Week 7 Issues in Microeconomics

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Week 7Issues in Microeconomics
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The labour market
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Demand for factors in the long run

• The optimum mix of capital and labour depends on
  the relative prices of these factors
• This helps to explain why more labour-intensive
  means of production are used in some countries
  where labour is relatively abundant.
• A change in the price of one factor will have
  both output and substitution effects
• A rise in the wage rate leads to
• substitution towards more capital-intensive
  techniques
• but also leads to lower total output

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The demand for labour in the short run
The marginal value product of labour is the
revenue obtained by selling the output
produced by an extra worker

• Under perfect competition, with diminishing
  marginal productivity
• the firm maximizes profit when the marginal cost
  of employing an extra worker equals the MVPL...

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The demand for labour in the short run
Below L, extra employment adds more to revenue
than to labour costs.
Above L, the reverse is so.
This decision is consistent with the MR SMC
rule for maximizing profit under perfect
competition.
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The supply of labour

• The LABOUR FORCE
• all individuals in work or seeking employment
• Labour supply
• for an individual, the decision on how many hours
  to offer to work depends on the real wage
• an individuals attitude towards leisure and
  income determines if more or less hours of work
  are supplied at a higher real wage rate.

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Labour supply in aggregate

• If we consider the economy as a whole, or an
  industry
• a higher real wage rate also encourages a higher
  participation rate
• so labour supply is likely to be upward-sloping

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Labour market equilibrium for an industry

• The industry supply curve SLSL slopes up
• higher wages are needed to attract workers into
  the industry
• For a given output demand curve, industry demand
  for labour slopes down
• Equilibrium is W0, L0.

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A shift in product demand
Beginning in equilibrium,
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A change in wages in another industry
Again starting in equilibrium,
An increase in wages in another industry
attracts labour,
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The information economy
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e-Economics
The information revolution is here
but economics still provides a reliable
framework to understand what is happening..
This is microeconomics in action
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Welfare indicators by country group
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e-products

• An e-product
• can be digitally encoded then transmitted
  rapidly, accurately and cheaply
• e.g. music, films, books, sport
• Fixed costs of producing e-products are huge
• but marginal costs of distribution are tiny
• implying vast economies of scale

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Network externalities
Suppose D1 represents the demand curve for a
product exhibiting network externalities
With price at P1, demand is limited.
If price is reduced to P2, more people find the
network attractive so not only is there a move
along the demand curve, but there is a shift in
demand.
P2
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Information the supply side

• Given substantial economies of scale, we expect
  monopoly suppliers of information products
• Dominant firm with competitive fringe
• e.g. Microsoft
• Niche market monopolies

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Pricing information products

• Strategies for pricing information products
• two-part tariff
• an annual charge to cover fixed costs, and a
  small price per unit related to marginal costs
• versioning
• the deliberate creation of different qualities to
  facilitate price discrimination
• bundling
• the joint supply of more than one product to
  reduce the need for price discrimination

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Competition vs. collaboration

• A strategic alliance is a blend of co-operation
  and competition, in which a group of suppliers
  provide a range of products that partly
  complement one another
• e.g. Microsoft and Intel
• airline alliances One World, Star

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Understanding the e-economy

• 1 The information revolution is changing our
  lives
• but few of its activities or market tactics are
  unprecedented
• 2 The revolution in technology has not required
  a corresponding revolution in economic theory

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Government spending and Revenue
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Government spending
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Private and public goods

• A private good
• if consumed by one person, cannot be consumed by
  another person.
• e.g. dental treatment
• A public good
• even if consumed by one person, can still be
  consumed by other people.
• e.g. street lighting

The strong externalities associated with public
goods, mean that government intervention may be
justified to ensure appropriate provision.
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Merit goods and bads

• Merit goods (bads)
• goods (bads) that society thinks everyone ought
  to have (ought not to have) regardless of whether
  they are wanted by each individual.
• e.g. Education, health services, cigarettes
• The government may spend money on compulsory
  education or compulsory vaccination because it
  recognizes that otherwise individuals act in a
  way they will subsequently regret.

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Varieties of taxes

• Direct taxes
• taxes on earnings from labour, rents, dividends
  and interest.
• e.g. income tax, corporation tax
• Indirect taxes
• taxes levied on expenditures on goods and
  services
• e.g. VAT, duty on alcohol
• Wealth taxes
• capital transfer tax, tax on property

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A tax on wages
With no tax, the labour market is in equilibrium
at wage W, hours L.
SS
Wage
W
DD
L
Hours worked
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The incidence of a tax

• Who pays a tax depends upon the elasticity of
  demand and supply for the product.
• This also affects the size of distortion caused
  by the imposition of a tax.

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The Laffer curve
shows how much tax revenue is raised at each
possible tax rate. Beyond t, higher tax rates
reduce revenue because of disincentive effects.
Tax revenue
100
t
Tax rate
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Industrial policy and competition policy
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Industrial policy andCompetition Policy

• Competition policy
• aims to enhance economic efficiency by promoting
  or safeguarding competition between firms
• Industrial policy
• aims to offset externalities that affect
  production decisions by firms

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Industrial policy

• Inventions and the patent system
• designed to provide a sufficient incentive for
  invention without suppressing competition for
  ever
• Research and Development (RD)
• the social return on risky projects may exceed
  the private return
• Dynamic change
• coping with sunset and sunrise industries

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Consumer surplus
Consider the demand curve D and suppose price is
at P with quantity demanded being Q.
A
Price
P represents the value placed on the good by the
marginal consumer
E
P
so D can be seen to represent marginal social
benefit
D
Q
Quantity
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Producer surplus
Price
Producer surplus is the excess of total
revenue over total costs
P
LAC LMC
D
Q
Quantity
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The social cost of monopolycomparing perfect
competition and monopoly
For simplicity, suppose as industry with
horizontal long-run average and marginal costs.
Under perfect competition, long-run equilibrium
would be with industry output Qc selling at price
Pc.
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The social cost of monopolycomparing perfect
competition and monopoly
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Perfect competition and monopoly under differing
cost conditions
Suppose that monopoly enjoys lower
cost conditions than under perfect competition
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Welfare implications

• In comparing the two situations, the loss of
  consumer surplus under monopoly (the red
  triangle)
• must be balanced against the gains from
  efficiency (the blue rectangle)

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Counting the cost of monopoly

• The size of the social cost of monopoly is
  difficult to evaluate
• in part it depends upon the elasticity of demand
• which influences the size of the red triangle
  of welfare loss