Chapter 9
THE MARKET FOR
FACTORS OF PRODUCTION
• 1. Perfect markets
• Supply of Labour
• Demand for labour
• Distribution of Income when Markets are
competitive
• Imperfect competition in factor markets
The circular flow of incomes and expenditure
(3) Factor
demand
£
(2) Goods
supply
£
Factor
services
P
Goods
P
S
S
P1
D1
O
Q
Factor
services
(4) Factor
supply
£
D1
O
Q1
Q
Goods
£
(1) Goods
demand
THE MARKET FOR
FACTORS OF PRODUCTION
• Perfectly competitive factor markets
• Everyone is a price taker, worker, firm, and
suppliers of capital and land.
• Freedom of Entry and Exit
• Factors are homogeneous
– Same level of skill and motivation
• Perfect Knowledge
– Know the contract, conditions and alternatives
– How good is your worker?
A labour market: Whole market
Sall workers
Hourly wage
in the market
Dall firms
in the market
O
Labour hours
Hourly wage
A labour market: Individual employer
Dindividual employer
O
Labour hours
A labour market: Individual worker
Hourly wage
Sindividual worker
O
Labour hours
Consumption Versus Work
Units of CONSUMPTION
30
a
Like Consumption
Don’t like work
20
What are our
indifference curves
shaped like?
10
I1
0
0
5
10
15
20
Hours worked
25
30
Consumption Versus Work
30
Units of CONSUMPTION
Consider point a
20
a
10
I1
0
0
5
10
15
20
Hours worked
25
30
Consumption Versus Work
Units of CONSUMPTION
30
20
a
10
I1
0
0
5
10
15
20
Hours worked
25
30
Consumption Versus Work
30
Units of CONSUMPTION
U2
U1
C Up, Work
down,
20
U0
U rising
10
I1
0
0
5
10
15
20
Hours worked
25
30
Constraint & Optimum
Units of CONSUMPTION
30
24 hours
U2
U1
20
U0
10
0
0
5
10
15
20
Hours worked
25
30
Suppose now wages
rise
Units of CONSUMPTION
30
U3 U 2
24 Hours work
@$1.00p =£24
U1
20
U0
10
0
0
5
10
15
20
Hours worked
25
30
The supply of hours worked
S
Hourly wage
w1
w0
O
L0
Hours worked
L1
Backward-bending supply curve of labour
Hourly wage
S
WI
O
Hours
WAGE DETERMINATION
UNDER PERFECT COMPETITION
• The supply of labour
– the supply of hours by an individual worker
 marginal
 income
 the
disutility of work
and substitution effects of wage changes
shape of the individual’s supply curve of labour
– the supply of labour to an individual employer
 Elastic
from the perspective of the employer
– the market supply of a given type of labour
 Generally
upward sloping
WAGE DETERMINATION
UNDER PERFECT COMPETITION
• Elasticity of supply
– the mobility of labour
– economic rent and transfer earnings
The market for nurses
Wage rate
S
D
O
Number of nurses
The market for Dame Edna Everage
Dame Edna’s salary
S
W
D
1
Number of Dame Ednas
2
WAGE DETERMINATION
UNDER PERFECT COMPETITION
• The demand for labour:
marginal productivity theory
– the marginal revenue product of labour
( MRPL )
• What is the additional output a firm can get
from hiring one more worker?
• How much will they get for that output
The marginal revenue product of labour
( MRPL )
• What is the additional output a firm can get
from hiring one more worker?
• How much will they get for that output
The marginal revenue product of labour
( MRPL )
• What is the additional output a firm can get
from hiring one more worker?
dQ
MPL or MPPL 
dL
•How much will they get for that output
UNDER PERFERCT COMPETTITON
The marginal revenue product of labour
( MRPL )
• How much will they get for that output
dQ
MRPL  P
dL
How much does it cost them to hire that worker?
W
Therefore hire workers until:
The profit-maximising level of employment
£
x
MRPL=MR* MPPL
O
Q of labour
WAGE DETERMINATION
UNDER PERFECT COMPETITION
• The demand for labour:
marginal productivity theory
– the marginal revenue product of labour
( MRPL )
– derivation of the firm's demand curve for labour
Deriving the firm’s demand curve for labour
£
a
MCL1
W1
MRPL
O
Q1
Q of labour
WAGE DETERMINATION
UNDER PERFECT COMPETITION
• Equality and inequality of wages under
perfect competition
– the tendency towards equality
– causes of inequality under perfect competition
– Who are the poor and who are the rich?
WAGE DETERMINATION
IN IMPERFECT MARKETS
• Factor market power: Monopsony
• A firm which is a monopoly purchaser of a
factor
– E.g. Single Employer in a Town
– Government
• A Monopolist restricts Quantity sold to keep
price up
• A Monopsonist restricts quantity purchased
to keep price down!!!
Monopsony
£
ACL W
(supply curve)
MRPL
O
Q of labour
WAGE DETERMINATION
IN IMPERFECT MARKETS
• Types of factor market power
• Firms with monopsony power in employing
labour
– MCL > W
– effects on wages and employment
• Monopsony implies Wages and Employment
Down