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					Unit V: Factor Markets                                            AP Micro Economics                                                                      Page: 123



                                                                                         GEORGE WASHINGTON HIGH SCHOOL
                                                                                                       2205 Forest Drive S.E.
                                                                                                      Cedar Rapids, Iowa 52403

                                                                                        History and Social Sciences Department
                                                                                        Advanced Placement Micro Economics
                                                                                                      Dr. F.C. McMann, Instructor
                                                                                                        fmcmann@cr.k12.ia.us
                                                                                                             319-558-3086




                                                             TABLE OF CONTENTS
                                                   UNIT V: FACTOR MARKETS 124
                                                   AP CONTENT SUMMARY                                         124
  1. FACTOR DEMAND ...............................................................................................................................124
          Demand for Resource For Competition .................................................................................................. 125
          Least Cost ................................................................................................................................................... 127
  2. SUPPLY OF LABOR & W AGE DETERMINATION ..................................................................................131
          Wage Determination For Perfect Competition........................................................................................ 132
          Wage Determination For Monoposony.................................................................................................... 134
  3. UNIONS: STRATEGIES & IMPACT ON W AGES AND EMPLOYMENT ...................................................136
          Lesson: Union Strategies for Increasing Wages and Employment .................................................... 137
          Analysis of Labor Union Actions in Two Labor Markets ...................................................................... 138
  4. RENT, INTEREST & PROFITS .............................................................................................................139
          Physical Capital – Time Value of Money ................................................................................................ 140
          Economic Rent and Loanable Funds ...................................................................................................... 141
  5. INCOME DISTRIBUTION & INEQUALITY................................................................................................142
          The Lorenz Curve Analysis ....................................................................................................................... 143
                                           LEFT HAND ACTIVITIES & CFU                                                145




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Unit V: Factor Markets                 AP Micro Economics                               Page: 124




                                 UNIT V: FACTOR MARKETS

AP Content Summary

III.    Factor Markets (10-18%)
        A.      Derived factor demand
        B.      Marginal revenue product
        C.      Labor market and firms‟ hiring of labor
        D.      Market distribution of income


                                    TOPIC I: Factor Demand

OBJECTIVES: You must be able to

1.      identify resources that are used in the productive process.
2.      explain the concept of derived demand.
3.      calculate and explain the quantity of a resource to be hired by a firm.
4.      construct a short run demand schedule for a resource.
5.      calculate and determine the relative amounts of proportions a producer shire hire of two
        or more resources.
6.      explain the relationship between MRP and the demand for an input.
7.      explain and apply the concept of least cost combination of inputs to novel data.
8.      explain and apply the rule for finding least cost combination.

READ:            Gwartney, Chapter 24, “The Supply of and Demand for Productive Resources”

                               KNOW THE FOLLOWING TERMS
Complementary factors                      Derived Demand
Marginal Physical Product                  Marginal Productivity Theory of Factor
                                           Demand
Marginal Revenue Product                   Output Effect
Substitution Effect

                               KEY CONCEPTUAL QUESTIONS

1.      What determines the demand for a factor of production in a competitive firm and in a
        monopolistic firm?
2.      List and explain three factors that would increase the demand for a resource.
2.      If a firm wants to maximize profits, how much of each factor should be hired (or bought)?




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Unit V: Factor Markets                AP Micro Economics                 Page: 125




                         Demand for a Resource: Pure Competition

          Workers         TP    MPP          Price         TR      MRP
          1               15                 $1.00
          2               27                 $1.00
          3               36                 $1.00
          4               42                 $1.00
          5               45                 $1.00
          6               46                 $1.00




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Unit V: Factor Markets               AP Micro Economics                         Page: 126



                     Demand for a Resource: Imperfect Competition

           Worker    TP      MPP      Price     TR        MRP     Total   MRC
           s                                                      Wages
           1         15               $1.30
           2         27               $1.20
           3         36               $1.10
           4         42               $1.05
           5         45               $1.00
           6         46               $0.95




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Unit V: Factor Markets                 AP Micro Economics                          Page: 127



                              Least Cost Choice: Two Inputs
                                  Capital and Labor Data
                         Cost of Labor = $8 // Cost of Capital = $12

