Transcript factor markets 2010

Factor Markets
Frederick
University
2011
Factor Markets
Production Factors:
 Labor (L)
 Land (N)
 Capital (K)
Economic
Decision-Makers
government
Final goods and
services
L, N, K
Primary income
households
firms
Income from Production
Factors
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labor
land
capital
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wage and salary
rent
dividend
interest
Factor Markets
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Firms hire production factors from households
Households receive factor income from firms
Households make decisions on supply of
production factors
Firms make decisions what factors to buy
(and how much of each) and what goods
(and how much) and how to produce
Demand for Production
Factors
Derived Demand – the demand for
production factors depends on the
demand for the products and services,
produced with these factors
Demand for Production
Factors
The firms maximize profits when
MC = MR
From the perspective of the labor market
MC = marginal cost of hiring one more
worker = MCL
From the perspective of the capital
market, MC = MCK
Demand for Production
Factors
From the perspective of the labor market
MR is the extra revenue derived when the
firm sells MPL =
MPL x P of the product =
MRPL – marginal revenue product of labor
Demand for Production
Factors
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The firm will hire workers until
MCL = MRPL
The firm will hire capital until
MCK = MRPK
The firm will hire land until
MCN = MRPN
Demand for Labor
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Questions:
How do firms decide how much labour
to hire?
Why do some jobs pay more than
others?
What is the effect of unions?
The Law of Diminishing Returns
total, marginal and average product
L
0
1
2
3
4
5
6
7
TPL
0
15
32
57
80
95
108
119
MPL
APL
15
17
25
23
15
13
11
15
16
19
20
19
18
17
Demand for Labor
we assume perfect competition in the labor market
pL 125
L
MPL P
MRPL
MRPL = DL
115
3
25
5
125
75
4
23
5
115
5
15
5
75
55
6
13
5
65
7
11
5
55
8
9
5
45
9
7
5
35
5
7
3
4
L
10
5
5
25
The demand for labor is determined by the MRPL
The labor demand curve is the MRPL curve
Factors, determining the
demand for labor
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P – price of the product of labor
Productivity – marginal labor
productivity (MPL)
Power – market power of sellers and
buyers
Perks
Prejudice
Policies of firms, unions, government
Factors Determining the Demand
for Production Factors
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Elasticity of demand for the product
Marginal factor productivity
Relative importance of the factor
Factor substitutability
Technological Choice and
Factor Substitutability
w
w
F
If the relative price of labor falls, the firm
hires more workers. Along with the increase
in the quantity of labor, its marginal
productivity falls
F’
From point F to point F’ the
substitution effect motivates
the firm to hire more labor
(it is relatively cheaper)
After point F’ MPL/PL < MPK/ Pk
и and the firm substitutes relatively
W”
F”
cheaper capital for the relatively more
expensive labor – a switch a to capital
L
intensive technology
L
The level of employment is the same at w и w”
Income Effect and Substitution
Effect
P
Normal
goods
Income
effect
Q
Price
effect
Q
Inferior Goods
regular
Giffen
goods
Q
Q
Q
Q
Q
Q
Q
Q
Q = const
Individual Supply of Labor
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Labor supply means a reduction of
leisure demand
With the increase in W, the quantity
of labor supplied increases
The opportunity cost of labor
increases, as well – the price of
leisure
The increase in the price of leisure
reduces the quantity of leisure
demanded
Income effect: w   leisure price 
 quantity of leisure demanded 
 quantity of labor supplied 
Income effect: w   real income 
 quantity of leisure demanded 
 quantity of labor supplied 
W
The income effect
overwhelms the
substitution effect
Hours of work
Factors, Determining
Aggregate Labor Supply
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Population
Age structure
Share of active population
Share of labor force in active population
Work time
Institutions
Factors, Determining the
Individual Labor Supply
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Labor mobility
Rate of employment
Living standards
Institutions
Price elasticity of labor supply
and price of labor
PL
DL
DL’
SL
ЕS = 0
PL
W2
w
W1
Pure economic rent
L
PL
∞ > Es > 0
DL
L
ES =∞
SL
E
L
The price of labor has two components
SL
L1
L2
Reservation
wage
L
L
1) Transfer earnings
2) Pure economic rent
The Capital Market
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Interest and rate of interest
Nominal and real interest rate
Time value of money
Present value (PV) vs. Future Value (FV)
Calculating the Present Value Discounting
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PV = € 100
i = 10%
FV = € 110
110 = 100 + 0.1 x 100 = 100 (1 + 0.1)
FV = PV (1 + i)
After the second period
FV2 = 110 + 0.1 x 110 = 110 (1 + 0.1)
110 = 100 (1 + 0.1)
FV2 = 100 (1 + 0.1)2
FV = PV (1 + i)t
PV = FV/((1 + i)t
The Price of an Interest
Bearing Asset
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Present Value of a Bond
PV = ∑ [ r/ (1+i)n ]+ P/ (1+i)n
Present value of an asset
with varying
returns
PV = R1/(1+i) + R2/(1+i)2 + …
…+ Rn/(1+i)n
Present value of an asset with constant
returns
PV = R/i
Price of land – capitalized rent
The Capital Budgeting
Decision
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The capital budgeting decision – a long term
decision
Methods of Ranking Investment Proposals
Payback method – calculating the time,
required to recoup the initial investment
Internal Rate of Return (IRR) - determining
the yield of an investment (calculating the
interest rate equating the cash outflows and
the cash inflows)
Net Present Value (NPV) – discounting the
future inflows vs. the initial investment