1. The document discusses pricing of inputs in markets, including labor and capital. A profit-maximizing firm will hire inputs up to the point where the marginal revenue product of each input equals its price. 2. Capital and time are also inputs that firms demand. The demand for capital is related to interest rates - as interest rates increase, the rental rate for capital increases, decreasing the demand. 3. Individual savings and firms' demand for loans determine equilibrium interest rates. Higher savings increases loan supply, lowering rates, while more investment by firms increases loan demand and rates.

1. GRADUATE
MICROECONOMIC
S
Presented by :
Hanik Inayatur Rohmah
Rohmad Adi Siaman
PART
7
Pricing in
Input Market Capital And Time

2. • Pricing in
Input
Market
Hanik
• Capital And
Time
Adis
• Until time
ended or no
more to
discussed
Discussion
• 
Go Home

3. Pricing in Input
Market

4. PRICING IN INPUT MARKETS
Input prices are also determined by
the forces of demand and supply

5. PROFIT-MAXIMIZING BEHAVIOR AND
THE HIRING OF INPUTS
Profit maximizing-firm will hire additional units
of any input up to the point at which the
additional revenue from hiring one more unit of
the input is exactly equal to the cost of hiring
that unit
MEK = MRK
MEL = MRL

6. PRICE-TAKING BEHAVIOR
v = MEK = MRK
w = MEL = MRL
v = rental rate
w = wage rate

7. MARGINAL REVENUE PRODUCT
Analyzing the additional revenue yielded by
hiring one more unit of an input, we should:
1. Ask how much output the additional input
can produce
2. How much the value of the sale of the output
that has been produced

8. MARGINAL REVENUE PRODUCT
……continued
Profit maximizing rules become:
v = MEK = MRK = MPK . MR
w = MEL = MRL = MPL . MR
MP = input’s marginal physical productivity
MR = marginal revenue

9. MARGINAL VALUE PRODUCT (MVP)
 firm sells its output in competitive market
 firm also a price taker in goods market
MR = P
Profit maximizing rules become:
v = MPK . P
w = MPL . P
MVP

10. MVP
….continued
The final condition for maximum profit:
v = MVPK
w = MVPL

11. RESPONSE TO CHANGES IN INPUT PRICES
SINGLE VARIABLE INPUT CASE

12. SINGLE VARIABLE INPUT CASE
a numerical example

13. RESPONSE TO CHANGES IN INPUT PRICES
TWO VARIABLE INPUT CASE
It is more complex:
 if w falls, there will be a change in labor
input and capital input → new cost-
minimizing combination of inputs
If capital input changes, the entire MPL
function shifts

14. TWO VARIABLE INPUT CASE
….continued
The total effect on the quantity of L hired caused
by a fall of wage can be decomposed to two
components:
• Substitution effect
• Output effect

15. Substitution effect:
in the theory of production, the substitution of
one input for another while holding output
constant in response to a change in the input’s
price
Output effect:
the effect of an input price change on the amount
of the input that the firm hires that results from a

17. SUMMARY OF FIRM’S DEMAND FOR
LABOR
A profit-maximizing firm will increase its hiring
of labor for two reasons:
 The firm will substitute the now-cheaper labor
for other inputs that are now relatively more
expensive → substitution effect
 The wage decline will reduce the firm’s
marginal costs → output increased → hiring of
all inputs increased → output effect

18. RESPONSIVENESS OF INPUT DEMAND
TO PRICE CHANGES
• Ease of substitution
The decrease in the hiring of labor from a rise
in w will depend on how easy it is for firms to
substitute other factors of production for labor.
• Costs and the output effect
In competitive market, wage rate ↑ → firm’s
cost ↑ → price of good ↑ → people purchase
of that good ↓→ production ↓ → labor demand
↓

19. The size of the output effect will depend on:
• How large the increase in marginal costs
brought about by the wage rate increase is →
how “important” labor is to total production
costs
• How much the quantity demanded will be
reduced by a rising price → how price-elastic
the demand for the product is

20. INPUT SUPPLY
• Labor
individual
• Capital equipment other
firms
• Natural resources ground

21. LABOR SUPPLY AND WAGES
People want to maximize their utility.
Individuals will balance the monetary rewards
from working against the psychic benefits of
other, nonpaid activities
In general, we might expect that a higher wage
rate will make people voluntarily agree to work
overtime or they might retire later or they might
do less at home.

