14.01 Principles of Microeconomics, Fall 2007 Chia-Hui Chen December 3, Lecture 31. Factor Market

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1 Supply of abor. Principles of Microeconomics, Fall Chia-Hui Chen December, ecture Factor Market Outline. Chap : Supply of abor. Chap : Demand of abor Supply of abor We derive the supply of labor by solving consumers utility maximization problems. To variables determining the utility are leisure (), hich is measured by hours, and income (Y ); the prices are and respectively. To maximize u(, Y ), e have u =. u Y If increases, on one hand, higher ages encourage people to ork more (point A to point B), hich is a substitution effect; on the other hand, higher ages allo the orker to purchase more goods, including leisure, hich reduces ork hours (point B to point C), hich is an income effect (see Figure ). When the age is higher, if the substitution effect exceeds the income effect, labor supply increases, and leisure decreases; if the income effect exceeds the substitution effect, labor supply decreases, and leisure increases (see Figure ). ike product markets, competitive, monopolistic, and monopsonistic markets are types of factor markets. In a competitive factor market, if the product market is also competitive, If the product market is monopolistic, MRP = P MP. MRP = MR MP = P ( ) MP. e d Cite as: Chia-Hui Chen, course materials for. Principles of Microeconomics, Fall. MIT OpenCourseWare ( Massachusetts Institute of Technology. Donloaded on [DD Month

2 Y Supply of abor C B Income Effect A Substitution Effect Figure : Substitution Effect and Income Effect of abor Supply. Income Effect > Substitution Effect Supply of abor Wage Income Effect < Substitution Effect..... Hours of Work per Day Figure : Backard-Bending Supply of abor. Cite as: Chia-Hui Chen, course materials for. Principles of Microeconomics, Fall. MIT OpenCourseWare ( Massachusetts Institute of Technology. Donloaded on [DD Month

3 . Factor Competitive S * * D =P MP Figure : Competitive Factor Market.. Factor Competitive Competitive market is most efficient, and there is no deadeight loss (see Figure ). When MR < P, both and decrease; the market is then not as efficient as competitive market, and has deadeight loss (see Figure ).. Factor Monopsony Marginal Value equals the demand. Marginal Expenditure Because is determined by e can see that and P S (Q)Q P S ME = = Q + P S > P S. Q Q ME = MV, <, < (see Figure ). One example of factor monopsonist is the government hiring soldiers. Cite as: Chia-Hui Chen, course materials for. Principles of Microeconomics, Fall. MIT OpenCourseWare ( Massachusetts Institute of Technology. Donloaded on [DD Month

4 . Factor Monopsony S *, P MP D =MR MP, * Figure : Noncompetitive Factor Market. ME S=AE *, D=MV, * Figure : Monopsonistic Factor Market. Cite as: Chia-Hui Chen, course materials for. Principles of Microeconomics, Fall. MIT OpenCourseWare ( Massachusetts Institute of Technology. Donloaded on [DD Month

5 . Factor Monopoly. Factor Monopoly An example of monopoly poer in factor markets involves labor unions. Economic rent is the difference beteen payments to a factor of production and the minimum payment that must be spent to obtain the factor; it is like producer surplus in a product market (see Figure ). S Economic Rent.... Figure : Economic Rent. When some orkers lose their jobs, remaining orkers have higher ages. If the union tries to maximize the number of orkers hired, it should set the age and labor employed and ; if the union tries to maximize economic rent, it should set the age and labor employed and. and >, < (see Figure ). It is hard to say hich one is better for the orkers. No consider a model of union orkers and non-union orkers. Assume the demand for union orkers is D U, and the demand for non-union orkers is D NU. The total market demand is fixed. D = D U + D NU Cite as: Chia-Hui Chen, course materials for. Principles of Microeconomics, Fall. MIT OpenCourseWare ( Massachusetts Institute of Technology. Donloaded on [DD Month

6 . Factor Monopoly, S * Economic Rent MR D, * Figure : Monopoly Poer of Sellers of abor. When a monopolistic union raises the age rate in the unionized sector of the economy from to U, employment in that sector falls; for the total supply of labor to remain unchanged, the number of non-union orkers increases and the age in the non-unionized sector must fall from to NU (see Figure ). Assume the total supply of orkers is ; the demands for nonunion and union orkers are NU = NU, U = U. When the union does not intervene, NU = U =. Thus and Then hich gives NU =, U =. = =, =, Cite as: Chia-Hui Chen, course materials for. Principles of Microeconomics, Fall. MIT OpenCourseWare ( Massachusetts Institute of Technology. Donloaded on [DD Month

7 . Factor Monopoly U S D NU * D U NU D Number of Workers Figure : Wage Discrimination in abor Market. and therefore U =, NU =. When the union maximizes the total age of union orkers as a monopolist, the first order condition is d d ( U U ) = ( U ) U =. d U d U Then thus For the nonunion orkers, U =, U = ; U =. NU =, NU =.. Cite as: Chia-Hui Chen, course materials for. Principles of Microeconomics, Fall. MIT OpenCourseWare ( Massachusetts Institute of Technology. Donloaded on [DD Month

8 Demand of Supply Demand of Supply In competitive factor market, assume Q =, and P =. MRP = MP MR =. is marginal cost of hiring labor, thus =, then D =. Cite as: Chia-Hui Chen, course materials for. Principles of Microeconomics, Fall. MIT OpenCourseWare ( Massachusetts Institute of Technology. Donloaded on [DD Month

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