class: center, middle, inverse, title-slide # 4.4 — Factor Markets ## ECON 306 · Microeconomic Analysis · Fall 2020 ### Ryan Safner
Assistant Professor of Economics
safner@hood.edu
ryansafner/microF20
microF20.classes.ryansafner.com
--- class: inverse # Outline ### [Labor Market for Competitive Firm](#12) ### [Labor Market for a Monopoly](#30) ### [Monopsony Power](#34) ### [Monopoly Power in Labor Markets: Unions](#54) --- # Returning to Firms .pull-left[ - Recall a firm uses technology that buys inputs, transforms them, and sells output `$$q=f(k,l)$$` - We classified inputs into the .hi[factors of production]: land, labor, capital - We *assumed* fixed factor prices - show up in total cost `\(=wL+rK\)` - Where do they come from? .hi[Factor markets] ] .pull-right[ .center[ ![:scale 70%](https://www.dropbox.com/s/zu2c5ijzqvz5sbh/inputoutput.png?raw=1) ] ] --- # Circular Flow .center[ ![:scale 60%](https://www.dropbox.com/s/fepwbznjbdoa9dk/circularflow.png?raw=1) ] --- # Firms’ Payments to Factors are Income To Households .quitesmall[ <table> <thead> <tr> <th style="text-align:left;"> Income Type </th> <th style="text-align:right;"> Amount (2016) </th> <th style="text-align:right;"> Percent </th> </tr> </thead> <tbody> <tr> <td style="text-align:left;"> Salaries and wages </td> <td style="text-align:right;"> $7217 Bn </td> <td style="text-align:right;"> 68.45% </td> </tr> <tr> <td style="text-align:left;"> Taxable pensions and annuities </td> <td style="text-align:right;"> $694 Bn </td> <td style="text-align:right;"> 6.58% </td> </tr> <tr> <td style="text-align:left;"> Partnership and S corporation net income </td> <td style="text-align:right;"> $629 Bn </td> <td style="text-align:right;"> 5.97% </td> </tr> <tr> <td style="text-align:left;"> Capital gains less losses </td> <td style="text-align:right;"> $621 Bn </td> <td style="text-align:right;"> 5.89% </td> </tr> <tr> <td style="text-align:left;"> Business net income </td> <td style="text-align:right;"> $389 Bn </td> <td style="text-align:right;"> 3.69% </td> </tr> <tr> <td style="text-align:left;"> Taxable Social Security benefits </td> <td style="text-align:right;"> $286 Bn </td> <td style="text-align:right;"> 2.71% </td> </tr> <tr> <td style="text-align:left;"> Taxable IRA distributions </td> <td style="text-align:right;"> $258 Bn </td> <td style="text-align:right;"> 2.45% </td> </tr> <tr> <td style="text-align:left;"> Ordinary dividends </td> <td style="text-align:right;"> $254 Bn </td> <td style="text-align:right;"> 2.41% </td> </tr> <tr> <td style="text-align:left;"> Total rental and royalty net income </td> <td style="text-align:right;"> $98 Bn </td> <td style="text-align:right;"> 0.93% </td> </tr> <tr> <td style="text-align:left;"> Taxable interest </td> <td style="text-align:right;"> $97 Bn </td> <td style="text-align:right;"> 0.92% </td> </tr> </tbody> </table> ] .source[Source: [Tax Foundation, 2018](https://taxfoundation.org/sources-of-personal-income-2016/)] --- # Firms’ Payments to Factors are Income To Households .pull-left[ .center[ ![](../images/Sources-of-Personal-Income-2016-Update-1.png) ] ] .pull-right[ .center[ ![](../images/FF612-chart-2.png) ] ] .source[Source: [Tax Foundation, 2018](https://taxfoundation.org/sources-of-personal-income-2016/)] --- # Supply and Demand in Factor Markets .pull-left[ - The price of a factor is governed by the same market forces as output: - .hi-red[Supply of Factor]: willingness of factor owners to accept and sell/rent their services to firms - landowners, workers, capitalists, resource owners, suppliers - .hi-blue[Demand for Factor]: willingness of firms to pay for/hire factor services ] .pull-right[ <img src="4.4-slides_files/figure-html/unnamed-chunk-2-1.png" width="504" style="display: block; margin: auto;" /> ] --- # Factor Market Prices and Opportunity Costs .pull-left[ - .hi[Factor price represents **opportunity cost** of hiring a