Ch09

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Ch09

  1. 1. Firm Choices in Input Markets© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  2. 2. Demand for Inputs: A Derived Demand • Derived demand is demand for resources (inputs) that is dependent on the demand for the outputs those resources can be used to produce. • Inputs are demanded by a firm if, and only if, households demand the good or service produced by that firm.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  3. 3. Inputs: Complementary and Substitutable • The productivity of an input is the amount of output produced per unit of that input. • Inputs can be complementary or substitutable. This means that a firm’s input demands are tightly linked together.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  4. 4. Diminishing Returns • Faced with a capacity constraint in the short-run, a firm that decides to increase output will eventually encounter diminishing returns. • Marginal product of labor (MPL) is the additional output produced by one additional unit of labor.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  5. 5. Marginal Revenue Product • The marginal revenue product (MRP) of a variable input is the additional revenue a firm earns by employing one additional unit of input, ceteris paribus. • MRPL equals the price of output, PX, times the marginal product of labor, MPL.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  6. 6. Marginal Revenue Product Per Hour of Labor in Sandwich Production (One Grill) (3) (2) MARGINAL (4) (5) (1) TOTAL PRODUCT OF PRICE (PX) MARGINAL TOTAL PRODUCT LABOR (MPL) (VALUE REVENUE LABOR UNITS (SANDWICHES (SANDWICHES ADDED PER PRODUCT (MPL X PX) (EMPLOYEES) PER HOUR) PER HOUR) SANDWICH)a (PER HOUR) 0 0 − − − 1 10 10 $.50 $ 5.00 2 25 15 .50 7.50 3 35 10 .50 5.00 4 40 5 .50 2.50 5 42 2 .50 1.00 6 42 0 .50 0 The “price” is essentially profit per sandwich; see discussion in text. a© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  7. 7. Marginal Revenue Product Per Hour of Labor in Sandwich Production (One Grill) MRPL = PX  MPL • When output price is constant, the behavior of MRPL depends only on the behavior of MPL. • Under diminishing returns, both MPL and MRPL eventually decline.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  8. 8. A Firm Using One Variable Factor of Production: Labor • A competitive firm using only one variable factor of production will use that factor as long as its marginal revenue product exceeds its unit cost. • If the firm uses only labor, then it will hire labor as long as MRPL is greater than the going wage, W*.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  9. 9. Marginal Revenue Product and Factor Demand for a Firm Using One Variable Input (Labor) • The hypothetical firm will demand 210 units of labor. W* =MRPL = 10© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  10. 10. Short-Run Demand Curve for a Factor of Production • When a firm uses only one variable factor of production, that factor’s marginal revenue product curve is the firm’s demand curve for that factor in the short run.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  11. 11. Comparing Marginal Revenue and Marginal Cost to Maximize Profits • Assuming that labor is the only variable input, if society values a good more than it costs firms to hire the workers to produce that good, the good will be produced. • Firms weigh the value of outputs as reflected in output price against the value of inputs as reflected in marginal costs.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  12. 12. The Two Profit-Maximizing Conditions • The two profit-maximizing conditions are simply two views of the same choice process.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  13. 13. The Trade-Off Facing Firms© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  14. 14. A Firm Employing Two Variable Factors of Production • Land, labor, and capital are used together to produce outputs. • When an expanding firm adds to its stock of capital, it raises the productivity of its labor, and vice versa. Each factor complements the other.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  15. 15. Substitution and Output Effects of a Change in Factor Price • Two effects occur when the price of an input changes: • Factor substitution effect: The effect tendency of firms to substitute away from a factor whose price has risen and toward a factor whose price has fallen.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  16. 16. Substitution and Output Effects of a Change in Factor Price • Two effects occur when the price of an input changes: • Output effect of a factor price increase (decrease): When a firm (decrease) decreases (increases) its output in response to a factor price increase (decrease), this decreases (increases) its demand for all factors.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  17. 17. Substitution and Output Effects of a Change in Factor Price Response of a Firm to an Increasing Wage Rate UNIT COST IF UNIT COST IF INPUT REQUIREMENTS PL = $1 PL = $2 PER UNIT OF OUTPUT PK = $1 PK = $1 TECHNOLOGY K L (PL x L) + (PK x K) (PL x L) + (PK x K) A (capitalWhen P • intensive) When PL = PK10 $1, the labor-intensive method $20 = 5 $15 of B (labor intensive) 3 10 $13 $23 producing output is less costly.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  18. 18. Substitution and Output Effects of a Change in Factor Price The Substitution Effect of an Increase in Wages on a Firm Producing 100 Units of Output TO PRODUCE 100 UNITS OF OUTPUT TOTAL TOTAL TOTAL CAPITAL LABOR VARIABLE DEMANDED DEMANDED COST When PL = $1, PK = $1, 300 1,000 $1,300 firm uses technology B When PL = $2, PK = $1, 1,000 500 $2,000 firm uses technology A • When the price of labor rises, labor becomes more expensive relative to capital. The firm substitutes capital for labor and switches from technique B to technique A.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  19. 19. Many Labor Markets • If labor markets are competitive, the wages in those markets are determined by the interaction of supply and demand. • Firms will hire workers only as long as the value of their product exceeds the relevant market wage. This is true in all competitive labor markets.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  20. 20. Land Markets • Unlike labor and capital, the total supply of land is strictly fixed (perfectly inelastic.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  21. 21. Demand Determined Price • The price of a good that is in fixed supply is demand determined. • Because land is fixed in supply, its price is determined exclusively by what households and firms are willing to pay for it. • The return to any factor of production in fixed supply is called pure rent.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  22. 22. Land in a Given Use Versus Land of a Given Quality • The supply of land in a • The supply of land of a given use may not be given quality at a given perfectly inelastic or location is truly fixed in fixed. supply.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  23. 23. Rent and the Value of Output Produced on Land • A firm will pay for and use land as long as the revenue earned from selling the output produced on that land is sufficient to cover the price of the land. • The firm will use land (A) up to the point at which: MRPA = PA© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  24. 24. The Firm’s Profit-Maximization Condition in Input Markets • Profit-maximizing condition for the perfectly competitive firm is: PL = MRPL = (MPL X PX) PK = MRPK = (MPK X PX) PA = MRPA = (MPA X PX) where L is labor, K is capital, A is land (acres), X is output, and PX is the price of that output.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  25. 25. The Firm’s Profit-Maximization Condition in Input Markets • Profit-maximizing condition for the perfectly competitive firm, written another way is: M PL M PK M PA 1 = = = PL PK PA PX • In words, the marginal product of the last dollar spent on labor must be equal to the marginal product of the last dollar spent on capital, which must be equal to the marginal product of the last dollar spent on land, and so forth.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  26. 26. Input Demand Curves • If product demand increases, product price will rise and marginal revenue product will increase.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  27. 27. Input Demand Curves • If the productivity of labor increases, both marginal product and marginal revenue product will increase.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  28. 28. Impact of Capital Accumulation on Factor Demand • The production and use of capital enhances the productivity of labor, and normally increases the demand for labor and drives up wages.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  29. 29. Impact of Technological Change • Technological change refers to the introduction of new methods of production or new products intended to increase the productivity of existing inputs or to raise marginal products. • Technological change can, and does, have a powerful influence on factor demands.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

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