TopicChapter 6 Input markets and income distribution

1
Topic/Chapter 6Input markets and income
distribution
Business EconomicsFor School of Management
StudentsSpring Semester 2008
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Topic/Chapter 6Input markets and income
distribution

• Will cover
• 6.1 The labour market
• 6.2 Different kinds of labour
• Not covered in lectures
• Students should read pages 138 - 144 of Begg
• 6.3 Other input markets
• Not covered in lectures
• Students should read pages 145 - 151 of Begg
• 6.4 Income Distribution
• Not covered in lectures
• Students should read pages 152 - 154 of Begg

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6.1 The labour marketLearning outcomes

• By the end of this section, you should
  understand
• The demand for labour
• Labour supply and work incentives
• Why poverty traps arise
• What determines wages and employment
• Why David Beckham and Robbie Williams earn so much

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Some Important Questions

• Why does David Beckham earn so much?
• Why does Tiger Woods earn more in a weekend than
  a professor earns in a year?
• Why can students studying economics expect to
  earn more than students studying philosophy?
• Why does an unskilled worker in the EU earn more
  than an unskilled worker in India?

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The Demand for Labour

• In general the demand for labour
• Is a derived demand depending upon the demand for
  goods and services.
• Is affected by the output/output price of the
  good or service produced
• Is affected by the price of labour relative to
  the price of other inputs

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The Demand for Labour by aSingle Firm in the
Long Run - 1

• Depends upon
• Technology
• Which affects the firms costs
• the price of each input
• Which again affects the firms costs
• the demand for output
• Which affects the revenue from sales
• The chosen output will be where MC equals MR
• And in doing so the it determines the demand for
  inputs

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The Demand for Labour by aSingle Firm in the
Long Run - 2

• In the LR a firm can adjust all its inputs and
  technique
• Hence if the wage rises, a firm substitutes away
  from labour towards other inputs
• such as capital since it is relatively cheaper
• Therefore, for a given output a higher wage makes
  a firm demand less labour and more of other
  inputs.

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The Demand for Labour by aSingle Firm in the
Long Run - 3

• But, by raising the cost of making the output a
  higher wage also reduces the firms chosen output
  level.
• Hence reducing the demand for all inputs
• Therefore, in the LR both effects reduce the
  demand for labour when the wage rises
• However, the effect on other inputs such as
  capital is ambiguous

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Demand for Labour in the Short Run - 1

• In the SR a firm has some fixed inputs such as
  capital and land
• Hence labour is the only input that can be varied
• The marginal product of labour MPL is the extra
  physical output when a worker is added, holding
  other inputs constant
• Beyond some point the diminishing marginal
  productivity of labour sets in

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Demand for Labour in the Short Run - 2

• However, profits depend upon revenue not just
  physical output
• Therefore need to define the marginal revenue
  product of labour MRPL
• Which is the change in sales revenue when an
  extra workers output is sold
• i.e. the marginal benefit of hiring an extra
  worker
• So that MRPLMR x MPL
• But if the firm is operating in a perfectly
  competitive market PMR
• So that MRPLP x MPL

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Demand for Labour in the Short Run - 3
The MRPL is the revenue obtained by selling the
output produced by an extra worker

• Under perfect competition, with diminishing
  marginal productivity a firm maximizes profit
  when the marginal cost of employing an extra
  worker equals the MRPL
• i.e. at wage W0 the firm hires No workers
• But at the lower wage W1 it hires more workers,
  N1
• Therefore under perfect competition in
  equilibrium
• W MRPL
• but given MRPLP x MPL
• then W P x MPL
• or if we rearrange
• MPL W/P

Wage, MRPL
W0
W1
MRPL
N1
N0
Employment
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Monopoly Power and theLabour Market - 1

• A firm may have MONOPOLY power in its output
  market
• The MRPL is no longer the MPL multiplied by the
  output price
• Given the firm faces a downward sloping demand
  curve, in order sell extra output the firm must
  cut its output price (even on existing output)
• Therefore to calculate the MRPL the firm must
  multiply the MPL by MR

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Monopoly Power and theLabour Market - 2
If two firms have identical technology
But firm 1 operates in a competitive output
market firm 2 operates in an imperfectly
competitive output market Then the MRPL2 is
steeper than the MRPL1 i.e. the marginal benefit
of an extra worker is lower for firm 2

MRPL1
MRPL2
Employment
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Monopsony Power in theLabour Market - 1

• A firm that is a MONOPSONIST must raise the wage
  to attract labour.
• Since the firms large scale affects the price of
  inputs
• So the marginal cost of an extra worker exceeds
  the wage paid to that worker
• And if all workers must get the same wage
• Extra hiring also bids up the wage paid to the
  existing workforce

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Monopsony Power in theLabour Market - 2
This illustrated here
Where W0 is the marginal cost of labour for a
competitive firm taking the wage as
given. However, the monopsonist faces an upward
sloping marginal cost of labour MCL schedule