factor for an alternative use] - Firms not only pay for direct use of a factor, but also indirectly for *not using* it in an alternate process! ] .pull-right[ .center[ ![:scale 100%](https://www.dropbox.com/s/mb9yaadujqe38fj/disappear.jpg?raw=1) ] ] --- # Factor Market Prices and Opportunity Costs .pull-left[ - .green[**Example**]: a producer of hammers buys steel, pays (the opportunity cost) for "taking" the steel away from alternative uses ] .pull-right[ .center[ ![:scale 100%](https://www.dropbox.com/s/mb9yaadujqe38fj/disappear.jpg?raw=1) ] ] --- # Factor Market Prices and Opportunity Costs .pull-left[ - .green[**Example**]: e.g. salary for a skilled worker must be high enough to keep them at their current firm, and not be attracted to other firms/industries ] .pull-right[ .center[ ![:scale 100%](https://www.dropbox.com/s/mb9yaadujqe38fj/disappear.jpg?raw=1) ] ] --- # Example Factor Market: Labor Markets .pull-left[ - Empirically, about 70% of total cost of production comes from labor - We’ll focus just on the .hi[market for labor] as an example factor market - Can do the same for *any* factor market - (e.g. capital, land, materials, etc.) ] .pull-right[ .center[ ![](https://www.dropbox.com/s/uwqthhm8l339l8f/labormarket.jpg?raw=1) ] ] --- class: inverse, center, middle # Labor Market for a Competitive Firm --- # Derived Demand in Factor Markets .pull-left[ - Demand for factors is a .hi-purple["derived demand"]: - Firm only demands inputs to the extent they **contribute to producing sellable output** - Firm faces a .hi-purple[tradeoff] when **hiring more labor**, as more labor `\(\Delta L\)` creates: 1. .hi[Marginal Benefit]: Increases output and thus revenue 2. .hi[Marginal Cost]: Increases costs ] .pull-right[ .center[ ![](https://www.dropbox.com/s/usjcm7s1euszomm/firms.png?raw=1) ] ] --- # Marginal Revenue Product (of Labor) - Hiring more labor increases output (i.e. labor's .hi-purple[`\\(MP_L\\)`]) - Recall: `\(MP_L=\frac{\Delta q}{\Delta L}\)`, where `\(q\)` is units of output -- - Additional output generates (i.e. labor's .hi-purple[`\\(MR(q)\\)`]) - Recall: `\(MR(q)=\frac{\Delta R(q)}{\Delta q}\)`, where `\(R(q)\)` is total revenue -- - Hiring more labor, on the **margin**, generates a **benefit**, called the .hi[marginal revenue product of labor, `\\(MRP_L\\)`]: `$$MRP_L=MP_L* MR(q)$$` - i.e. the number of new products a new worker makes times the revenue earned by selling the new products --- # Marginal Revenue Product for *Competitive* Firms .pull-left[ - This is the .hi-blue[Firm's Demand for Labor]: `$$MRP_L=MP_L* MR(q)$$` - For a firm in a .hi[competitive (output) market], firm's `\(MR(q)=p\)`, hence: `$$MRP_L=MP_L*p$$` where `\(p\)` is the price of the firm's *output* ] <img src="4.4-slides_files/figure-html/unnamed-chunk-3-1.png" width="504" style="display: block; margin: auto;" /> --- # Marginal Revenue Product for *Competitive* Firms .pull-left[ `$$MRP_L=MP_L* p$$` - Marginal benefit of hiring labor, `\(MRP_L\)` **falls** with more labor used - production exhibits **diminishing marginal returns to labor**! - .hi[Choke price for labor demand]: price too high for firm to purchase any labor ] <img src="4.4-slides_files/figure-html/unnamed-chunk-4-1.png" width="504" style="display: block; margin: auto;" /> --- # A Competitive *Factor* Market .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-5-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ <img src="4.4-slides_files/figure-html/unnamed-chunk-6-1.png" width="504" style="display: block; margin: auto;" /> ] - If the .hi[*factor* market is competitive], labor supply for an individual firm is *perfectly elastic* at the market price of labor `\((w^*)\)` --- # A Brief Digression on Economic Rents I .pull-left[ - Recall .hi-red[market supply] is the **minimum willingness to accept**, the minimum price necessary to bring a resource to market (its opportunity cost) - But all (equivalent) labor is paid the *market wage*, `\(w^*\)` determined by market labor supply and labor demand ] .pull-right[ <img src="4.4-slides_files/figure-html/unnamed-chunk-7-1.png" width="504" style="display: block; margin: auto;" /> ] --- # A Brief Digression on Economic Rents II .pull-left[ - Some workers would have accepted a job for less than `\(w^*\)` - These inframarginal workers earn .hi[economic rent] in excess of what is needed to bring them into the market (their opportunity cost) ] .pull-right[ <img src="4.4-slides_files/figure-html/unnamed-chunk-8-1.png" width="504" style="display: block; margin: auto;" /> ] --- # A Brief Digression on Economic Rents III .pull-left[ - Consider a factor (such as land) for which the supply is perfectly inelastic (e.g. a fixed supply) - Then the **entire value of the land is economic rent**! - .hi-purple[The *less* elastic the supply of a factor, the *more* economic rent it generates!] ] .pull-right[ <img src="4.4-slides_files/figure-html/unnamed-chunk-9-1.png" width="504" style="display: block; margin: auto;" /> ] --- # Labor Supply and Firm's Demand for Labor .pull-left[ - We've seen a falling `\(MRP_L\)`, the marginal benefit of hiring labor - .hi[Marginal cost of hiring labor], `\(w\)`, remains constant - so long as firm is not a big purchaser (has no market power) in the labor market ] .pull-right[ <img src="4.4-slides_files/figure-html/unnamed-chunk-10-1.png" width="504" style="display: block; margin: auto;" /> ] --- # Labor Supply and Firm's Demand for Labor .pull-left[ - At low amounts of labor, .blue[marginal benefit] `\(\color{#0047AB}{MRP_L} > \color{#D7250E}{w}\)` .red[marginal cost] - Firm will hire more labor ] .pull-right[ <img src="4.4-slides_files/figure-html/unnamed-chunk-11-1.png" width="504" style="display: block; margin: auto;" /> ] --- # Labor Supply and Firm's Demand for Labor .pull-left[ - At high amounts of labor, .blue[marginal benefit] `\(\color{#0047AB}{MRP_L} < \color{#D7250E}{w}\)` .red[marginal cost] - Firm will hire less labor ] .pull-right[ <img src="4.4-slides_files/figure-html/unnamed-chunk-12-1.png" width="504" style="display: block; margin: auto;" /> ] --- # Labor Supply and Firm's Demand for Labor .pull-left[ - Firm hires `\(L^*\)` optimal amount of labor where `\(w=MRP_L\)` - i.e. marginal cost of labor `\(=\)` marginal benefit of labor ] .pull-right[ <img src="4.4-slides_files/figure-html/unnamed-chunk-13-1.png" width="504" style="display: block; margin: auto;" /> ] --- # Labor Supply and Firm's Demand for Labor .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-14-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ <img src="4.4-slides_files/figure-html/unnamed-chunk-15-1.png" width="504" style="display: block; margin: auto;" /> ] --- # Labor Supply and Firm's Demand for Labor .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-16-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ <img src="4.4-slides_files/figure-html/unnamed-chunk-17-1.png" width="504" style="display: block; margin: auto;" /> ] .smaller[ - If market supply of labor decreases, wages increase & firms hire fewer workers (and vice versa) ] --- # Example .content-box-green[ .green[**Example**]: Victoria’s Tours is a travel company that offers guided tours of nearby mountain biking trails. Its marginal revenue product of labor is given by `\(MRP_L = 1,000 – 40l\)`, where `\(l\)` is the number of tour-guide weeks it hires and `\(MRP_L\)` is measured in dollars per tour-guide week. The going market wage for Victoria’s Tours is $600 per tour-guide week. ] 1. What is the optimal amount of labor for Victoria’s Tours to hire? 2. At and above what market wage would Victoria’s Tours not want to hire anyone? 3. What is the most labor Victoria’s Tours would ever hire, given its marginal revenue product? --- class: inverse, center, middle # Labor Demand for a Monopoly --- # Labor Demand for Competitive vs. Monopolist Firm .