Chapter 5 Flashcards
Labor demand when the product market is not competitive
Profit maximization
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● Decision rules:
○ Income generated by employing one more unit of an input exceeds additional expense =
○ Income generated by one more unit of input is less than additional expense,
○ Income generated by one more unit of input = to additional expense =
● Two thing to note:
- A firm can only
○ As long as marginal revenue from added unit of output exceeds marginal cost,
○ Marginal cost exceeds marginal output:
○ Firm can increase/decrease output using 2 types of input:
- Theory must address
Labor demand when the product market is not competitive
Profit maximization
● Firms (employers of labor) seek to maximize profits
● Decision rules:
○ Income generated by employing one more unit of an input exceeds additional expense = add a unit of input
○ Income generated by one more unit of input is less than additional expense, reduce employment of input
○ Income generated by one more unit of input = to additional expense = no change
● Two thing to note:
- A firm can only change variables within it control (increasing or decreasing output NOT price)
○ As long as marginal revenue from added unit of output exceeds marginal cost, firm will continue to expand output
○ Marginal cost exceeds marginal output: firm will decrease output
○ Firm can increase/decrease output using 2 types of input: labor and capital
- Theory must address small (marginal) changes that must be made almost daily. Holding employment of other inputs constant
Marginal income from an additional unit of input
Marginal revenue product =
● Example:
○ 20,000 spectators attendance increase
○ 25$ for each additional fan
○ Marginal revenue product =
Marginal revenue product = change in physical output produced (marginal product) x MR(marginal revenue) generated per unit of physical output
● Example:
○ 20,000 spectators attendance increase
○ 25$ for each additional fan
○ Marginal revenue product = 20,000 x $25 = $500,000
Marginal product (of labor):
…
Marginal product of capital:
…
Marginal product (of labor): the change in physical output produced by change in units of labor, holding capital constant
MP= ΔQ ÷ ΔL
Marginal product of capital: the change in output associated with a one-unit change in the stock of capital, holding labor constant
MP =ΔQ÷ Δ K
Marginal revenue:
● Pure competitive market (no control over price):
● Differentiated product (some control):
Marginal expense of an added input:
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Marginal revenue:
● Pure competitive market (no control over price): marginal revenue per unit of output sold is = to product price
MRPL = MPL x MR
● Differentiated product (some control): extra units of output can be sold only if product price is reduced
MRPL = MPL x P
Marginal expense of an added input:
● Competitive labor market (no control over wages that must be paid): “wage taker”, marginal expense of labor = market wage
○ Therefore, labor supply curve = horizontal at the going way
The short-run demand for labor when both product and labor markets are competitive
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The short-run demand for labor when both product and labor markets are competitive
● In the short-run: firm only needs to decide whether to alter its output level, how to increase/decrease output is not an issue because only employment of labor can be adjusted
A critical assumption: declining MPL
● Positive MP L :
● Falling MP L :
A critical assumption: declining MPL
● Positive MP L : as long as output increases as labor is added
● Falling MP L : as more input is used, MP L declines → “law of diminishing returns” is an empirical proposition that derives from the fact that as employment expands, each additional worker has progressively smaller share of capital stock to work with
From profit maximization to labor demand
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From profit maximization to labor demand
● Profits are maximized only when employment is such that any further one-unit change in labor would have a marginal revenue product equal to marginal expense:
○ MRPL = MEL
● We can represent profit-maximizing level of labor input as that level at which
○ MPL x P = W , stated in monetary unit (dollars)
● Profit-maximizing condition for hiring labor in terms of physical quantities:
○ MPL = W ÷ P
Labor demand in terms of real wages:
