Resource
(Factor) Markets
Labor
Income
Poverty
Other resources
Chapters 24-27
Economic Concepts Recycled
n
Input-process-output
n
Law of
Diminishing Returns
n
Benefit-Cost
Analysis
n
Profit
Maximization Rules
n
Consumer
Equilibrium
n
Price Floor
Resource Markets
n
Supply:
n
Owners offer
resources for sale (or hire) in order to earn income.
n
Demand:
n
Firms need
resources for inputs to produce goods and services.
The Value of a Resource
n
Productivity =
output/input
n
resources are the
inputs…
n
…into a process…
n
…which produces
outputs…
n
…that is, goods
and services.
The Value of a Resource
n
The more
productive the resource is, the greater value it is.
n
…and the buyer
will be willing to pay more for it.
Labor Productivity
n
Labor
productivity = output per worker
n
We measure
productivity on the margin:
n
Marginal product
(MP):
n
= the added
output produced as one more worker is added
Labor Productivity
n
The Law of
Diminishing Returns applies.
n
With a fixed
capital input (a fixed sized factory), adding workers leads to diminishing
returns:
n
MP for each added
worker decreases as the number of workers increase.
Two Classes of Resources
n
Physical capital
n
Human capital
How to Increase Labor Productivity
n
Increase the
physical capital
n
more or better
tools for the worker
How to Increase Labor Productivity
n
Increase the
physical capital
n
more or better
tools for the worker
n
Improve the human
capital
n
more or better
training for the worker
Wages and Productivity Increases
n
A more productive
worker is more valuable to the firm
n
Thus, he/she
should command higher pay
n
Vice versa
applies
Review: Input-Process-Output Model
n
Resources are
inputs into a process
n
Process
transforms inputs into outputs
n
Outputs are goods
and services that satisfy customers’ wants and needs
Derived Demand for Resources
n
Customers have a
demand for the outputs
n
This is a direct
demand
n
Firms have a
demand for the inputs to make the outputs
n
This demand is
derived from the product demand
n
There is no
independent demand for labor
Derived Demand for Resources
n
An increase in
customer demand for a product causes a firm to increase its demand for
resources used to make that product
n
Vice versa
applies
The Benefit of Hiring Labor
n
The firm benefits
when the produced goods are sold to customers:
n
Benefit =
Marginal Revenue Product (MRP)
n
the added dollars received from selling the added output produced by
adding one more worker
n
MRP
(dollars/added worker) = MR (dollars/added output) x MP (output/added worker)
n
MRP = MR x MP
The Benefit of Hiring Labor
n
MRP = MR x MP
n
MR slopes
downward (or is horizontal in perfect competition)
n
MP slopes
downward due to diminishing returns
n
Therefore, MRP
slopes downward
The Benefit of Hiring Labor
n
MRP = MR x MP
n
MRP slopes
downward
n
Firms hire more
workers if wages fall and vice versa
n
Therefore, MRP is
the firm’s demand curve
The Cost of Hiring Labor
n
For labor, it
includes all these costs:
n
actual wages or
salary paid
n
employment taxes
paid
n
the cost of the
benefits package
n
the
administrative costs of hiring workers
n
Collectively, we
will name this cost the wage
Calculating MRP = MR x MP (chart)
The Labor Demand Curve
n
At lower wages,
firms will want to hire more workers
n
At higher wages,
firms will want to hire fewer workers
n
This is true for
the other resource categories, also
Increasing Labor Demand
n
Labor demand
increases if:
n
Product demand
increases
n
derived demand
n
hire more workers
(1)
n
Labor
productivity increases
n
the worker
becomes more valued
n
raise wages (2)
Decreasing Labor Demand
n
Labor demand
decreases if:
n
Product demand
decreases
n
derived demand
n
lay off workers
(1)
n
Labor
productivity decreases
n
the worker
becomes less valued
n
lower wages (2)
Hiring: a benefit-cost analysis
n
If MRP > wage,
add a worker
n
if you do, $ in
exceeds $ out, and profits rise
n
If MRP < wage,
lay off a worker
n
if you do not, $
out exceeds $ in, and profits fall
n
If MRP = wage,
you have the ideal number of workers
n
Hiring up to a
point where MRP = wage maximizes profits
Hiring (chart)
Product demand increases (chart)
Productivity increases ( 2 charts)
Changing the Resource Mix
n
As labor costs
rise, firms mechanize the job (shift to capital inputs)
n
The logic here is
the same as upsetting consumer equilibrium
An Equilibrium Resource Mix
n
MPlabor/Plabor
= labor productivity divided by the price of labor
n
MPcapital/Pcapital
= capital productivity divided by the price of capital
n
Firm is in
equilibrium when:
n
MPlabor/Plabor
= MPcapital/Pcapital
Changing the Resource Mix
n
Equilibrium: MPlabor/Plabor
= MPcapital/Pcapital
n
Let Plabor increase
n
Now: MPlabor/Plabor
< MPcapital/Pcapital
n
The firm:
n
Now prefers more
capital and less labor
n
Changes the
process: substitutes machinery for workers
n
Switches from
labor-intensive to capital intensive
Choosing a Resource Mix
n
Firms choose a
mix of resources that minimizes ATC and thereby improves profit
n
Let the price of
one input rise.