                     Labor                                         Capital
  QL        TPL       MPL      TRL      MRPL       QC       TPC     MPC      TRC     MRPC
  0          0         0       $0        $0        0         0       0        $0      $0
  1         12        12       24        24        1         13      13       24      26
  2         22        10       44        20        2         22      9        44      18
  3         28         6       56        12        3         28      6        56      12
  4         33         5       66        10        4         32      4        64      8
  5         37         4       74         8        5         35      3        70      6
  6         40         3       80         6        6         37      2        74      4
  7         42         2       84         4        7         38      1        76      2


                                     Least Cost Selection

  QL       MPL       MRPL      MP/PL      QC       MPC      MRPC     MP/PC
  1        12         $0                  1         13       26
  2        10         24                  2         9        18
  3         6         20                  3         6        12
  4         5         12                  4         4        8
  5         4         10                  5         3        6
  6         3         8                   6         2        4
  7         2         6                   7         1        2


                     Issue: How much labor and how much capital?




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Unit V: Factor Markets                  AP Micro Economics                                Page: 128



                                         PRACTICE EXERCISES

1.      Complete the following labor demand table for a firm that is hiring labor competitively and
        selling its product in a competitive market.

Labor Units      Total Units     MPP              Price            Tot. Rev.        MRP
1                17                               $2
2                31                               $2
3                43                               $2
4                53                               $2
5                60                               $2
6                65                               $2

A.      How many workers will the firm hire if the going wage rate is $27.95? $19.95? Explain
        why the firm will not hire a larger or smaller number of workers at each of these wage
        rates.
B.      Show in graphical form the labor demand curve of this firm.
C.      Re-determine the firms demand curve for labor on the assumption that it is selling in an
        imperfectly competitive market and that, although it call sell 17 units at $2.20 per unit, it
        must lower product price by $.05 in order to sell the marginal physical product of each
        successive worker. Answer the question posed in A and graphically illustrates the
        demand curve. Explain the differences.


Labor Units      Total Units     MPP              Price            Tot. Rev.        MRP
1                17                               $2.20
2                31                               $2.15
3                43                               $2.10
4                53                               $2.05
5                60                               $2.00
6                65                               $1.95




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Unit V: Factor Markets                                AP Micro Economics                                Page: 129




Problem 2 Patty's Pizza Parlor has the production function per hour shown in the accompanying
table. The hour wage rate of each worker is $10.00. Each pizza sells for $2.00
Quantity of Labor (Workers)                      Quantity of Pizza
0                                                0
1                                                9
2                                                15
3                                                19
4                                                2
5                                                24
                  B. In what type of product market does Patty operate? Explain how you can tell?
                  C. In what type of factor (labor) market does Patty operate? Explain how you can tell?
                  D. Calculate the marginal product of labor for each worker and the value of the marginal product
                     per worker
                  E. Draw the value of the marginal product curve. Use your diagram to determine how many
                     workers Patty should employ. (Be certain all axes, lines, and curves are labeled)
                  F. Now the price of pizza increases to $4.00. Calculate the value of the marginal product per
                     worker and draw the new value of the marginal product curve into your diagram. Use the
                     diagram to determine how many workers Patty should employ now.
                  G. Using the original price of $2.00, assume that the wage rate rises for $10.00 to $15.00.
                     Redraw the graph in part (d) to show how Patty's demand for workers responds to changes in
                     the wage rate.
                  H. Assuming the original graph drawn in part (d), and with an hourly wage rate of $10.00,
                     assume now that Patty bus a new high tech pizza oven that allows her workers to become
                     twice as productive as before.
                         a. Calculate the new marginal product of labor and the new value of the marginal
                              product of labor.
                         b. Using the diagram in part (d) with a wage rate of $10.00, determine how Patty's
                              hiring decision responds to this increase in the productivity of her workforce.
                                                Patty's Labor Demand Graph

             $40.00



             $35.00



             $30.00



             $25.00
  Wage/MRP




                                                                                                    MRP
             $20.00                                                                                 MPR2
                                                                                                    MRC

             $15.00



             $10.00



              $5.00



              $0.00
                      0        1            2               3                4    5           6
                                                    Quantity of Laboers




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Unit V: Factor Markets                  AP Micro Economics                               Page: 130



Problem 2: Suppose Patty is maximizing profit. The price of pizza is $2.00 per box. Each
worker is being paid $12.00 and she employs six workers.

    A.      What is the marginal product of the sixth farm worker?
    B.      Is the marginal product of the fifth worker greater or less than the marginal product
            of the sixth worker?
    C.      If, when, the price of pizza increases to $3.00 a box, Patty hires eight workers, what
            is the marginal product of the eighth worker?