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○ Implies 2 things:
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Labor demand in terms of real wages:
● Demand for labor in the short run is equivalent to the downward-sloping segment of is MPL schedule
● To maximize profits (given any real wage rate), a firm should stop employing labor at the point in which any additional labor would cost more than it would produce
○ Implies 2 things:
■ Employ labor until real wage = MP L BUT not beyond that point
■ Profit-maximizing level of employment lies in range where MP L is
declining Labor demand
Labor demand in terms of money wages:
● Labor demand curve in the short run slopes
● The MRP L curve slopes downward
● The demand curve and the MRPL
● Labor demand curve in the short run slopes downward because it is the MRPL Curve
● The MRP L curve slopes downward because of labor’s diminishing marginal product
● The demand curve and the MRPL curve coincide
Market demand curves:
● Market demand curve (or schedule) is the …
● Slopes …as a function of the real wage
○ Real wage falls:
○ Real wage increases:
Market demand curves:
● Market demand curve (or schedule) is the summation of the labor demanded by all firms in a particular labor market at each level of the real wage
● Slopes downward as a function of the real wage
○ Real wage falls: number of workers that firms want to employ increases
○ Real wage increases: number of workers that firms want to employ decreases
Objections to the marginal productivity theory of demand:
- Almost no employer is aware…
○ Answer to objection 1: employers must at least …
○ Employers can know …
- Many cases, it seems that … ex…
○ Answer to objection 2: to ex…
Objections to the marginal productivity theory of demand:
- Almost no employer is aware of marginal revenue product of labor. Employers are mostly unable to accurately measure output of individual workers.
○ Answer to objection 1: employers must at least intuit them (profit-maximizing conditions, measuring MRPL ) to survive in a competitive environment
○ Employers can know these concepts without verbalizing them
- Many cases, it seems that adding labor while holding capital constant would not add to output at all. Example: 1 secretary, 1 computer. Adding a 2nd secretary with no computer will not generate more output
○ Answer to objection 2: two secretaries can take turns using computer, while other secretary is doing other work tasks
The demand for labor in competitive markets when other inputs can be varied
Labor demand in the …
● To maximize profits, labor and capital …
○ MPL…
○ MPK ….
● Isolating …
○ P = …
○ P = …
● Profit maximization requires that
○ W …
■ W…
■ c…
● What would happen to demand for labor in the long run of the wage rate facing a profit-maximizing firm were to rise
○ The rise in W …
○ MPK ….
○ Rise in W will …
The demand for labor in competitive markets when other inputs can be varied
Labor demand in the long run
● To maximize profits, labor and capital must be adjusted so marginal revenue product of each equals its marginal expense
○ MPLx P = W
○ MPK x P = C (profit − maximizing condition for capital)
● Isolating P
○ P = W ÷ MPL
○ P = C ÷ MPK
● Profit maximization requires that
○ (5.8)W ÷ MPL = C ÷ MPK , hence to maximize profits the firm must adjusts
its labor and capital inputs so that marginal cost of producing an added unit of output using labor is equal to the marginal cost of producing an added unit of output using capital
■ W/MPL =added cost of producing an added unit of output when using
labor to generate the increase in output
■ c/MPK= marginal cost of producing an extra unit of output using capital
● What would happen to demand for labor in the long run of the wage rate facing a profit-maximizing firm were to rise
○ The rise in W disturbs equality in equation 5.8 and the firm will want to cut back on use of labor even before it can adjust its capital which will raise MPL
○ MPK falls which will cause firm to want to reduce its stock of capital
○ Rise in W will end equality in equation 5.8 = marginal cost of production
using labor now exceeds marginal cost using capital
The demand for labor in competitive markets when other inputs can be varied Part 2
● Conclusion:
○ Increase in … = firm to …
■ Firm’s profit-maximizing level of output …
■ Rise in W also causes firm to …
■ Scale & substitution effects of a wage …
More than 2 inputs:
● …. inputs: …
● Increase in price of one input ….
● Increase shifts demand ….
