1.7 Resource Markets
Resource Markets (AP only unit)
•
•
•
•
Derived factor demand
Marginal Revenue Product (MRP)
Marginal Resource Cost (MRC)
Profit maximization rule of resource employment
(MRP=MRC)
• Perfectly competitive labor markets
• Monopsonistic labor markets
• The least-cost rule of resource employment
Unit Overview
Resource Markets
Online:
Labor Market
Factors of
Production
Wages
Living wages
Income
Practice Activities
1.7 Resource Markets
Introduction to
Resource Markets
Introduction to Resource Markets
Throughout most of this course we have examined the interactions of buyers and sellers in
product market, in which households are the buyers and firms the sellers. Recall from our
circular flow model, however, that a market economy includes a market in which the roles are
reversed.
Resource (or Factor) Markets: Where
households provide firms with the factors of
production needed to produce good and
services. The resources sold include: Labor,
Land and Capital. Households receive money
payments for their resources. These are:
• For Labor – WAGES
• For Land – RENT
• For Capital - INTEREST
These payments are determined just like any
other price, by market supply and demand.
1.7 Resource Markets
Introduction to
Resource Markets
Degrees of Competition in Resource Markets
Resource markets, like product markets, can have lots of competition or be relatively
uncompetitive. However, unlike product markets, competition in resource markets is among the
BUYERS of resources, not among the SELLERS of products.
A perfectly competitive resource market: Is one in which there are hundreds of firms competing with
one another to HIRE WORKERS… The market price is the wage rate firms pay workers, and this is determined
entirely by the market demand for labor and the market supply of labor.
Firms in perfectly competitive labor markets are known as “wage-takers” because they can hire as many
workers as they like at the equilibrium wage rate. They do not need to raise wage to attract more workers.
An imperfectly competitive resource market: Is one in which there is only one firm (or a relatively
small number of firms) hiring all of one particular type of labor. This type of labor market is known as a
monopsony, which means “single buyer”
Firms in a monopsonistic labor market are known as “wage-makers” because in order to attract more
workers, they must raise the wages they pay all their workers.
1.7 Resource Markets
Derived Demand for
Resources
Derived Resource Demand
Demand for any resource (labor, land or capital) is derived demand. This means it depends on
other factors, including:
• The price of the good the resources is used to produce,
• The productivity of the resource
The demand for a resource is determined primarily by the productivity of the resource. Recall
from an earlier unit the law of diminishing returns. This stated that;
As additional units of a variable resource put towards the production of a good using fixed
resources, the output of additional units of the variable resource will eventually decrease.
• In other words, the more labor you add to a fixed amount of capital, the less additional
output the labor will produce.
• For this reason, demand for labor is going to be inversely related to the price of labor (the
wage rate).
• Firms will only wish to hire more workers as the wage rate falls.
1.7 Resource Markets
Marginal Revenue Product
Marginal Revenue Product
The demand for a resource (we will focus on labor) is based on the productivity of the resource
and the price of the good being produced. Labor demand is based on the marginal revenue
product of labor.
Marginal Revenue Product of Labor (MPR) = the change in a firm’s total revenue resulting from
the employment of one additional worker. It can also be measured by the marginal physical
product of labor multiplied by the price of the good being produced.
𝑀𝑅𝑃 =
∆𝑇𝑅
𝑜𝑟 … 𝑀𝑃𝐿
∆𝑄𝐿
× 𝑃𝑔 (where Pg is the price of the good)
MRP is the revenue attributable to the last worker hired… Due to diminishing marginal returns,
as more and more workers are hired in the short-run, MRP will decrease, because:
•
•
Labor productivity decreases as labor is added to fixed capital, and in the case of a price-making firm,
The price of the output must decrease as output increases in order for the firm to sell additional units.
1.7 Resource Markets
Marginal Revenue Product
Marginal Revenue Product for a Perfectly Competitive Seller
The marginal revenue product of labor is determined by the productivity of labor and the price
of the output. Consider the production data for a bakery below.
•
•
•
The bakery sells its bread in a perfectly competitive market at a price of $2 per loaf
The bakery can hire anywhere from 1 to 8 workers.
Calculating the MRP will tell the bakery how much revenue each additional worker adds to the firm’s
total revenue.
Calculate the MRP of each
worker:
• Multiply the marginal
product of each worker
(how much output she
contributes) and the price
of bread.