MCL
W0
Employment
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Monopoly and Monopsony Power
Profit is maximised when the marginal revenue
from an extra worker equals its marginal cost.
Therefore
A firm that is a price taker in both markets
hires L1 workers A firm with market power hiring
labour hires L2 workers A firm who has market
power in the product market hires L3 workers And
a firm with market power in both markets hires L4
workers

MCL
W0
MRPL1
MRPL2
L1
Employment
L4
L2
L3
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Changes in a firms demandfor labour - 1

• A rise in the output price raises the marginal
  benefit of labour at any particular wage.
• It shifts the entire MRPL schedule outwards,
  raising the demand for labour
• For a given output price two other things raise a
  firms demand for labour

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Changes in a firms demandfor labour - 2

• Technical progress
• Makes labour more productive and therefore raises
  its marginal benefit
• Greater quantity of other inputs which labour can
  work with
• More capital raises the demand for labour by
  shifting the MRPL up, so that at any wage the
  firm hires more workers than before

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Demand for Labour by industry

• Unlike product demand we cant simply
  horizontally sum individual labour demand curves
  to get the industry demand curve
• At a lower wage each firm wants to hire more
  labour
• This expands industry output, bidding down the
  output price
• Since even a competitive industry must cut its
  price to be able to sell the higher output
• The fall in the output price shifts to the left
  each individual firms labour demand curve
• Therefore the industry demand for labour curve is
  steeper than the horizontal sum of firms
  individual labour demand curves

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The Supply of Labour

• Depends both on
• How many people (want to) work and
• The number of hours worked
• Therefore to analyse labour supply need to
  consider how many hours do people in the labour
  force wish to work and what makes people join the
  labour force
• The LABOUR FORCE
• all individuals in work or seeking employment
• Labour force PARTICIPATION
• the participation rate is the fraction of people
  of working age who join the labour force

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Hours of work

• The amount of hours worked by a person in the
  labour force will depend upon the REAL WAGE w/p
• The nominal wage (w) divided by the the price of
  goods (p)
• i.e. the amount of goods and services that can be
  bought from working
• Therefore we have a consumer choice between goods
  as a whole (work) and leisure
• Hence there is an income and a substitution
  effect
• And the income and substitution effects work in
  opposite directions
• It is therefore an empirical matter on the actual
  outcome
• But evidence suggests that the real wage has
  little effect on the quantity of hours supplied

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UK Participation Rates ()
SourceGeneral Household Survey
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The Poverty Trap

• The POVERTY TRAP means that getting a job makes a
  person worse off than staying at home
• If the real wage rises it may be possible to pole
  vault over the poverty trap into work that pays
• Conversely lower real wages make the poverty trap
  worse
• Hence higher real wages increase the incentive to
  join the labour force

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Labour supply to an industry

• In the short-run an industry faces an upward
  sloping labour supply curve
• When an industry expands it usually has to bid up
  the wages to hire more labour
• In the long-run the industrys labour supply
  curve is flatter
• When short-run expansion bids up the wages more
  workers will be attracted into the industry in
  the LR
• With more workers available in the LR the
  industry does not have to raise the wage so much
  to attract extra workers

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Industry Labour Market Equilibrium

• The industry supply curve LS slopes up
• For a given output industry demand for labour
  slopes down
• Equilibrium is W/P0, N0
• An increase in demand increases employment and
  the real wage
• With a new equilibrium at W/P1 and N1

Real Wage
LS
W/P1
W/P0
LD1
LD0
N1
N0
Quantity of labour
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So why does David Beckhamearn so much?

• Very steep supply curve
• Even paying a lot more money it is hard to
  attract many more people with the appropriate
  skills into the industry
• With TV rights the derived demand curve for their
  labour is high
• Resulting in very high real wages

LS
Real Wage
W/P
LD
N
Quantity of labour
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6.2 Different kinds of labourLearning outcomes

• By the end of this section, you should
  understand
• The many different kinds of labour
• How human capital adds to skills
• When investment in education and training makes
  sense
• The role of trade unions
• How globalization affects trade unions
• Note 6.2 is not covered in lectures
• Students should read pages 138 - 144 of Begg

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6.3 Other input marketsLearning outcomes

• By the end of this section, you should
  understand
• The markets for capital and land
• Flows over time, and stocks at a point in time
• The markets for renting capital services and for
  buying new capital assets
• The required rental on capital
• How land rentals are determined
• Note 6.3 is not covered in lectures
• Students should read pages 145 - 151 of Begg

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6.4 Income DistributionLearning outcomes

• By the end of this section, you should
  understand
• The functional distribution of income
• The personal distribution of income
• Their relation to input markets
• Note 6.4 is not covered in lectures
• Students should read pages 152 - 154 of Begg