● Perfect …. in production: …
The demand for labor in competitive markets when other inputs can be varied Part 2
● Conclusion:
○ Increase in W = firm to reduce desired employment level for 2 reasons
■ Firm’s profit-maximizing level of output will fall and associated
reduction in required inputs (both capital and labor) is an example of
the scale effect
■ Rise in W also causes firm to substitute capital for labor so it can again produce in the least-cost manner; changing mix of capital and labor in production process is known as substitution effect
■ Scale & substitution effects of a wage increase: have ambiguous
effect on firm’s desired stock of capital but both serve to reduce the
demand for labor
More than 2 inputs:
● Substitute inputs: the greater use of one in producing output can compensate for reduced use of the other. Increases in price of the other input may shift the entire demand curve for a given category of labor either to right or left depending on strength of substitution and scale effects
● Increase in price of one input shifts demand for other input to left: scale effect has dominated the substitution effect and the 2 inputs are known as gross complements
● Increase shifts demand for other input to the right, substitution effect has dominated and the two inputs are gross substitutes
● Perfect complements/complements in production: two inputs must be used together
○ No substitution effect
○ Only scale effect
○ Two inputs must be gross complements
Labor demand when the product market is not competitive
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Maximizing monopoly profits
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● Monopolist …
○ …
● Express demand for labor in short run in terms of real wage:
○ …
● MR/Palways less than 1: …
● Demand curve monopoly…
○ Level of employment and level of profit-maximizing …
Do monopolies pay higher wages?
● …
Labor demand when the product market is not competitive
● Monopolistic, noncompetitive product markers on the demand for labor
● Are not price takers
Maximizing monopoly profits
● Are not price takers
● Can expand sales by reducing product price, means that their marginal revenue from
an extra unit of output is less than product price (ME L = W)
● Monopolist would hire workers until marginal revenue product of labor (MRP L ) =
wage rate
○ MRPL = MR x MPL = W
● Express demand for labor in short run in terms of real wage:
○ (MR/P) x MPL=(W/P)
● MR/Palways less than 1: since marginal revenue is always less than a monopoly’s product price
● Demand curve monopoly will lie below competitive market demand curve
○ Level of employment and level of profit-maximizing output is lower than
competitive market
Do monopolies pay higher wages?
● Pay high wages and pass costs along to consumers in the form of higher prices
Policy application: the labor market effects of employer payroll taxes and wage
subsidies
Who bears the burden of a payroll tax
● Effects on labor demand: …
● Effects on labor supply: …
○ Less responsive labor supply to changes in wages: …
Policy application: the labor market effects of employer payroll taxes and wage
subsidies
Who bears the burden of a payroll tax
● Effects on labor demand: Employees are not exempted from bearing costs when the government chooses to generate revenues through a payroll tax on employers
● Effects on labor supply: depends on amount of employer payroll tax that gets shifted nto employee’s wages
○ Less responsive labor supply to changes in wages: fewer employees who
withdraw from market and higher proportion of tax that gets shifted to workers in the form of a wage decrease
Policy application: the labor market effects of employer payroll taxes and wage
subsidies Part 2
… as a device to help the poor
● Opposite…
● Can be in form ….
● Credits….
Hiring …:
● General: …
● Selective (or targeted):…
Payroll tax cuts:
● Stimulates ….
● Cutting payroll taxes during period when there is high unemployment….
● Reduce employer payroll tax =…
Policy application: the labor market effects of employer payroll taxes and wage
subsidies Part 2
Employment subsidies as a device to help the poor
● Opposite of payroll tax
● Can be in form of cash payments or tax credits
● Credits may directly reduce firm’s payroll-tax rate or reduce some other tax by
amount proportional to number of labor hours hired. Credit has the effect of reducing the cost of hiring labor
Hiring subsidy programs:
● General: not conditional on the characteristics of the people hired
● Selective (or targeted): makes the subsidy conditional on hiring people from certain target groups (disadvantaged)
Payroll tax cuts:
● Stimulates hiring
● Cutting payroll taxes during period when there is high unemployment can increase employment
● Reduce employer payroll tax = labor demand curve would shift right