• This tells us the most the
bakery would be willing to
pay each worker, or, the
DEMAND FOR LABOR
Quantity of labor
(QL)
Total Product
per hour
(TP)
Marginal
Product per hour
(MP)
Price of the
Product
(P)
Marginal
Revenue Product
(MPxP)
0
0
-
-
1
6
6
2
12
2
11
5
2
10
3
15
4
2
8
4
18
3
2
6
5
20
2
2
4
6
21
1
2
2
7
21
0
2
0
8
20
-1
2
-2
1.7 Resource Markets
Marginal Revenue Product
Marginal Revenue Product for a Perfectly Competitive Seller
The MRP of labor is analogous with the firm’s demand for labor. This is because:
• MRP tells the firm how much additional revenue each worker adds to the total revenu
• The firm will be willing to pay anything UP TO, but not greater than, each worker’s MRP in
order to hire that worker.
Consider, for example, the 4th worker in the bakery:
Quantity of labor
Marginal Revenue
• The fourth worker contributed 3 additional loaves of
(QL)
Product (MPxP)
bread per hour to the bakery’s output
0
• Each loaf sold for $2
1
12
• So the worker was accountable for $6 per hour of
2
10
additional revenue for the bakery.
3
8
• The bakery would happily pay this worker $3 per hour,
4
6
or even $4, or ever $5, or even $5.99!
5
4
6
2
7
0
8
-2
The bakery would be willing to pay the baker up to, but no
more than $6 per hour, since this is exactly how much
revenue the worker contributes per hour!
1.7 Resource Markets
Marginal Revenue Product
Marginal Revenue Product for a Perfectly Competitive Seller
By plotting the marginal revenue product of labor against the quantity of labor hired, we can see
the firm’s demand for labor curve.
14
Demand for Labor
MRP = PL (wage rate)
12
10
8
6
4
Notice from the graph:
• There is clearly an inverse relationship between
the quantity of labor demanded and the wage
rate.
• At higher wage rates, a lower number of
workers will be hired (because the MRP has to
be high enough to cover the wages paid)
• At lower wage rates a larger number of workers
is demanded (since the firm can afford to hire
workers with a lower MRP).
2
D=MRP
1
2
3
4
5
6
7
QL
1.7 Resource Markets
Marginal Revenue Product
Marginal Revenue Product for an Imperfectly Competitive Seller
Now let’s consider how the level of competition in the product market will affect a firm’s
demand for labor. Assume now that our bakery is selling bread in an imperfectly competitive
market, making the firm a price-maker. The bakery must now lower its price to sell additional
loaves of bread.
Marginal
Calculate the MRP of each
worker:
• Notice that now BOTH
marginal product AND the
price of bread falls,
• The bakery is willing to pay
more for the first couple
workers, because the price of
bread is high
• But MRP falls more rapidly
than it did for the perfectly
competitive seller.
Quantity of
labor (QL)
Total Product
per hour
(TP)
0
0
-
-
1
6
6
5
30
2
11
5
4
20
3
15
4
3
12
4
18
3
2
6
5
20
2
1
2
6
21
1
0.8
0.8
7
21
0
0.8
0
8
20
-1
1
-1
Product per
hour
(MP)
Price of the
Product
(P)
Marginal
Revenue
Product (MPxP)
1.7 Resource Markets
Marginal Revenue Product
Marginal Revenue Product for an Imperfectly Competitive Seller
An imperfectly competitive seller’s demand for labor will be much less responsive to chages in
the wage rate than a perfectly competitive seller. In other words, demand for labor is more
inelastic among monopolistic firms (and other imperfectly competitive sellers).
Quantity of labor
(QL)
Marginal Revenue
Product (MPxP)
0
-
1
30
2
20
3
12
4
6
5
2
6
0.8
7
0
8
-1
Demand for labor is highly inelastic:
• To go from one worker to 2 workers, the seller would
require a $10 decrease in the wage rate. This
compares to the perfectly competitive seller, which
hired a second worker when the wage fell by only $2
• Because the price of bread decreases as the bakery
makes more bread, it is very hesitant to hire
additional workers, i.e. demand for labor is wage
inelastic
1.7 Resource Markets
Marginal Revenue Product
Marginal Revenue Product for an Imperfectly Competitive Seller
By plotting the marginal revenue product of labor against the quantity of labor hired, we can see
the firm’s demand for labor curve.
30
28
Demand for Labor
MRP = PL (wage rate)
24
20
16
12
8
Notice from the graph:
• The blue line represents the imperfectly
competitive seller’s demand for labor.
• The green line is the perfectly competitive
seller’s demand for labor
• The imperfectly competitive seller’s labor
demand begins at a higher wage rate (since it
can sell bread at a higher price at first), but
drops rapidly with the additional workers hired
due to the fact that both MP and P are declining
as output increases.
