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Economics of Public Policy. Labor Market Equilibrium Economics of Health Care Public Goods. Labor Market Equilibrium. Understand the relationship between wages and the marginal productivity of workers Analyze how wages and employment are determined in competitive labor markets.

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Economics of public policy
Economics of Public Policy

  • Labor Market Equilibrium

  • Economics of Health Care

  • Public Goods

Labor market equilibrium
Labor Market Equilibrium

  • Understand the relationship between wages and the marginal productivity of workers

  • Analyze how wages and employment are determined in competitive labor markets

The labor market
The Labor Market

  • Marginal product of labor (MP)

    • The additional output a firm gets by employing one additional unit of labor

  • Value of marginal product of labor (VMP)

    • The dollar value of the additional output a firm gets by employing one additional unit of labor

  • In a competitive market,

    • wage = VMP

Adiron woodworking company
Adiron Woodworking Company

  • Makes cutting boards from free scrap wood

    • Price of a cutting board is $20

  • Going wage is $350 per week

Adiron woodworking company1
Adiron Woodworking Company

  • The company will hire workers until the value of the marginal product of the last worker is equal to the wage

    • Cost-Benefit Principle

    • Workers earn $350 per week

  • Adiron will hire four workers

    • The fifth worker costs more ($350) than the benefits he delivers ($280)

Demand for labor
Demand for Labor

Firm 1



D1 = VMP1


Wage ($/hour)

D = VMP1 + VMP2




Wage ($/hour)


Firm 2


D2 = VMP2

Wage ($/hour)




Total Employment



Work hours/day

Individual labor supply
Individual Labor Supply

  • Individuals trade-off income and leisure

    • More work hours means more income AND less leisure

  • Suppose the wage increases

    • Substitution effect: work more

      • Leisure is more expensive

    • Income effect: work less

      • Purchasing power increases for a given work schedule

    • A higher wage may increase or decrease the quantity of labor supplied by the individual

Labor supply of programmers
Labor Supply of Programmers

  • Labor supply for a single profession has a positive slope

    • Higher wages attract workers from other careers

  • An increase in wages from W1 to W2 increases quantity of labor supplied from L1 to L2

    • Movement along the labor supply curve




Wage ($/hour)



Employment of programmers


Equilibrium in the labor market of programmers
Equilibrium in the Labor Market of Programmers

  • Demand for programmers increases from D1 to D2

    • Initial impact is a shortage of programmers at W1

    • In the short-run, wages are bid up to W3

  • In the long run

    • Movement up the supply curve and down the demand curve

    • Quantity of labor supplied increases from L1 to L2

    • Wages settle at W2









Employment of programmers


Health care delivery
Health Care Delivery

  • Health care spending has grown faster than income

    • Up from 4% of national income in 1940 to 14% in 2005

    • Part of the increase is due to improved quality of tests, procedures, drugs, etc.

    • Part is due to the third-party payment system

      • Growth in use of insurance for payments

        • Employer-provided and government-provided

Health care delivery1
Health Care Delivery

  • Cost-benefit test assures efficient allocation of health care

    • Perform a service only if the benefit exceeds the cost

  • Costs are easy to measure

  • Benefits are complicated

    • Usual measure is willingness to pay marginal cost

      • Some patients are unable to pay for basic services

        • Society assumes some responsibility via government-provided insurance

    • Confused by third-party payment system

The demand for hospital care
The Demand for Hospital Care

  • Price of hospital room is$300 per day

    • If David pays, MC to him is $300

    • David equates marginal cost and marginal benefit and stays one day

    • If insurance pays, MC to David is zero

      • He stays 3 days


Price ($/day)




Length of hospital stay (days)

Full insurance coverage creates waste
Full Insurance Coverage Creates Waste

  • If David pays, stay is 1 day

  • If insurance pays, stay is 3 days

    • Extra benefit of 2nd and 3rd day to David is $300

    • Extra cost is 2 days times $300 per day = $600

    • $300 surplus lost

Alternative coverage scheme
Alternative Coverage Scheme

  • Insurance company pays David $700

    • Insurance company saves $200 compared to a 3-day stay

  • David stays 1 day

    • Pays hospital $300

    • David keeps $400

      • The $300 benefit he would get from staying 3 days PLUS $100 pure surplus

  • Total surplus increases $300


Price ($/day)




Length of hospital stay (days)

Policy implications
Policy Implications

  • Research shows that when individuals pay for their health care, they consume less

  • An more efficient system can be designed

    • Adopt a system of high deductible health insurance

    • Use stipend payments for the poor

  • An efficient policy will increase the size of the health care pie

Public goods
Public Goods

  • Government is the only organization with the power to compel actions

    • Taxes

    • Military service

    • Imprison people

  • All other institutions – family, business, charitable organizations, etc. – rely on voluntary transactions

  • Government decisions can be analyzed using economic principles

Public goods1
Public Goods

  • Public good is a good that is both nonrival and nonexcludable

    • A nonrival good is one whose consumption by one person does not diminish its availability to others

      • National defense ; Economics lectures

    • A non-excludable good is one that is difficult or costly to exclude non-payers from consuming

      • Over-the-air broadcasts; Fireworks displays

  • A pure public good is, to a high degree, both nonrival and nonexcludable.

Public goods and government
Public Goods and Government

  • A collective good is a good or service that, to at least some degree, is nonrival but excludable

    • Sometimes provided by government

  • A good is a pure private good if

    • Non-payers can easily be excluded and

    • Each unit consumed by one person means one less unit available for others

  • A pure commons good is a rival good that is nonexcludable

    • Fish in open water

Paying for public goods
Paying for Public Goods

  • Not everyone benefits equally from a public good or service.

  • Example

    • Prentice and Wilson have adjacent properties

      • Fighting zebra mussel infestation

      • New device to control mussels is $1,000 to serve both properties

      • Wilson's income is higher and value device at $800

      • Prentice values device at $400

Paying for public goods1
Paying for Public Goods

  • Equal sharing of costs with a head tax

    • A head tax is a tax that collects the same amount from every taxpayer

  • Result: no new device

    • $500 is more than Prentice's reservation price

      • Prentice vetoes device

  • A regressive tax has a tax rate that varies inversely with income

  • A proportional income tax requires all taxpayers to pay the same proportion of their incomes in taxes

  • A progressive tax takes a larger share of higher incomes as tax

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