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-18-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ - Recall a firm's demand for labor: `\(MRP_L= MP_L * MR(q)\)` - A firm in a **competitive output industry** has its `\(MR(q)=p\)` - So we saw its .hi-blue[Labor Demand], `\(MRP_L = MP_L * p\)` ] --- # Labor Demand for Competitive vs. Monopolist Firm .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-19-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ - Recall if firm is a **monopolist** in its **output** industry, its `\(MR(q) < p\)` - So its .hi-blue[Labor Demand], `\(MRP_L = MRP_L * MR(q)\)` - Since `\(MR(q) < p\)`, .hi-purple[a monopoly in its output industry will always have lower demand for labor], and thus, .hi-purple[hire less labor than a competitive firm] - Monopoly produces less output, so wants fewer inputs! ] --- # Labor Demand for Competitive vs. Monopolist Firm .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-20-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ - This is about the competitiveness of the **output** or .hi-purple["downstream"] market - Here, both competitive firm and monopolist in downstream markets face the same perfectly elastic .hi-red[labor supply] - We've assumed no market power in the **input** or .hi-purple["upstream"] market (for labor) - We next consider market power in the upstream (labor) market... ] --- class: inverse, center, middle # Monopsony Power --- # Monosony .pull-left[ - What if the firm has .hi-purple[market power in a factor market]? - Consider extreme example: .hi[monopsony]: a factor market with a **single buyer** ] .pull-right[ .center[ ![](https://www.dropbox.com/s/6t0gb5f38aoe7pn/monopolyman.jpg?raw=1) ] ] --- # Monosony and Market Supply of Labor .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-21-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ - Market power in *hiring* labor implies that the firm faces the **whole market factor supply curve** for labor - Market supply is upward sloping - .hi-red[Factor (inverse) supply] describes minimum price workers are willing to accept to work ] --- # Monosony and Market Supply of Labor .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-22-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ - As firm chooses to hire more `\(L\)`, must raise wages on *all* workers to hire them ] --- # Monosony and Market Supply of Labor .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-23-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ - As firm chooses to hire more `\(L\)`, must raise wages on *all* workers to hire them - .green[Output effect]: increased cost from increased number of workers ] --- # Monosony and Market Supply of Labor .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-24-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ - As firm chooses to hire more `\(L\)`, must raise wages on *all* workers to hire them - .green[Output effect]: increased cost from increased number of workers - .red[Price effect]: increased cost from raising wage for all workers ] --- # Monopsony and Marginal Cost of Labor I - If monopsonist wants to hire more labor, `\(\Delta L\)`, its labor cost `\(C(L)\)` would change by: .center[ `\(\Delta C(L)=\)`.green[`\\(w \Delta L\\)`] `\(+\)` .red[`\\(L \Delta w\\)`] ] -- - .green[Output effect]: increases number of labor hired `\((\Delta L)\)` times wage `\(w\)` per worker -- - .red[Price effect]: raises wage per worker `\((\Delta w)\)` on *all* workers hired `\((L)\)` -- - Divide both sides by `\(\Delta L\)` to get .hi-purple[Marginal Cost of Labor, `\\(MC(L)\\)`]: `$$\frac{\Delta C(L)}{\Delta L}=\color{#6A5ACD}{MC(L)=w+\frac{\Delta w}{\Delta L}L}$$` -- .small[ - Compare: supply for a **price-taking** firm is perfectly elastic: `\(\color{#6A5ACD}{\frac{\Delta w}{\Delta L}}=0\)`, so we saw `\(\color{#6A5ACD}{MC(L)=w}\)`! ] --- # Monopsony and