4
D=MRP
1
2
3
4
5
6
7
1.7 Resource Markets
Market Labor Demand
Competitive Labor Markets – Market Demand for Labor
The demand for labor is based on the marginal revenue product of labor in a particular industry.
•
•
On the previous slides we showed individual firms’ demands for labor.
In the labor market as a whole, demand for labor consists of the sum of all the individual firms in the
market.
Assume, for example, that there are 100 bakeries competing to hire bakers. Each firm has the MRP for labor
that we calculated previously. Market labor demand is simply the sum of all the individual firms competing
for workers.
Each Firm’s Demand
for Labor
12
10
14
X 100 firms =
8
6
4
2
D=MRP
1
2
3
4
5
6
7
QL
MRP = PL (wage rate)
MRP = PL (wage rate)
14
The Market Demand
for Labor
12
10
8
6
4
2
D=MRP
100
200
300 400
500
600
700
QL
1.7 Resource Markets
Market Labor Supply
Competitive Labor Markets – Market Supply of Labor
To understand how supply of labor is determined, we must only imagine how households
respond to changes in the wage rate being paid to a particular type of worker:
The equilibrium wage rate and the quantity of
labor employed in a perfectly competitive
labor market is determined by the intersection
of labor supply and labor demand!
The Perfectly Competitive
Labor Market
14
Supply of
Labor
12
MRP = PL (wage rate)
There is a direct relationship between the
wage rate and the supply of labor
• Imagine the wages for bakers is rising.
More individuals will be willing and able to
become bakers at higher wage rates, since
it means more income is to be earned!
• If wages for bakers are falling, fewer
individuals will be willing and able to work
as bakers, since it would mean lower
income for the households.
10
8
6
4
2
D=MRP
100
200
300
400
500
600
700
QL
1.7 Resource Markets
Marginal Resource Cost
Marginal Resource Cost
A firm faces a downward sloping demand for labor curve due to the decreasing productivity of
labor in the short-run (and for a price-maker, the falling prices of its output). To determine
exactly how many workers a firm should hire, it must consider not only the MRP of labor, but
also the Marginal Resource Cost:
Marginal Resource Cost (MRC): The cost to a firm of hiring one additional worker.
∆𝑇𝐶
𝑀𝑅𝐶 =
∆𝑄𝐿
• In perfectly competitive labor markets, MRC = the Wage Rate: A “wage-taker” is a firm that
can hire as many workers as it wants at the market wage rate. The cost of each additional
worker, therefore, is simply the wage the firm must pay that worker, which never changes as
the level of employment changes!
• In a monopsonistic labor market, MRC is always greater than the wage rate: A “wagemaker” is a firm that must raise the wages it offers workers in order to attract more
individuals to come work for the firm. Since hiring one more worker requires raising wages
for workers who are already employed, the cost of hiring the additional worker is higher than
the actual wage the firm has to pay that worker.
1.7 Resource Markets
Profit Maximization
Profit Maximization Rule of Resource Employment
Based on what we know about MRP (the change in a firm’s revenues of hiring one more worker)
and MRC (the change in a firm’s costs of hiring one more worker), the decision of how many
workers to employ can be thought of as simple cost/benefit analysis.
The Profit Maximization Rule of Resource Employment: If the cost of hiring an additional
worker (the MRC) is less than the benefit of hiring the worker (the MRP), then the worker
should be hired! If the cost is greater than the benefit, then he should not be hired.
Workers should be hired up until the MRP = MRC
In perfectly competitive labor markets, this means individual firms should hire workers
until the MRP of the last worker is equal to the market wage rate.
1.7 Resource Markets
Profit Maximization
Profit Maximization in a Perfectly Competitive Labor Market
Based on the rule explained in the previous slide, a perfectly competitive employer will want to
hire workers until the MRP of the last worker equals the market wage rate.
The Perfectly
Competitive Labor
Market
12
14
Supply of
Labor
10
8
We
6
4
2
D=MRP
100
200
300 400
500
600
A Single Firm in the
Labor Market
12
MRP = PL (wage rate)
MRP = PL (wage rate)
14
700 Q
L
10
8
We
MRC
6
4
2
D=MRP
1
2
3
4
5
6
7
QL
The MRC seen by the individual firm is the market wage rate (We). The “wage-taker” can hire as
many workers as it wishes at We.
1.7 Resource Markets
Profit Maximization
Profit Maximization in a Monopsonistic Labor Market
As explained previously, a monopsonist is a firm which must raise wages to attract new workers
to the market. The firm is a “wage-maker”. For this reason, the MRC is always going to be
greater than the wage rate the firm is actually paying.
