Chapter 13.Pricing and Employment of Inputs
Topics to be Discussed
n Competitive Factor Markets
n Factor Markets with Monopsony Power
n Factor Markets with Monopoly Power
Competitive Factor Markets
n Characteristics
1) Large number of sellers and buyers of the factor of production
2) The buyers and sellers of the factor of production are price takers
n We will illustrate the demand for a factor input and assume only one input is variable
• Demand for factor inputs is a derived demand
– Depends on output demand
n The Decision to Hire or Fire
• Assume
– Two inputs are needed to produce output : Capital (K) and Labor (L)
– Cost of K is r and the cost of labor is w
– K is fixed and L is variable
• Problem
– How much labor to hire
n Measuring the Value of a Worker’s Output
• The owner of donut shop wants to know whether it is profitable to hire an
additional worker.
• It will be profitable if the additional revenue from an additional worker is greater
than its cost. (i.e., MRPL > wage )
• Marginal Revenue Produce (MRPL)
• MRPL = (MR) (MPL)
n Assume perfect competition in the product market
• Then MR = P
• MRPL = (P) (MPL)
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Competitive Factor Markets
n Question
• When more workers are hired, what will happen to the value of MRPL?
• MRPL is downward sloping because MPL decreases due to diminishing marginal
returns.
n Question
• Why is the MRPL for the monopoly output market below the MRPL for the
competitive output market?
• In a competitive output market, MR=P.
• In a monopolistic output market, MR < P
n Choosing the profit-maximizing amount of labor
• If MRPL > w (the marginal cost of hiring a worker): hire the worker
• If MRPL < w: hire less labor
• If MRPL = w: profit maximizing amount of labor
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Hiring by a Firm in the Labor Market (with Capital Fixed)
The profit maximizing firm will hire L* units of labor at the point where the
marginal revenue product of labor is equal to the wage rate.
Competitive Factor Markets
n If the market supply of labor increased relative to demand (baby boomers or female
entry), a surplus of labor would exist and the wage rate would fall.
n Question
• How would this impact the quantity demanded for labor?
Competitive Factor Markets
n Comparing Input and Output Markets
MRPL  (MPL )( MR)
and at profit maximizing
number of workers MRPL  w
(MPL )( MR)  w
MR  w MPL
w MPL  MC of production
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Competitive Factor Markets
n Comparing Input and Output Markets
• In both, input and output choices occur where MR = MC
– MR from the sale of the output
– MC from the purchase of the input
Competitive Factor Markets
n The Supply of Inputs to a Firm
• Determining how much of an input to purchase
– Assume a perfectly competitive factor market
n Observations
• The firm is a price taker at $10.
• S = AE = ME = $10
• ME = MRP @ 50 units
n Question
• Why is 50 units the profit maximizing quantity?
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Competitive Factor Market
n A competitive factor market is in equilibrium when the price of the input equates the
quantity demanded to the quantity supplied.
Labor Market Equilibrium
n Equilibrium in a Competitive Output Market
DL(MRPL) = SL
wC = MRPL
• MRPL = (P)(MPL)
• Markets are efficient
n Equilibrium in a Monopolistic Output Market
• MR < P
• MRP = (MR)(MPL)
• Hire LM at wage wM
• vM = marginal benefit to society
• wM = marginal cost to the firm
• Profits maximized
• Using less than the efficient level of input
•
•
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Equilibrium in a Competitive Factor Market
n Economic Rent
• For a factor market, economic rent is the difference between the payments made to
a factor of production and the minimum amount that must be spent to obtain the
use of that factor.
Economic Rent
n Question
• What would be the economic rent if SL is perfectly inelastic?
n Land: A Perfectly Inelastic Supply
• With land inelastically supplied, its price is determined entirely by demand, at least
in the short run.
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Factor Markets with Monopsony Power
n Assume
• The output market is perfectly competitive.
• Input market is pure monopsony.
Marginal and Average Expenditure
Factor Markets with Monopsony Power
n Examples of Monopsony Power
• Government
– Soldiers, Missiles, B2 Bombers
• NASA
– Astronauts
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Factor Markets with Monopoly Power
n Just as buyers of inputs can have monopsony power, sellers of inputs can have
monopoly power.
n The most important example of monopoly power in factor markets involves labor
unions.
Objectives of the Union Leader.
1. To maximize the number of workers hired
: L* at wage w*.
2. To maximize the economic rent that employees earn
: L1 at wage w1.
3. To maximize total wages paid to workers
: L2 at a wage rate of w2
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Bilateral Monopoly Marketsr
n Bilateral Monopoly
• Market in which a monopolist sells to a monopsonist.
n Observations
• Hiring without union monopoly power
– MRP = ME at 20 workers and w = $10/hr
• Union’s objective
– MR = MC at 25 workers and w = $19/hr
Bilateral Monopoly
n Who Will Win? : Depending on the bargaining power
• The union will if its threat to strike is credible.
• The firm will if its threat to hire non-union workers is credible.
• If both make credible threats the wage will be at wc.
Minimum Wage above higher market-wage: Explained already.
- Issue :
o how many jobs are lost due to the minimum wage.
o Isn’t there any side-effects in imposing minimum wage.
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o Summary
In a competitive input market, the demand for an input is given by the MRP, the
product of the firm’s marginal revenue, and the marginal product of the input.
A firm in a competitive labor market will hire workers to the point at which the
marginal revenue product of labor is equal to the wage rate.
When factor markets are competitive, the buyer of an input assumes that its purchase
will have no effect on the price of the input.
Economic rent is the difference between the payments to factors of production and the
minimum payment that would be needed to employ those factors.
When a buyer of an input has monopsony power, the marginal expenditure curve lies
above the average expenditure curve.
When the input seller is a monopolist such as a labor union, the seller chooses the
point on the marginal revenue product curve that best suits its objective.
When a monopolistic union bargains with a monopsonistic employer, the wage rate
depends on the nature of the bargaining process.
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