Marginal Cost of Labor II .smallest[ - If we have a linear inverse supply function for labor of the form `$$\color{#e64173}{w=a+bL}$$` - `\(a\)` is the choke price (intercept) - `\(b\)` is the slope ] -- .smallest[ - Marginal cost of labor again is defined as: `$$MC(L)=w+\color{#44C1C4}{\frac{\Delta w}{\Delta L}}L$$` ] -- .smallest[ - Recognize that `\(\color{#44C1C4}{\frac{\Delta w}{\Delta L}}\)` is the slope, `\(b\)`, `\(\left(\frac{rise}{run} \right)\)` ] -- .smallest[ `$$\begin{align*} MC(L)&=w+(\color{#44C1C4}{b})L\\ MC(L)&=(\color{#e64173}{a+bL})+bL\\ \color{#6A5ACD}{MC(L)}&=\color{#6A5ACD}{a+2bL}\\ \end{align*}$$` ] --- # Monopsony and Marginal Cost of Labor IV .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-25-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ `$$\begin{align*} \color{#D7250E}{w(L)}&\color{#D7250E}{=a+bL}\\ \color{#8b1a1a}{MC(L)}&\color{#8b1a1a}{=a+2bL}\\ \end{align*}$$` - Marginal cost of labor starts at same intercept as Supply (average cost of labor) `\((a)\)` with twice the slope `\((2b)\)` .tiny[ Note: If these past few slides have sounded familiar, this is the [exact same process](https://microf20.classes.ryansafner.com/slides/4.1-slides#14) by which we derived a *monopolist*’s marginal *revenue* curve! ] ] --- # Monopsony's Hiring Decisions .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-26-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ - Optimal quantity is where `\(MC=MR\)` - Firm's `\(MC(L)=MRP_L\)` ] --- # Monopsony's Hiring Decisions .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-27-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ - Optimal quantity is where `\(MC=MR\)` - Firm's `\(MC(L)=MRP_L\)` - Monopsonist faces *entire* .hi-red[market supply] - Can lower wages as low as workers’ minimum WTA (Supply) ] --- # Monopsonist’s Hiring Decisions .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-28-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ - Optimal quantity is where `\(MC=MR\)` - Firm's `\(MC(L)=MRP_L\)` - Monopsonist faces *entire* .hi-red[market supply] - Can lower wages as low as workers' minimum WTA (Supply) - Compared to a competitive labor market `\((L_c,w_c)\)`, .hi-purple[monopsonist hires fewer workers and pays them lower wages] `\((L_m,w_m)\)` - Creates **deadweight loss** ] --- # Monopsony Depends on Price Elasticity of Supply .center[ .smallest[ The more (less) elastic labor supply, the less (more) monopsony power ] ] .pull-left[ .center[ .smallest[ Less Elastic Labor Supply Curve ] ] <img src="4.4-slides_files/figure-html/unnamed-chunk-29-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ .center[ .smallest[ More Elastic Labor Supply Curve ] ] <img src="4.4-slides_files/figure-html/unnamed-chunk-30-1.png" width="504" style="display: block; margin: auto;" /> ] --- class: inverse, center, middle # Monopoly Power in Labor Markets: Unions --- # Monopoly Power in Labor Markets: Unions .pull-left[ <img src="4.4-slides_files/figure-html/unnamed-chunk-31-1.png" width="504" style="display: block; margin: auto;" /> ] .pull-right[ - If **seller**/s of labor (workers) has market power, can act like a **monopolist** on the labor market - .hi-green[Example]: A labor union - Faces entire market demand for labor, and thus its marginal revenue curve too - Acts like a monopolist, restricts `\(L_u < L_c\)` to push up `\(w_u > w_c\)` ] --- # The Problem of Bilateral Monopoly .pull-left[ - What if **both** sides of the market **have market power**? - A downstream .hi-blue[monopsonist buyer] vs. an upstream .hi-red[monopolist seller] - This is the problem of .hi[bilateral monopoly] - Find out more in my [industrial organization course](https://ios20.classes.ryansafner.com) - One solution is .hi-purple[vertical integration]: merge into a single firm across both markets ] .pull-right[ .center[ ![](https://www.dropbox.com/s/yxmwhodig74frfs/negotiation.jpg?raw=1) ] ]