Chapter 11 Factor Markets

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Chapter 11Factor Markets

• Up to this point
• Looked at Demand and Supply how they are
  derived
• Market structure which is meeting place for
  demand and supply. Investigated how numbers
  affect interaction
• Now we are interested in how FACTORS OF
  PRODUCTION (FOP) are rewarded.

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Chapter 11Factor Markets

• How are FOP rewarded?
• Direct remuneration of labour
• Payment to owners of capital in form of interest
• Payment to natural resources and other inputs in
  production process
• In this chapter look at how government
  intervention can affect remuneration of FOP

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Chapter 11Factor Markets Market for factors of
production

• Understanding the functioning of the market for
  FOP can explain difference in pay.
• Market for FOP is different from good (services)
  market but directly linked.
• To make goods ( services) we need FOP.
• We do not hire people for the sake of it, they
  give us something in return

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Chapter 11Factor Markets
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Chapter 11Factor Markets

• To consider the workings of the market for FOP
  must also consider the market structure( the
  number of sellers and buyer)
• In FOP market
• Sellers are EMPLOYEES ( they sell labour)
• Buyers are EMPLOYERS ( they buy labour)
• Again consider perfect competition and imperfect
  competition

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Chapter 11Factor Markets Perfect Competition

• Assumption
• Many rival employers compete for FOP of given
  quality which is made available by many rival
  employees
• Each employer purchases a small of available
  supplies cannot influence price
• Owners of FOP cannot affect price
• Freedom of entry and exit
• No restrictions on movement of labour, capital or
  use of natural resources
• Perfect information within the market
• FOP are homogenous ( FOP of specific type, e.g.
  labour are identical)

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Chapter 11Factor Markets Functioning of Market

• In any market demand meeting supply determines
  prices
• Similarly in FOP market demand meeting supply
  determines FACTOR EARNINGS.
• In goods market Firms supply household with good
  they want
• In FOP market households supply firms with FOP
  they want
• 2 diff markets but directly linked

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Chapter 11Factor Markets Functioning of Market

• How are the markets linked?
• If goods are wanted, FOP must produce such goods
  demand for FOP
• If these goods are no longer wanted the FOP
  previously used to produce the goods will no
  longer be demanded.
• Demand for FOP is DERIVED from demand for Goods
• FOP demand is a DERIVED DEMAND

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Chapter 11Factor Markets Functioning of Market

• E.G Imagine Speedy Cobblers make shoes
• The owner of Speedy Cobblers is one many
  shoemaking services available.
• In the market for FOP
• Demand curve downward sloping ( cheaper labour
  the more of it is demanded)
• Supply curve is upward sloping ( higher pay, the
  more people willing to work )
• Intersection of demand and supply
• No of demand No of Supply and the earnings (
  price ) they get exchanged at is determined

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Chapter 11Factor Markets Functioning of Market
175
Q1
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Chapter 11Factor Markets Functioning of Market

• Supply for Individual firm is horizontal
• If a firm pays less than going rate no one will
  work for the firm ( perfect information )
• If firm pays higher than going rate it is paying
  more for the same things its rivals get so
  changing its cost structure
• Supply for the firm demanding labour is
  horizontal (can hire as many as it wants at the
  given price Price taker)
• How many shoemakers should Speedy Cobblers hire?
• Determined by demand

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Chapter 11Factor Markets Functioning of Market

• Demand for Individual firm.
• Consider Example

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Chapter 11Factor Markets Functioning of Market

• Hiring more shoemakers means we can make more
  shoes.
• Note that marginal product column which shows
  additional production with every additional
  shoemaker we hire is increasing then decreasing
  because of LDMR
• Marginal revenue (MR) per shoe is fixed
• Firm is price taker in goods and FOP market
• Marginal Revenue Product (MRP)?

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Chapter 11Factor Markets Functioning of Market

• Marginal Revenue Product (MRP)?
• Two concepts together MR and MP what are they?
• Additional revenue gain from hiring an additional
  unit of input
• Not the same as Marginal revenue
• MRP MR MP
• MRP ( Q/ L) ( TR/ Q)
• MRP TR/ L

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Chapter 11Factor Markets Functioning of Market

• How does a firm decide on of workers to employ
  at market price of R175?
• Marginal Input cost Curve (MIC) horizontal
  supply
• Demand curve shows willingness to pay
• Demand for labour wage/quantity of worker combo
  that employer is willing to pay for.
• Employer willing to pay employer additional
  revenue received when worker is employed.
• Firms demand curve is MRP
• Profit maximisation MRP MIC

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Chapter 11Factor Markets Functioning of Market
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Chapter 11Factor Markets Functioning of Market

• Change in Demand for product and effect on
  employment levels?

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Chapter 11Factor Markets Elasticity of demand
for labour

• Elasticity of the demand of the good produced by
  labour
• Substitutability of labour and other FOP
• Elasticity of complementary FOP ( greater
  elasticity of complements greater elasticity of
  labour)
• Greater wage cost as proportion of production,
  greater elasticity.