The Monopsonistic Labor Market
14
MRP = PL (wage rate)
Observe from the graph:
• Because the single employer must
raise wages to attract more workers, it
will always cost the firm more to hire
one more worker than the wage it has
to pay that worker.
• Wages must be risen for all workers!
• The MRC rises faster than the wage
rate.
• As a result, the firm will hire fewer
workers and pay them lower wages
than would be paid in a perfectly
competitive labor market!
MRC
Supply of
Labor
12
10
8
6
We
4
2
D=MRP
100
200
300 400
500
600
700 Q
L
1.7 Resource Markets
Profit Maximization
Employment in Perfectly Competitive vs. Monopsonistic Markets
Due to its wage-making ability, a monopsonist will employ fewer workers and pay lower wages
than would be hired in a perfectly competitive labor market.
MRP = PL (wage rate)
14
12
The Monopsonistic Labor Market
14
Supply of
Labor
MRP = PL (wage rate)
The Perfectly
Competitive Labor
Market
10
8
We
6
4
2
MRC
Supply of
Labor
12
10
8
6
We
4
D=MRP 2
100
200
300 400
500
600
700 Q
L
D=MRP
100
200
300 400
500
600
700 Q
Monopsonistic labor markets are undesirable to workers, for whom there will be fewer
employment opportunities and lower wages offered.
L
1.7 Resource Markets
Minimum Wages
Minimum Wages in Labor Markets
Assume the government sets a minimum wage in the two labor markets below. A minimum
wage is a price floor in a labor market, set above the equilibrium wage rate.
MRP = PL (wage rate)
14
12
The Monopsonistic Labor Market
14
Supply of
Labor
MRP = PL (wage rate)
The Perfectly
Competitive Labor
Market
10
Wm
8
6
4
2
MRC
Supply of
Labor
12
10
8
Wm
6
4
D=MRP 2
100
200
300 400
500
600
700 Q
Qs of labor will increase, while Qd will decrease.
Unemployment results in the PC labor market
L
D=MRP
100
200
300 400
500
600
700 Q
Wm becomes the firm’s MRC, and it’s lower than the
previous MRC. The firm will end up hiring more workers!
L
1.7 Resource Markets
The Least Cost Rule
The Least Cost Combination of Resource Employment
When deciding on the optimal combination of two resources (say workers and robots) a firm
should consider the marginal product per dollar spent on each resource.
• Similar to the utility maximization rule of consumer behavior, which said that consumers
should buy the goods which provide them with the most marginal utility per dollar.
• When a firm employs the resource that gives it the most marginal product per dollar, the firm
is maximizing its “bang for its buck”
The Least Cost Combination of Resources: When a firm is hiring two resources (labor and
capital) it should attempt to employ them up to the point where the last dollar spent on labor
yielded the same additional output as the last dollar spent on capital:
𝑴𝑷𝑳 𝑴𝑷𝑪
=
𝑷𝑳
𝑷𝑪
Where… MPL is the marginal product of labor and PL is the price of labor, and
MPC is the marginal product of capital and Pc is the price of capital
1.7 Resource Markets
Quick Quiz
Quick Quiz on Resource Markets
1. Why is the Marginal Revenue Product curve equivalent to an individual firm’s labor Demand
curve?
A. In pure competition, a firm will hire workers up to the point at which the market wage rate (MRC) is
equal to its MRP. Hence, the firm’s MRP schedule constitutes the firm’s D for labor, because each
point on this curve indicates the number of workers the firm would hire at each possible wage rate.
2. Why does a purely competitive firm’s D for labor tend to be more elastic than an imperfect
competitor’s?
A. Perfect competitors face a downward sloping D curve because marginal productivity diminishes as
more workers are hired. Imperfect competitors face diminishing marginal productivity AND product
price falls as output increases. Therefore, imperfectly competitive firms are LESS responsive to
changes in the wage rate than perfect competitors. (i.e. less elastic resource D)
3. What makes resource demand "derived demand"?
A. Demand for resources is derived from the productivity of the resource as well as the price of the
good or service the resource is used to produce
1.7 Resource Markets
Discussion Questions
Discussion Questions on Resource Markets
1.
2.
3.
4.
5.
6.
7.
8.
What determines demand for labor?
What determines the supply of labor?
How is the wage rate determined?
Why are wages higher in the US and Western Europe than in countries like India
and China?
What is the difference between nominal wage and real wage?
What determines the level of employment and the wage rate in a purely
competitive labor market and a representative firm? (include a diagram)
What determines the level of employment and the wage rate in an imperfectly
competitive labor market? (include a diagram)
What are the effects of a minimum wage? Is a minimum wage good or bad for
society? (include a diagram)