n
The firm uses
less of that input.
n
It switches to a
lower cost input.
n
This changes the
resource mix.
Choosing a Resource Mix
n
Industrialized
countries stress capital goods.
n
Unit labor costs
are high
n
Unit capital
costs are relatively inexpensive
n
Developing
countries stress labor.
n
Unit labor costs
are low
n
Unit capital
costs are relatively high
Automation
n
Jobs are lost
when employer shifts from labor-intensive process to a capital-intensive
process
Automation
n
Low skill jobs
disappear (replaced by machinery)
n
High skilled jobs
increase (designing, building, maintaining and operating machinery)
n
Lower costs lead
to market expansion.
n
More of this good
gets produced.
n
History shows us
that many more high-skill jobs will be created than low-skill jobs destroyed
Wages are earned
n
Firms pay wages
to workers to use their productivity to produce salable products.
n
There are direct
connections between:
n
product demand
and the number of workers needed
n
worker
productivity and wages earned
Raising Wages
n
Increased
productivity means more valuable workers
n
More valuable
workers merit higher wages
n
If the current
employer will not pay higher wages, some other employer will
n
Thus, MRP
shifting right due to increased productivity must be balanced by increased
wages, until wage=MRP again
n
Raising wages
with no productivity increase leads to layoffs
Unjustified wage increase (chart)
Minimum Wage Law
n
Government
intervenes in the labor market, usually at the low-skill level.
n
A minimum wage
law is a price floor. Two distinct effects:
n
Reduces quantity
of labor demanded (kills jobs).
n
Increases the
quantity of labor supplied (increases unemployment).
Minimum Wage Effects (2 charts)
Labor Supply Elasticity
n
Low skill jobs
require low skill workers
n
time to become
qualified is short
n
available supply
of applicants is large
n
a small wage rise
leads to a large increase in applicants
n
this is a highly
elastic supply
Labor Supply Elasticity
n
High skill jobs require high skill workers
n
time needed to
become qualified is long
n
available supply
of applicants is usually small
n
even a large wage
rise will not generate much of an increase in applicants
n
this is a highly
inelastic supply
Labor Supply Elasticity
n
As time to
respond increases, more workers finish their training
n For high skilled workers, supply becomes more elastic
(less inelastic) as time passes
Reality
n
Demand for
high-skilled labor is increasing faster than supply
n
High-skilled
wages will rise
n
Demand for low-skilled
labor is stagnant or increasing slower than supply
n
Low-skilled wages
should fall
n
Minimum wage laws
forbid this, so low-skilled unemployment rises instead
n
The income gap
between “rich” and “poor” will continue to grow
Why Go To College?
n
Apart from all
the fun and actually learning something, the cold, hard reality is that your
earnings over a lifetime will shoot up tremendously.
The Coordinating Function
n
Adam Smith’s Invisible
Hand directs resources to their most valued use.
n
The most valued
inputs are those that make the most valued outputs.
n
High-valued
outputs have increasing demand.
n
So will
high-valued inputs. They will be paid more.
n
Low-valued
outputs have decreasing demand.
n
So will
low-valued inputs. They will be paid less.
The Economics of Discrimination
n
Assume two labor
markets using same skills:
n
In one,
discrimination excludes some workers
n
Supply curve
shifts left, fewer workers get higher wages
n
In the other, no
discrimination and excluded workers above migrate here
n
Supply curve
shifts right, more workers get lower wages
Union vs. Nonunion
n
We begin at a
wage rate of $15 in both the unionized sector, (a), and the non-unionized
sector, (b).
n
Next, the union
increases its wage rate to $18 either through collective bargaining or by
decreasing the supply of labor in the unionized sector (shown).
Union vs. Nonunion
n
Fewer persons now
work in the unionized sector, and we assume that those persons who lose their
jobs move to the non-unionized sector.
n
The supply of
labor in the non-unionized sector rises, and the wage rate falls.
