Chapter 16: Competitive Input Markets

Transcription

1 Chapter 16: Competitive Input Markets Competitive Input Market Market Supply Firm s Input Demand Perfectly- Competitive Equilibrium Economic Rent Ricardian Rent Comparative Statics Slutsky Equation Minimum Wage Outline and Conceptual Inquiries Deriving the Market Supply Curve for Labor Application: Implications of Restricting US Immigration on Farm Labor Supply Understanding Economic Rent Do you have high or low economic rent? Land Rent: The Henry George Single-Tax Scheme Should only land be taxed? Application: Optimal Commodity Taxes based on Rents Ricardian Rent: Input Demand is a Derived Demand from the Output Market Do high store rents result in high product prices? Marginal Productivity Theory of Factor Demand One-Variable-Input Case: VMP L = w as the Labor Demand Function Two-Variable-Input Case: Deriving Input Demands from VMP s Functions Application: Firm Hierarchies and Wage Rates Establishing Perfectly Competitive Equilibrium in the Factor Market Appendix to Chapter 16 Investigating Comparative Statics of Input Demand One-Variable-Input Case Two-Variable-Input Case: Substitution Effect Do firms substitute one input for another given an input price change? Will a firm alter its output given an input price change? Responsiveness of Demand to Input Price Change Application: Minimum Wage Are you affected by the minimum wage? Should teenagers be in favor of or opposed to an increase in the minimum wage?

2 Summary 1. The market supply curve for labor is derived by the horizontal summation of individual workers supply curves. 2. Economic rent is that portion of total payment to a factor that is in excess of what is required to keep the factor in its current occupation. The price at which a factor is just willing supply is called the reservation price. 3. A firm will employ the profit-maximizing level of a variable input where the VMP of the input is set equal to its price. This corresponds to the tangency of the isoprofit line with the production function. 4. For one variable input, the VMP curve is the firm s demand curve for the input. For two or more inputs, the VMP functions are solved simultaneously for the input demand functions. 5. A perfectly competitive input market is characterized by many buyers and sellers of an input. Each firm can buy (hire) all the inputs it wants at the market price (wage). Each supplier of the input can offer as much of the input it wants at the given price (wage). 6. (Appendix) The total effect of an input price change may be decomposed into the substitution and output effects. The substitution effect measures a change in the level of an input given a change in its price, holding output constant. The output effect is the change in level of an input when the output changes as a result of a change in the input price. 7. (Appendix) The minimum wage is a price floor below which the wage rate cannot fall. If the minimum wage is below the equilibrium wage rate, it has no effect on the market. However, if it is set above this equilibrium wage rate, it will influence the market level of the input. The actual effect is an empirical question. Key Concepts average input cost (AIC) economic rent isoprofit line labor market supply curve marginal input cost (MIC) marginal revenue product (MRP) minimum wage output effect price efficiency reservation wage Ricardian rent substitution effect total input cost (TIC) value of the marginal product (VMP)

3 Key Equations VMP L = w The profit-maximization condition for a perfectly competitive firm in the output market is to equate the value of the marginal product for a variable input (labor) to its associated price (wage). MRP L = w The profit-maximization condition for a firm is to equate the marginal revenue product for a variable input (labor) to its associated price (wage). The total effect on an input (labor) from its own price (wage) change may be decomposed into the substitution and output effects.

4 TESTING YOURSELF Multiple Choice 1. In the following figure, what is the economic rent? v 12 X S a. $800 b. $150 c. $200 d. $ X D X 2. Economic rent will be as labor supply becomes. a. Smaller; more inelastic b. Larger; more inelastic c. Unchanged; unitary d. Larger; more elastic. 3. Ricardian rent a. Is equal to the profit accruing to an input b. In equilibrium, will be equal for all inputs c. In equilibrium, will be zero d. Is zero in the long run. 4. Ely Chair Company sells wooden rocking chairs in a perfectly competitive market at a price of $45 each. The marginal product of adding another worker is 2 chairs per day. What is the value of marginal product of adding another worker? a. $22.50 b. $45 c. $90 d. $ A profit-maximizing perfectly competitive firm will employ an input up to where the a. Marginal products of each input are equal b. Marginal product of each input is zero c. Input price equals the value of its marginal product d. Input s value of marginal product starts to decline.