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Chapter 11Factor Markets Supply of labour

• Can be investigated at 3 levels
• Individual
• Firm
• Industry
• Individual
• Disutility of work
• Worker sacrifices leisure for work
• Work itself or environment may be unpleasant for
  the worker
• Thus work brings with it some discomfort
  disutility

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Chapter 11Factor Markets Supply of labour

• Every extra hour that a person works there is
  additional disutility
• Marginal disutility of work will tend to increase
  are work increases,
• Thus to persuade workers to work more hours, more
  pay has to offered to them higher wages for
  higher disutility of work
• This explains why overtime rates are usually
  higher than standard rates

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Chapter 11Factor Markets Supply of labour

• But this might give the false impression that
  supply curve of labour is always positive sloping
• When supplying labour 2 forces are at work( that
  determine supply of labour)
• Income effect
• As wages increase workers feel that they already
  earn enough
• Value leisure more than working longer hours.
• This give up work to have more leisure
• Substitution effect
• As long as wages increase, people tend to work
  longer hours
• Willing to sacrifice leisure for work as long as
  wages increase OC of leisure increases
• Question With increase in wages is the OC of
  labour going up or down?

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Chapter 11Factor Markets Supply of labour
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Chapter 11Factor Markets Supply of labour

• Elasticity of supply of labour
• Wages changing in one industry will not lead to
  unlimited move of labour into that industry. Why?
• Difficulties in changing jobs
• Geographical immobility
• Occupational immobility
• In the long run, people can be retrained and
  adjust to market conditions

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Chapter 11Factor Markets Economic Rent and
Transfer Earnings

• Earnings of FOP can be split into 2 components
• Transfer earnings minimum payable money to a
  factor to persuade it to say in its present use
• Economic rent Amount paid over and above
  transfer earnings
• Size of the two is determined by elasticity of
  supply of the FOP.

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Chapter 11Factor Markets Economic Rent and
Transfer Earnings
B
Economic Rent
A
O
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Chapter 11Factor Markets Economic Rent and
Transfer Earnings

• Looking at above example
• Moving from point a to b more painter enter the
  market because price increases
• At point b, painters entering the market wages
  paid to them is just enough to keep them in the
  market
• Painters that entered between point a and b,
  painters already in the market, receive economic
  rent they receive more that is required to keep
  them in the market.

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Chapter 11Factor Markets Economic Rent and
Transfer Earnings

• With the other half of the diagram, the more
  inelastic the supply, the more of wages paid is
  economic rent.
• Quasi Rent short term economic rent
• With change in supply, economic rent is eroded
  away.

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Chapter 11Factor Markets Inequality

• Under perfect competition
• All workers should earn the same wages
• But this is not the case in reality
• Workers have different abilities
• Can invest in human capital
• Workers are not perfectly mobile
• Jobs require different types of skills
• Miners vs accountants

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Chapter 11Factor Markets Inequality

• Other reasons for inequality
• Ownership of factors of production
• Discrimination
• Gender, race or law enforced discrimination

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Chapter 11Factor Markets Market failure and
Government Intervention

• Why do markets fail
• No perfect information
• Markets take time to adjust
• Markets are sometimes incomplete
• Existence of non-competitive markets
• Resources are not evenly distributed thus
  perpetuating inequality

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Chapter 11Factor Markets Market failure and
Government Intervention

• Government Failure
• Government intervenes to correct market failure
• Government can also fail
• Rational behaviour for politicians is to maximise
  votes
• Rent seeking government involvement in economy
  can lead to distortion which can introduce rent
  seeking behaviours.
• Bureaucrats and civil servants maximising
  behaviour which lead to inefficient use of too
  many inputs to produce certain level of output

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Chapter 11Factor Markets Market failure and
Government Intervention

• Government intervention and trade unions
• Government can intervene using maximum and
  minimum prices
• Trade unions distort the markets as well
  particularly using minimum prices.
• Same explanation as we used in chapter 7

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Chapter 11Factor Markets Wage determination in
imperfect markets

• Just like in goods market we can have imperfect
  conditions in factors market
• If there is single buyer of labour monopsony
• If there is a single buyer and single seller
  Bilateral monopoly
• We can have a bilateral monopoly if we a
  monopsony and all the sellers are organised by a
  trade union then we bilateral monopoly

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Chapter 11Factor Markets Wage determination in
imperfect markets

• Two cases we will look at
• Monopolist in Goods market but perfect
  competition in FOP market
• Monopsony in FOP market

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Chapter 11Factor Markets Wage determination in
imperfect markets

• Monopolist in Goods market but perfect
  competition in FOP market
• In this case monopolist prices where MR MC but
  Pltgt MR

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Chapter 11Factor Markets Wage determination in
imperfect markets

• So what we have if we has a monopolist is this
• Value of marginal product because MP is sold at
  the price ( which is not equal to MR)
• VMP P MP
• In perfect competition we had MRP MR MP
• VMP gt MRP if we have a monopolist
• So what does the graph for a monopolist look
  like?