The Economics of Discrimination
n
The employer who
discriminates could be passing up the better workers
n
If so, he pays
higher wages to less skilled workers
n
Non-discriminating
employers then could get better employees at a lower wage
n
In competition,
when prices fall, the discriminator will have a higher cost structure
n
They will reach
P=ATC (zero profit) first
Income Distribution
n
Income is
distributed unequally in the US (and elsewhere
in the world):
n
How do you define
“the rich”?
n
How do you define
“the poor”?
n
How do you define
“the middle class”?
Income Distribution?
n
Who distributes
income?
n
Government?
n
Employers?
n
Income is earned
by workers and other resource owners; it is not given out for no particular
reason
n
Some income is
redistributed by government:
n
Collect taxes
n
Disseminate
transfer payments
Income Distribution
n
The 50% mark was
very close to $49,999 in 1991.
n
More like $52,000
now.
n
If your family
earns more than that, welcome to the upper half!
Defining Terms
n
People’s
attitudes:
n
22% call
themselves poor
n
77% call
themselves middle class
n
1% call
themselves rich
Income Distribution
n
Based on
quintiles
n
bottom 1/5 of
families earn 3.4% of income
n
middle 3/5 of
families earn 46.6% of income
n
top 1/5 of
families earn 50% of income
Lorenz Curve, US, 2004
n
The diagonal line
would exist if everyone earned the same income.
n
The sag
represents the inequality of distribution
Impact of taxes and transfer payments
n
Lorenz did not
include taxes or transfer payments
n
Taxes decrease
income in the top 4/5 of families
n
Make them
“poorer”
n
Transfer payments
increase income in the bottom 1/5 of families
n
Make them
“richer”
Income Mobility
n
There is a very
small group of permanently poor in the US
n
In a decade, of
those in the bottom 1/5:
n
95% move up to a
higher quintile
n
about 30% move up
to the highest quintile
n
Only 5% remain in
the lowest quintile
n
In a decade, 2/3
of those in the middle quintile moved either up or down
n
In a decade, 37%
of those in the highest 1/5 fell to a lower quintile
Why Family Incomes Differ (chart)
Characteristics of High and Low Income
Families
n
High Income
Families
n
well-educated
n
intact
(two-adult) family structure
n
dual earners,
full-time
n
in their prime
working years
n
Low Income
Families
n
poorly educated
n
one-adult family
structure
n
part-time or
sporadic work experience
n
young or elderly
Why Are Incomes Unequal?
n
Some have the
capability and the desire to earn more
n
Some skills are
more in demand than others
n
Some have had
better opportunity than others
n
Some control more
productive resources than others
The Gap Between “Rich” and “Poor”
n
Moving from the
industrial age deep into the information age, the income gap between skilled
workers and unskilled workers is getting larger
n
As the number of
single-adult family units increase, the income gap between two-adult families
and one-adult families is getting larger
Should the Goal be Equal Income
Distribution?
n
Each family would
receive the same income regardless of:
n
what they
produce,
n
how much they are
in demand,
n
or differences in
skill or talent or education
n
Same reward no
matter what the effort
Consequences of Equal Income Distribution
n
Destroys
incentive to work harder, produce more, or improve oneself.
n
Destroys
efficiency.
n
Lowers the
standard of living.
Equality vs. Efficiency: The trade-off
n
Efficiency: Best use of resources
to produce the most valued outputs. To do this, the most desired resources must
receive higher payment
n
Equality: Each resource input
receives an equal payment, regardless of its value.
n
Trade off:
n
More equality?
Reduce efficiency (standard of living lowers)
n
More efficiency?
Reduce equality (standard of living rises)
War on Poverty
n
Poverty level defined:
n
a family earning
less than three times the cost of a nutritional diet
n
about $20,000 for
a family of four
An Ideal Welfare System
n
To increase
equality, government taxes higher income earners and transfers this to those
with lower income
n
this is the basis
of an ideal welfare system
n
such a system
sacrifices the “reward for effort” concept of efficiency to promote greater
equality
War on Poverty
n
Combating poverty
was a private sector function until the 1930’s
n
The New Deal
(1930s) created “relief” programs as temporary help for those in poverty
n
The Great Society
shifted poverty assistance to the Federal government in 1964. Includes: aid to
families with dependent children, food stamps, and other welfare programs
War on Poverty
n
Income-based
poverty programs cost nearly $350 billion per year
n
Since 1964, it
totals over $10 trillion
n
Percentage of
families in poverty has stayed about 11% since the 1970s
War on Poverty
n
War on Poverty was enacted in 1964.
n
Since 1967, the
poverty rate for all people has been about 12 to 15 percent, even though over $10 trillion has been spent on poverty
programs.
n
Black and
Hispanic poverty stayed very high until welfare was reformed in the Clinton Administration