The Factors of Production The Labour Market The Demand for Labour: Marginal Revenue Product - the increase in a firm’s total revenue that results from the use of one more unit of input. (this can be calculated by multiplying marginal product by the price of the product) MRP = MPL x price Marginal Revenue Product (MRP) = Total Revenue (TR) Inputs The cost of employing labour is simply the (hourly, daily, weekly) wage rate. Profit maximization occurs when for the last unit of labour employed: MRPL = W Any factor of production will be bought up to the point where its MRP just equals its price. The downward-sloping portion of the MRP curve is the firm’s demand curve for that factor. The marginal revenue for competitive firms is constant (horizontal) and equal to price, whereas for imperfectly competitive firms, it declines with output, driving marginal revenue product down faster. (This is why the MRP curve is steeper for a firm operating in an oligopolistic product market than for one operating in a perfectly competitive product market). The Supply of Labour: Labour Force - the total number of people over the age of 15 who are willing and able to work Labour Force Supply – the total # of hours that those in the labour force are willing to work Reasons for Upward Sloping Supply: 1) As the wage rate increases, employment becomes more attractive 2) Extra hours may be supplied by present employees However, working more hours means less leisure. As one’s income rises, eventually leisure becomes more valuable than additional hours of work. Net effect of above opposing forces: supply of labour is upward sloping, but relatively inelastic Market Equilibrium: There are both supply and demand elements underlying every wage rate. Perfectly Competitive Monopsony Perfectly Inelastic Supply Labour Market of Labour S S S D(MRP) D (MRP) D(MRP) In a perfectly competitive A monopsony labour market A factor market with labour market, industry is one in which it is the only perfectly inelastic supply supply and demand for buyer of labour. It would is one where the supply of labour determine the need to pay a higher wage to the factor is fixed. No market wage rate. The attract additional workers matter how much the price individual firm operating (i.e. it faces an upward is raised, nothing can be within this market faces a sloping supply of labour done to increase the perfectly elastic supply curve). Furthermore, it has quantity of that factor (i.e. curve for labour at this to pay this higher wage rate land). wage rate. not only to additional In this case, all earnings In this case, there is no workers, but also to all are economic rent. There economic rent. All labour previously hired. are no transfer earnings earnings are transfer In this case, the earnings in that there are no earnings. Therefore, area beneath the supply alternate uses of the employees make just curve is transfer earnings, factor in question. enough to keep them in and the earnings area this job and no extra. above the supply curve is economic rent. Long-Run Supply of Labour: The size of Canada’s labour force has grown considerably over the last 35 years for two reasons: 1) Growth in population due to post WWII baby boom as well as recent immigration; 2) Overall increase in the labour force participation rate. Long-Run Demand for Labour: Increases in productivity have caused increases in long-run demand for labour. Also, the demand for any factor is derived demand. If demand increases for the products the factors are used to produce, the demand for the factor will increase. This has happened over time. Productivity and the Real Wage: Real Wage – the purchasing power of the nominal wage (i.e. nominal wage divided by price level) Nominal Wage – the wage rate expressed as a dollar-and-cents figure Real Wage = Nominal Wage Price Level 1) Both supply and demand are determinants of wage rates. 2) There are distinct long-run trends of growth in both the labour supply and demand. 3) The average real wage for labour for the whole economy has increased over time, and this increase is closely related to increases in labour productivity. The Effects of Trade Unions and Professional Associations: Unions or professional associations can attempt to raise the wages of their members by: 1) increasing the demand for their members by advertising the employer’s product or their members’ skills (increases both the wage and quantity of labour employed). 2) restricting the supply of labour into certain types of jobs by convincing the government to establish legal qualifications for the work and then affecting the number of people who would obtain such qualifications (increases the wage rate but decreases the quantity of labour employed). 3) negotiating a fixed wage rate above the equilibrium wage (increases the wage rate but creates a surplus of workers and decreases the quantity of labour employed). Explanations of Wage Differentials: Wage differentials can exist because: 1) human capital (the accumulation of all skills and knowledge acquired by individuals) varies between individuals 2) some jobs involve more risks than others 3) some jobs have unpleasant characteristics 4) some jobs have attractive non-pecuniary benefits 5) there is discrimination in labour markets The Concept of Economic Rent: Economic Rent – the return to any factor of production that has a perfectly inelastic supply Transfer Earnings – a necessary payment that a factor of production must earn in order for it to remain in its present use. Activity: Shade in the regions of economic rent and transfer earnings on each of the three graphs on the second page of this note. The Natural Resource Market Natural resources are both renewable (trees and wild fish) and non-renewable (minerals). The use of one more unit of a non-renewable resource reduces, forever, the supply with which nature has endowed this planet. It is for this reason that non-renewable resources are an important topic with economists. Some argue that since supply is fixed for non-renewable resources, it must be perfectly inelastic. In the very long-run, this is essentially true. However, in the short-run, it is extremely unlikely that providers of these resources will offer for sale, everything they have available, unless prices are extremely high. Therefore, as price increases, it is possible for more of the resource to be made available for sale. This makes its supply something less than perfectly inelastic. The optimum rate of extraction of a non-renewable resource (like oil) depends on the difference between the change in the price of oil and the interest rate. Assume that the present rate of interest on financial investments is 5% and that it remains unchanged. Therefore, if we extract a barrel of oil today and sell it for $20, investing the proceeds, it would give us a revenue of approximately $25.50 in five years. If, five years from now, the price of a barrel of oil is also exactly $25.50, then our rate of extraction is exactly correct. If the price of oil turns out to be less than $25.50, we are extracting too fast and if it turns out to be greater than $25.50, we are conserving oil too much. Common Property Resource – a resource not owned by an individual or a firm. (social regulation is important with such a resource to ensure responsible extraction wins out over pursuit of immediate return). The Capital Goods Market Demand and supply for capital good are very similar to those of any product, and are therefore quite conventional. Demand for Capital Goods The demand for capital goods is derived from the marginal revenue product of capital (just like labour). MRP of capital – the extra benefit of an additional unit of capital is equal to the marginal physical product it produces multiplied by the price of the product. The demand for capital goods is: 1) inversely related to interest rates since the purchase of capital generally has to be financed 2) affected by changes in technology When deciding on amounts of substitutable factors like capital and labour, a firm would take into account both productivity and the price of the factors. MPK = MPL Note: This is similar to the PK PL optimal purchasing rule. Factor Substitution Effect: The phenomenon of one factor replacing another factor as a result of technological change. (i.e. new machinery taking the place of a robot). Factor Output Effect: The phenomenon of rising total output leading to an increased demand for labour. (i.e. new technology enables producers to produce the product more efficiently and therefore, more cheaply. This lowers the price of the final product and increases the quantity demanded. The resulting increase in total output actually increases the demand for labour). The Entrepreneurial Market Joseph Schumpeter, an economist who taught at Harvard in the early part of the 20th century, saw the entrepreneur as an innovating doer who bridged the gap between a mere idea and a productive application. He believed that the entrepreneur is the engine of economic growth and development in a capitalist economy. Economists since Adam Smith, have always argued that competition will tend to squeeze out economic profits. Schumpeter argued that the innovations of the entrepreneur are the source of long-term economic profits. New innovation creates unique situations in which profits can be made. By the time the innovation becomes established and economic profits are squeezed out, the entrepreneur will have come up with some new innovation, thereby sustaining economic profits.