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Chapter 11Factor Markets Wage determination in
imperfect markets
Wages
VMP1
Supply Labour
We
VMP
MRP
Q1
Q2
Labour
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Chapter 11Factor Markets Wage determination in
imperfect markets

• So a monopolist they should be willing to pay the
  value the get out each user should hire at Q2
• But because they have market power, output will
  be lower than in perfect competition.
• Lower output implies lower demand thus wages will
  be lower suffices to pay people where MRP is
  satisfied, they will only hire where MRP Supply
  ( We)
• Though the value they get is VMP1
• The difference between We and VMP1 becomes PROFIT

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Chapter 11Factor Markets Wage determination in
imperfect markets

• Firms with market power in Labour market
• If one firm ( few firms) can influence the wage
  rate
• Called WAGE MAKERS
• Reason Choices for alternative employment for
  workers is limited
• Firms face UPWARD SLOPING supply curve
• Supply curve wages that must be paid to
  attatract labour
• More labour more must be paid

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Chapter 11Factor Markets Wage determination in
imperfect markets
MCL
AC W (Supply Curve)
W2
W1
MRPL
Q1
Q2
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Chapter 11Factor Markets Wage determination in
imperfect markets

• Wage that must be paid is average cost for the
  firm
• Supply curve Average cost for the firm
• Marginal cost of hiring additional labour will
  increase and be higher than Average cost.
• Higher wage must be paid to attract next worker
  but other must also get same wage as the next
  worker so they also get a small increase on their
  existing pay.

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Chapter 11Factor Markets Wage determination in
imperfect markets

• Profit will be maximised where MRP MC
• Q1 labour will be hired at wage W1
• In perfect competition we will have more
  employment and higher wages
• So by restricting output, a monopsony will
  suppress wages
• Workers do not receive last workers MRP.

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Chapter 11Factor Markets Wage determination in
imperfect markets

• Labour with Market power Trade unions

Wages
Excess Supply
Supply
Wt
A
B
We
Demand
Qe
Qs
Qd
Labour
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Chapter 11Factor Markets Wage determination in
imperfect markets

• Imagine Monopsony and imagine case with Trade
  union
• Economic theory cannot tell us exactly where wage
  will be because this is determined by relative
  bargaining power.
• But please look at this in the textbook
  understand why.
• You do not have to draw the diagram have a
  general understanding of what is taking place. Pg
  273
• Market for Land and capital must understand
  what is going on you will not be required to
  reproduce it. Pg 275-276
• Remember Supply of land is ALWAYS FIXED
  (INELASTIC) because there only so many acres of
  land you can get in South Africa without invading
  other countries!

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Chapter 11Factor Markets Inequality

• Why do we worry about inequality?
• Poverty trap
• Economic Growth
• We try to find ways to alleviate inequality.
• But to do that we must know how much inequality
  is in the economy.
• How do we measure inequality?

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Chapter 11Factor Markets Inequality
E
45o line Equality line
80
60
D
Cumulative percentage of Income
40
C
20
B
A
R
40
80
60
20
0
Cumulate percentage of People
47

• Gini Coefficient
• Uses Lorenz curve as illustration
• Calculated by dividing the inequality area by
  lower rectangular triangle.
• Quintile Ratio
• Ratio of of income of poorest X percent of the
  population to the of income of the richest y
  percent of the population.
• E.G can compare the ratio of poorest 40 to
  income of richest 20

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The END?

• HINTS for the Example
• DO NOT GUESS THERE WILL BE NEGATIVE MARKING AND
  WE WILL STICK TO IT!!!! POLICY REQUIRES THAT WE
  DO.
• THE TUTS ARE A GOOD INDICATION OF WHAT WILL COME
  IN THE EXAM
• LONG QUESTIONS WILL FOCUS ON THE LATER CHAPTERS (
  UNDERSTAND MONOPOLY AND HOW GOVERNMENT
  INTERVENTION MAY AFFECT IT!
• BRING CALCULATORS!
• BRING PENCILS AND ERASERS
• DONOT COPY IF YOU GET THE ANSWER WRONG BUT USE
  THE WRONG ANSWER IN THE REST OF THE QUESTION WILL
  GET YOUR MARKS
• DONOT PANIC IF U RUN OUT OF TIME, SIMPLY PUT
  YOUR ANSWERS IN POINT FORM AND YOU WILL STILL GET
  YOUR MARKS.
• USE DIAGRAMS WHERE YOU CAN AND LABEL IT
  CORRECTLY YOU WILL BE GRANTED HALF THE MARKS.
  EXPLANATION GETS YOU THE REST