monopoly Power of Sellers of
Labor
Wage
per
worker
•Demand w/no monopsony power.
•Supply of union labor w/no monopoly power.
•Labor market competitive with L* workers
hired at wage w*
•Demand equals Supply
A
SL
w*
DL
MR
L*
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Number of Workers
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Monopoly Power of Sellers of
Labor
 The union’s monopoly power allows it to
choose any wage rate and quantity
supplied
If wanted to maximize number of workers
hired, would choose competitive outcome.
If wanted to obtain higher wages, would
restrict membership to L1 workers to get hirer
wage w1
Those who find jobs are better off. Those
without jobs are worse off.
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Monopoly Power of Sellers of
Labor
 Is restrictive union worthwhile?
Yes, if maximizing economic rent is the goal.
The union acts like a monopolist restricting
output to maximize profits
Rent for a union represents the wages
earned in excess of opportunity cost.
Union must choose workers so that the
marginal cost equals the marginal revenue
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Monopoly Power of Sellers of
Labor
 Cost is the marginal opportunity cost
since it is a measure of what an employer
has to offer an additional worker to get
him or her to work for the firm.
 But, the wage necessary to encourage
additional workers to take jobs is given
by supply curve for labor, SL
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Monopoly Power of Sellers of
Labor
 Rent maximizing combination of wage
rate and number of workers is where MR
crosses supply.
 Price comes from the demand curve
 This gives a combination of L1 and w1
 Shaded area below the demand curve
and above the supply curve to the left of
L1 is the economic rent that all workers
receive
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Monopoly Power of Sellers of
Labor
Wage
per
worker
Maximizing rents to workers
means choosing labor where
MR crosses S.
Wage comes from demand.
w1
w2
SL
Economic
Rent
A
w*
DL
MR
L1
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L2
L*
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Factor Markets with Monopoly
Power
 Rent maximizing policy can help nonunion
workers if they can find nonunion jobs.
 If jobs are not available, this could cause too
much of a distinction between winners and
losers
 Looking back at graph, an alternative objective
is to maximize aggregate wages that all union
members receive
 This gives L2 and w2
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Unionized and Non-unionized
Workers
 When union uses monopoly power, some
workers are not hired. Those workers
either try to find nonunion jobs or choose
initially not to join union.
 Assume the total supply of workers is
fixed – supply is SL
 Demand for unionized labor is DU and
demand for non-unionized labor is DNU
 Total market demand is DU + DNU = DL
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Unionized and Non-unionized
Workers
 What if union chooses to raise wage above
competitive wage w*, to wU
 Number of workers hired by the union falls by
amount LU
 As these workers find employment in nonunion
sector, wage rate in that sector adjusts until
labor market is in equilibrium
 At new wage rate, wNU, additional numbers
hired in sector is LNU
 Equals number of workers who left unionized sector
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Wage Discrimination in Labor
Market
SL
Wage
per
worker
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 non-unionized sector
must fall from w* to wNU
wU
w*
wNU
DU
LU
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DNU
LMU
DL
Number of Workers
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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.
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The Decline of Private Sector
Unionism
 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.
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The Decline of Private Sector
Unionism
 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.
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Wage Inequality – Have Computers
Changed the Labor Market?
 1950 - 1980
Relative wage of college graduates to highschool graduates hardly changed
 1980-1995
The relative wage grew rapidly
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Wage Inequality – Have Computers
Changed the Labor Market?
 In 1984, 25.1% of all workers used
computers
 1993 – 45.8%
 2001 – 53.5%
For managers and professionals it was over
80%
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Wage Inequality – Have Computers
Changed the Labor Market?
 Percent change in use of computers
College degrees
 1984
- 1993 -- 42 to 82%
Less than high school degree
 11%
- from 5% to 16%
With high school degree
 21%
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- from 19 to 40%
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Wage Inequality – Have Computers
Changed the Labor Market?
 Growth in wages – 1983 to 1993
College graduates using computers – 11%
Non-computer users – less than 4%
Statistical analysis show that overall the
spread of computer technology is responsible
for nearly half the increase in relative wages
during this period
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Wage Inequality – Have Computers
Changed the Labor Market?
 Is this increase in relative wages of
skilled workers bad?
Although growing inequality can
disadvantage low-wage workers, it can also
motivate workers
 Opportunities
for upward mobility through highwage jobs have never been better.
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Wage Inequality – Have Computers
Changed the Labor Market?
 Should you complete a college degree?
In 2000, college graduates age 25 and over
earned nearly $400 more per week than
those with only a high school diploma
This is a real wage increase for college grads
and a real wage decrease for high school
dropouts compared to 1979.
Unemployment rate among college grads is
four times less than in high school drop outs
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