5 6. Firms A and B purchase labor in a perfectly competitive labor market. At the profitmaximizing level of output for each firm, the following information is known: a. p B = 9 b. w = 14 c. p B = 4 d. Both a and b. and p A = $6. Which of the following statements is correct? 7. Suppose Young s Market has only one variable input: labor. The firm s production function is q = 5L 1/2. If the price of the output is $10 and the wage paid to workers is $5, how many workers should be hired? a. 20 b. 15 c. 10 d Which of the following is a necessary condition for price efficiency? a. Technological efficiency b. Allocative efficiency c. Scale efficiency d Both b and c. 9. If there are two or more variable inputs, the value of marginal product curve for one of the inputs, say labor, will be a. The same as the demand for labor b. More elastic than the demand for labor c. Less elastic than the demand for labor d. More elastic for low levels of labor and more inelastic as labor increases. 10. Which is not a characteristic of a perfectly competitive factor market? a. There are only a few buyers of the factor b. Each firm takes the factor price as given c. There are many sellers of the factor d. Each firm can hire all the factor it wants at the going market wage 11. Suppose a firm sells its output in an imperfectly competitive market. Thus, a. MP > MR b. VMP > MRP c. MR > VMP d. MRP > VMP.

6 12. Which of the following equations demonstrates the relationship between the marginal revenue product of labor and the value of marginal product of labor? a. b. c. d. 13. In general, if a perfectly competitive firm in both the output and input markets acquired some monopoly power in the output market, the result would be a(n) in the employment of factors and factor prices. a. Increase; a fall b. Increase; no change c. Decrease; no change d. Decrease; a rise. 14. The addition to total input cost from employing an additional unit of an input is called the of the input. a. Average input cost b. Marginal product c. Marginal input cost d. Marginal revenue product. 15. (Appendix) Suppose a firm uses two variable inputs: labor and capital. If the wage paid to labor falls, the a. Substitution effect implies that the firm will increase the amount of capital b. Substitution effect implies that the firm will increase the amount of labor c. Output effect implies that the firm will decrease the amount of capital d. Output effect implies that the firm will decrease the amount of labor.

7 Short Answer 1. Describe how the market supply of labor is derived. 2. What is economic rent? Illustrate graphically the area of economic rent earned by a factor of production. 3. In the nineteenth century, Henry George proposed a high land tax. Illustrate graphically why he believed this type of tax would not create inefficiencies. 4. Assume that a firm uses only one variable input, labor. Graph the firm s production function. Use an isoprofit line to illustrate the profit-maximizing level of labor. What is the profitmaximizing rule? 5. Describe the conditions necessary for a firm to be economically efficient. 6. Illustrate graphically how a decrease in capital affects the value of the marginal product of labor. If a firm uses more than one variable input, is the firm s demand for labor the same as its value of marginal product? Explain. 7. Describe the relationship between the marginal revenue product of labor and the value of marginal product of labor for both a perfectly competitive firm and an imperfectly competitive firm. How is this relationship affected by the elasticity of demand for the firm s product?

8 Problems 1. Suppose a labor market is composed of two individuals: Kimberly and Sean. Kimberly s labor supply function is and Sean s is Find the market labor supply function. 2. Suppose the inverse demand for an input is v = 25 X D and the inverse supply function is v = 5 + 4X S. Find the equilibrium input price and quantity. What is the level of economic rent? 3. Suppose the Ely Company employs only labor as its variable input, with the technology q = 20L 1/2. Its output is sold in a perfectly competitive market at a price of $25 each. If the wage rate is $125, how many workers will the firm hire and what will be its level of output? 4. Suppose a firm has the production function q = K 1/3 L 2/3. Derive the demand functions for both L and K in terms of p, v, and w. Are these demand functions downward-sloping? Explain. 5. Tim s Corporation sells its output in an imperfectly competitive market. It faces a demand for its product of p = 70 15q. Its production function is q = 2L 1/2 and its short-run marginal curve is SMC = 5q. Find the marginal revenue product of labor. Prove that the marginal revenue product of labor is less than the value of the marginal product of labor. 6. (Appendix) Consider the following labor market demand and supply curves: X D = 20 2w, X S = w. a. Find the equilibrium wage and quantity of labor hired. What is the economic rent? b. Suppose the government institutes a minimum wage of $5. What will happen in this labor market? Calculate economic rent after the imposition of this new law.