3         Assume that a manufacturer of machine tools is employing variable resources A and B in
         his fixed plant in such amounts that the MRP of the last units of A and B employed are
         $70 and $45 respectively. Resource A can be hired at $20 and B at $15 per unit. Is the
         firm hiring A and B in the best amounts? Explain the nature of the changes that would
         occur, if any, and describe the results.




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Unit V: Factor Markets                AP Micro Economics                             Page: 131



                     TOPIC 2: The Supply of Labor and Wage Determination

OBJECTIVES: You must be able to:

1. explain how the marginal productivity theory of resource demands applies to wage rate
       determination.
2. explain how wage rate is determined.
3. calculate and determine wage rates in a competitive and monopsonist labor markets
4. explain the determinants of income distribution.
5. explain concept of bilateral monopoly.

READ: Gwartney, Chapters 24

                              KNOW THE FOLLOWING TERMS

Bilateral Monopoly                             Monopsony
Wage                                           Marginal Factor (Resource) Cost (MRC)
Least Cost Combination of Inputs               MRP = W
MRP = MPP * P

                              KEY CONCEPTUAL QUESTIONS

1.      How is an industry wage rate determined?
2.      Compare and contrast the wage rates and levels of employment in a purely competitive
        industry with that of an imperfect competitor.




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Unit V: Factor Markets               AP Micro Economics                           Page: 132




                The Supply of Labor: Pure Competition in Hire of Labor

Workers        TP        MPP       MRP           Wage         Total Wages   MRC
1              15                                $6.00
2              27                                $6.00
3              36                                $6.00
4              42                                $6.00
5              45                                $6.00
6              46                                $6.00




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Unit V: Factor Markets                   AP Micro Economics                             Page: 133



                                      PRACTICE EXERCISES

Problem 1:

Use supply and demand analysis to determine how each of the following events affects demand
and/or supply of the resource and subsequently its price and quantities.

Market               Event                                     Diagram D S P Q
High School math     Wages for mathematicians employed in
teachers             private industry rise
Computers            Technological change raises the speed
                     of computer calculations.
Computer             The cost of obtaining computer training
technicians          falls
Welders              Technological change lowers the cost of
                     robots used to weld auto parts on auto
                     assembly lines
Agricultural land    A vitamin C fad raises the price of
in Southern          oranges
California


Problem 2:       A governor of a Midwest state has suggested that a tax be imposed on college
and university tuition and the revenues generated is spent on making payments to firms that
provide on-the-job training for low-skilled labor. Draw diagrams to show what happens to the
demand for labor, the supply of labor, and the equilibrium wage rate in the markets for each of
the following

         1.     College graduates
         2.     Industrial workers with skills acquired on the job
         3.     College professors
         4.     Skilled industrial workers




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Unit V: Factor Markets               AP Micro Economics                      Page: 134



                 The Supply of Labor: Monopsony in the Hire of Workers

Workers     TP      MPP   Price        TR       MRP       Wage     Total   MRC
                                                                   Wages
1           15            $1.30                           $6.00
2           27            $1.20                           $7.00
3           36            $1.10                           $8.00
4           42            $1.05                           $9.00
5           45            $1.00                           $10.00
6           46            $0.95                           $11.00




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Unit V: Factor Markets                  AP Micro Economics                              Page: 135




                                     PRACTICE EXERCISES

1.        Given the data below, determine the wage rates and the number of persons to be
          employed. Graph the information and explain your answers. Assume three conditions in
          the labor market
          A.      that the firm hires in a competitive labor market where wage rate is $6 per hour
          B.      assume that a firm is only employer in the town and that the supply of labor is
                  described by the information in the left column.
          C.      assume a competitive product market, where the product price is $2.00

Workers        TP            MP            MRP           Workers      Wage          MRC
0              0                                         0            $2
1              16                                        1            $2
2              30                                        2            $4
3              39                                        3            $6
4              46                                        4            $8
5              49                                        5            $10
6              50                                        6            $12




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Unit V: Factor Markets                 AP Micro Economics                               Page: 136



           TOPIC 3: Unions: Strategies and Impact on Wages and Employment


OBJECTIVES: You must be able to:

1. explain the purpose of labor unions and their organization.
2. explain the effects of unions and specific union tactics on wages and employment in
       competitive and monopolistic markets.
3. explain the concept of bilateral monopoly and the indeterminate of input prices.
4. evaluate the validity of specific legislation aimed at increasing wage rates and employment.

