Chapters 16.1-16.5, 17.1-17.4, 18.1, 18.2: Input & Labor Markets, Wages & Rent
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Chapters 16.1-16.5, 17.1-17.4, 18.1, 18.2: Input & Labor Markets, Wages & Rent. Input Demand Curve of a Competitive Firm. Input demand shows the total quantity of the input that will be demanded at various prices

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Input demand curve of a competitive firm
Input Demand Curve of a Markets, Wages & RentCompetitive Firm

  • Input demand shows the total quantity of the input that will be demanded at various prices

  • Input demand will depend on the marginal value product (MVP), which is the extra revenue a competitive firm receives by selling the additional output generated when employment of an input is increased by 1 unit

    • For a competitive firm, MVP = MPL * P (this is b/c output price is constant for a competitive firm)

    • It makes sense for a firm to hire to the point where MVP = w, w = MPL*P and therefore w/MPL = P


Competitive firms demand for labor all inputs variable
Competitive Firms Demand for Labor: All Inputs Variable Markets, Wages & Rent

  • When all inputs are variable, an input’s MVP curve shifts with changes in the employment of other inputs

    • A lower wage rate causes the firm to substitute toward labor and away from capital

  • Input demand is a “derived demand” reflecting the fact that industry demand for an input ultimately derives from consumers’ demand for the final product produced by that input

Dollars

per

unit

Capital

A1

MC

New expansion path

MC’

A

12

E

E2

E2

A’

P3

E

10

E1

IQ2

E1

IQ1

q1

q2

0

Output

0

Z’

Z1

20

26

30

Labor

Substitution

Effect

Output Effect


Competitive industry demand for labor
Competitive Industry Demand for Labor Markets, Wages & Rent

The firm

The market

Wage

Wage

A

$300 = w

A’

$300 = w

B

$200 = w’

B’

$200 = w’

C

C’

d(P = $100)

∑ d(P = $100)

∑ d’(P = $80)

d’(P = $80)

D

Labor

0

20

27

30

Labor

0

2,000

2,700

3,000


Elasticity of an industry s demand curve for an input
Elasticity of an Industry’s Demand Curve for an Input Markets, Wages & Rent

  • Elasticity of input demand is the sensitivity of input demand to changes in input cost

    = (%input demand)/(%input cost)

  • Four major determinants of the elasticity of an industry’s demand for an input

    • Elasticity of the final product

    • The substitutability of one input for another in production

    • The supply of other inputs

    • Time period


Supply of inputs
Supply of Inputs Markets, Wages & Rent

Wage

Wage

S

S

w2

w2

w1

w1

0

L1

(100,000,000)

Labor (in all industries)

L1

(5,000)

0

L2

(15,000)

Labor (in software programming industry)


Equilibrium in input markets
Equilibrium in Input Markets Markets, Wages & Rent

The Equilibrium Wage and Employment Level for a Competitive Industry

Input Price Equalization Across Industries

The firm

Aerospace industry

Telecommunications industry

The industry

Wage

Wage

Wage

SSA

SS’A

Wage

SST

SS’T

S

$400 = wA

$350 = w’A

$350 = w’T

s

$300 = w

s

$300

= w

$250 = w1

$300 = wT

d

D

DA

DT

l

(500)

Labor

0

0

L0

(6,000)

L

(10,000)

L1

(12,000)

Labor

0

LA

(500)

L’A

(700)

Labor

0

LT

(800)

L’T

(1,000)

Labor


Income leisure choice of the worker
Income Leisure Choice of the Worker Markets, Wages & Rent

Weekly

Income

A

B

Y2

E

$800 = Y1

U3

U2

G

U1

$20

F

1 hr.


Supply of hours of work
Supply of Hours of Work Markets, Wages & Rent

Weekly

Income

A’

H

$25

1 hr.

$25

1 hr.

A

E’

$20

1 hr.

E1

U2

E

U1

L3

L1

Leisure

L2

H’

Z

0

S

I

TE


A backward bending labor supply curve
A Backward Bending Labor Supply Curve? Markets, Wages & Rent

Weekly

income

Hourly

wage

A’’

$30

E’’

$30

1 hr.

A’

E’’

$25

E’

E’

1 hr.

A

$25

$20

1 hr.

E

E

$20

Labor

0

L2

L3

L1

ZL3

Z

Leisure

ZL1

ZL2


Why do wages differ
Why Do Wages Differ? Markets, Wages & Rent

  • If wage rates differ across occupations and there is free entry and exit from/into occupations, shouldn’t we see individuals leave the low wage occupation (shifting supply to the left) and enter the high wage occupation (shifting supply to the right), equalizing wages across occupations. So why do wages differ across individuals and occupations?

  • Compensating wage differentials

  • Differences in human capital

  • Differences in ability


Minimum wages
Minimum Wages Markets, Wages & Rent

S

S

Wage

Wage

$5.15

$6.00

$4.00

$5.15

D

D

0

Unskilled

Labor

0

L2

L1

L3

Unskilled

Labor

L2

L1

L3


Burden of social security tax
Burden of Social Security Tax Markets, Wages & Rent

  • Social security is financed by a payroll tax composed of two equal-rate levies, one collected from employers and one collected from employees (about 7.6% on each for the first $80K of income), so who really pays for this tax?

Wage

Wage

S

S

$10.50 = w’’

$10 = w

$10.00 = w

Total revenue

$8.50 = w’

$8 = w’

$2

$2

D

D

D’ = D - T

D’ = D - T

0

Labor

L1

0

Labor

L1


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