READ: Gwartney, “Special Topic 11,” 697-707

                                   KNOW THE FOLLOWING TERMS

Arbitration                                      Blacklist
Business Unionism                                Closed Shop
Collective Bargaining                            Featherbedding
Industrial Union                                 Labor Contract
Lockout                                          Mediation
Money Wage                                       Real Wage
Right To Work Laws                               Secondary Boycott
Strike                                           Strikebreakers
Union                                            Union Shop
Yellow Dog Contract                              Craft Union

                  PRACTICE EXERCISES & KEY CONCEPTUAL QUESTIONS

1. What is a labor union and what to what extent, if any, do they help workers?




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Unit V: Factor Markets                AP Micro Economics             Page: 137



                         Two Union Strategies for Increasing Wages




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Unit V: Factor Markets               AP Micro Economics            Page: 138



                         Union Wage Setting in Two Labor Markets




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Unit V: Factor Markets                     AP Micro Economics                                 Page: 139



                                 TOPIC 4: Rent, Interests, and Profits

OBJECTIVES:        You must be able to:

1.        distinguish between pure economic rent and quasi-rent.
2.        distinguish between the nominal and real interest rate.
3.        calculate the nominal interest rate, given the real interest rate and the anticipated rate of
          inflation.
4.        distinguish between savings and investment
5.        calculate present value and relative profitability of an investment or an asset portfolio.

READ: Gwartney, Chapter 26, “Investment, the Capital Market, and the Wealth of Nations.”

                                  KNOW THE FOLLOWING TERMS

Economic Rent                                        Financial Market Structure
Interest                                             Investment
Net Productivity of Capital                          Nominal Interest Rate
Rate of Return                                       Real Interest Rate
Risk                                                 Saving
Single Tax Movement                                  Present Value

                 PRACTICE EXERCISES & KEY CONCEPTUAL QUESTIONS
1. What is rent?
2. What are interest rates and profits and what are their economic functions?
3. How do firms make decisions concerning the rate of investment (acquisition of new capital)

                                          Problem and Practice

You have to consider buying a printer to use in at your college. The printer will cost $380.00 and
you expect it to produce additional revenue of $100 per year for each of the next five years (-- yes
you are a slow learner and didn't take all the AP test that you should have taken; hence you won't
graduate in four years). At the end of the fifth year, the printer is worthless. So now consider the
following:

     a.       What is the value of the printer to you if the annual interest rate is 10%? Is the
              purchase of the printer justified?
     b.       Would your answer change if the interest rate were 8%?
     c.       Would your answer change if the printer cost $350?
     d.       Would your answer to part (a) change if the printer could be sold for $50 at the end of
              the fifth year?
     e.       What are the lessons that you can derive for this exercise?




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Unit V: Factor Markets                 AP Micro Economics                     Page: 140



             Physical Capital, Investment & Time Value of Money: An investigation

                                            Table 1

Number of Trucks         MRP Annual Income MRC Present
                         Received              Value
1                        $10,000
2                        $10,00
3                        $8,000
4                        $5,500
5                        $2,000

                         Assume you can purchase truck for $50,000
                               Assume interest rate is 10%
                                 Renting truck is $5,000



RULE 2:          Present Value (PV)



RULE 3:          PV Formula



                                      Application = $1.00

# of Years               5%                      10%                 15%
1
4
10
15

                               Conclusions on Present Value




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Unit V: Factor Markets               AP Micro Economics           Page: 141




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Unit V: Factor Markets                 AP Micro Economics                          Page: 142




        D.       Income Distribution
                 1. Equity
                 2. Sources of income inequality

                         Case Study 1: Income Distribution & Inequality


OBJECTIVES: You must be able to:

1.    list factors that cause differences in household income
2.    draw and describe the information provided by a Lorenz curve
3.    calculate and explain a Gini coefficient
4.    define the official definition of poverty
5.    state the arguments for and against redistribution of income
6.    summarize theories underlying arguments for redistribution of income
7.    define the major government redistribution programs and the groups to which they are to
      reach
READ: Gwartney, Chapter 27, “Income Inequality and Poverty”


                                KEY CONCEPTUAL QUESTIONS
1.      What is a Lorenz curve, and what does it measure?
2.      What has happened to the distribution of income in the United States?
3.      What is the difference between income and wealth?
4.      Why do people earn different incomes?




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Unit V: Factor Markets                   AP Micro Economics                                Page: 143



                                         The Lorenz Curve




                                       PRACTICE PROBLEM

Table (i) shows the distribution of income in the United States, and table (ii) shows the distribution
of income in Canada.

(i)
           Households                                              Income
Percentage       Cumulative              Percentage           Cumulative           Average (dollars)
                 Percentage                                   Percentage
Lowest 20        20                      3.5                  3.5                  10,136
Second 20        40                      8.8                  12.3                 25,468
Third 20         60                      14.5                 26.8                 42,629
Fourth 20        80                      23.1                 49.9                 66,839
Highest 20       100                     50.1                 100.0                145,970


(ii)
Households                                          Income (percentage)
Lowest 20 percent                                   7.4
Second 20 percent                                   13.2
Third 20 percent                                    18.1
Fourth 20 percent                                   24.9
Highest 20 percent                                  36.4

      a. Draw the Lorenz curves for Canada and the United States
      b. Compare the distribution of income in Canada with that in the United States. Which
         distribution is more unequal?




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Unit V: Factor Markets                                                                                                AP Micro Economics                                        Page: 144



                                                                                                                  Lorenz Curve Analysis

                                       100


                                                          90


                                                          80


                                                          70
  Percent Income (Cumulative)




                                                          60


                                                          50                                                                                                                      Equality


                                                          40


                                                          30


                                                          20


                                                          10


                                                              0
                                                                  0         10           20           30         40          50        60           70    80    90      100
                                                                                                                   Percent Households


 %
 House                                                                    2006               1995          „975               1950          1930
      20                                                                          3.4            3.7              4.4           4.5           4.1
      40                                                                          8.7            9.1             10.5            12           9.2
      60                                                                         14.7           15.2             17.1          17.4          14.1
      80                                                                         23.2           23.3             24.8          23.4          20.9
    100                                                                            50           48.7             43.2          42.7          51.7

                                                                                                             Lorenz Curve Analysis

                                                              100


                                                              90


                                                              80


                                                              70
                                Percent Income (Cumulative)




                                                              60


                                                              50                                                                                                     Equality


                                                              40


                                                              30


                                                              20


                                                              10


                                                                  0
                                                                      0     10          20       30         40          50        60        70       80   90   100
                                                                                                             Percent Households




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Unit V: Factor Markets                AP Micro Economics                             Page: 145



Let Hand Activities


1. Why does the demand curve for a resource slope downward? Distinguish between a perfect
    and an imperfect market
2. What are the reasons why the resource demand curve will shift to the right (left)?
3. How do you measure the elasticity of demand for a resource?
4. Explain the least cost formula. What does it mean?
5. What is the marginal productivity theory of income?
6. Why is a firm in a purely competitive labor market a wage taker?
7. How do firms determine the profit maximizing number of people to hire?
8. How are wage rates determined in a perfectly competitive labor market?
9. Explain the slope of the supply curve for labor in perfectly competitive labor market and an
    imperfect labor market?
10. How does an imperfect competitor decide on wages and the number of people hired in an
    imperfect competition labor market?
11. What is the impact of a minimum wage on the perfect competitor labor market? How does
    the impact of the minimum wage differ in an imperfect competition labor market?
12. What are the goals of unions?
13. How does collective bargaining impact the number of people hired and their wage rates in a
    perfect competition labor market and an imperfect competition labor market?

GRAPHS: In your notes, locate the following graphs

    1. A single firm's demand for labor, with a given wage rate.
    2. An industry supply and demand graph showing equilibrium wages and quantities of labor
       hired.
    3. A side by side graph showing the relationship between the industry demand and supply
       and the demand and supply for a single firm.
    4. An imperfect firm's demand for labor with a given wage rate
    5. A monopsonist view of how wages are determined and the quantities of labor hired.




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Unit V: Factor Markets                       AP Micro Economics                             Page: 146




                                                         3 Graph C
Graphical & Data Analyses (GDA): For each
set of graph(s) or table(s), write five sentences
that (i) describes the graph and/or data (ii) makes
inferential statements about the graph/data

1 Graph A




                                                         4- Table 1

                                                         Labor        Output     Price
                                                         1            15         $6
                                                         2            30         $6
                                                         3            40         $6
                                                         4            48         $6
                                                         5            54         $6
                                                         6            59         $6
                                                         7            62         $6


                                                         Praxis: Available Sunday evening preceding the
                                                         Quarterly CFU
2 Graph B




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