22. EQUILIBRIUM INPUT PRICE DETERMINATION

23. Factors that shift input demand and supply curve

24. MONOPSONY (a single buyer)
 Monopsony is a condition in which one firm is
the only hirer in a particular input market
 Monopsonist facing an upward-sloping supply
curve for an input
The marginal expense will exceed the market
price of the input (for example: MEL > w)
 Marginal expense is the cost of hiring one
more unit of an input

25. A numerical example
Suppose that:
• Yellowstone National Park is the only hirer of bear wardens.
• The number of people willing to take this job (L) is a simple positive
function of the hourly wage (w) given by L = ½ w

27. MONOPSONIST’S INPUT CHOICE
a monopsonist will hire an input up to the point
at which the additional revenue and additional
cost of hiring one more unit are equal
MEL = MVPL
(for the case of labor)

28. A graphical demonstration

29. Causes of Monopsony
A firm must possess considerable power in the
market for a particular input. This cannot occur
in competitive market

30. BILATERAL MONOPOLY
A market in which both suppliers and demanders have
monopoly power. Pricing is indeterminate in such market

31. Capital And Time

32. Time Periods and the Flow of
Economic Transactions
Transaction
across periods
Durable goods
Borrow or lend
the goods

33. Individual Savings as The Supply of
Loans
Effect of individual savings
Frees up
resources that
can be used to
produce
investment goods
Provide funds for
firms to finance
investment goods

34. Two-Period Model of Saving
C0 : consumption this year.
C1 :consumption in the following year.
r : real interest rate
Because the consumers goal is to maximize
utility they can choose to consume this year (C0)
or next year (C1)
C0 = Y
C1 = (1 + r)Y
Utility is maximized:
• at C*
0, C*
1 where the
MRS equals (1 + r) and
touch the budget line
•where the rate which
this person is willing to
trade C0 for C1.
0
1
0
C
1
C*
(1+r) Y
CC* Y
U2
U1
U3

35. Substitution and Income Effects of a
Change in r
Effect of Increase in r Income effect :
The preferred
consumption point
move from S to
C 0**, C1 ** (decreases
saving)
Substitution effect:
Increases savings (C0
falls from C0 * to C0 **)
Budget line upward
The effect is
ambiguous depend on
which effect is
stronger and how
much r rise

36. Firms’ Demand for Capital and Loans
Firm’s Goal
• Maximize
Profit
Add the rent of
capital equipment
• Until Marginal
Revenue =
Rental rate of
Equipment

37. Rental Rates and Interest Rates
.)(
CostsBorrowingonDepreciatirateRental
PrdrPdP
v


P : price
d : rate of depreciation
r : real interest rate

38. Inverse Relation of Demand and
Interest Rate
.)(
CostsBorrowingonDepreciatirateRental
PrdrPdP
v



39. Ownership of Capital Equipment
Two
Businesses of
Ownerships
Produce
Goods
Lease capital
equipment to
themselves

40. Determination of the Real Interest
Rate
• The supply of loans
assumed to be an
upward sloping function
of the interest rate, r.
• The demand for loans is
negatively related to the
interest rate.
• Higher rates increase the
equipment rental rate.
• Q*, r* is the equilibrium,
with the rate that links
economic time periods
together.
S
D
r*
Quantity of loans
per period
Q*
Real
interest
rate

41. Changes in the Real Interest Rate
The increased demand causes an increase in
the real interest rate.
Factors that increases firms’ demand for capital
equipment which will increase the demand for loans :
Technical
progress that
makes
equipment more
productive
Declines in the
equipment
market prices
Optimistic views
of the demand
for products

42. Changes in the Real Interest Rate
Factors that affect savings by individuals
which will shift the supply curve of loans
Government-provided
pension plans
Reduce individuals’ current
savings which increases the
real interest rate
Reductions in taxes on
savings
Increase the supply of loans
and decrease the real
interest rate

43. Present Discounted Value
Transactions at different
times
Cannot be compared
directly
Because of the interest that
is received or paid
Time value of money

44. Next year Today
Present Discounted Value

45. Single-Period Discounting
$ 1
today
(1+r)
$ 1 next
year
Present
value of $1
next year
$ 1 today (1+r)
Present
value of
$1 next
year
$1 (1+0,05) $0,95

46. Present Value
Interest Rate
Years until Payment
Is Received 1 Percent 3 Percent 5 Percent 10 Percent
1 $.99010 $.97087 $.95238 $.90909
5 .95147 .86281 .78351 .62093
10 .90531 .74405 .61391 .38555
100 .36969 .05203 .00760 .00007
.
)1(
1$
yearsnin$1ofValuePresent n
r


47. Present Value and Economic Motives
Firm’s Goal
•Maximize the profit
Over the
time
•Maximize the present value
of all future profits
Or stated as
•Maximize the present value
of the firm

48. Pricing of Exhaustible Resources
Scarcity Cost
the opportunity
costs of future
production foregone
because current
production depletes
exhaustible
resources

49. The Size of Scarcity Costs
• The actual value depends upon the future
resource price.
– For example, suppose the firm believes that
copper will sell for $1 per pound in 10 years.
– Selling one pound today will mean $1 foregone
in the future since copper supply is fixed.
– If r = 5 percent, the present value equals $0.61.
– If production marginal costs = $0.35 per
pound, scarcity costs = $0.26 per pound
($0.61-$0.35).

50. Time Pattern of Resource Prices
Equilibrium could only occur if the price increase
equaled the real rate of interest.
No change in real
production cost /
Firm’s expectation
in future prices
Price of
resources rise
only at real rate
of interest
Rarely happen
Resource price rose
slower than r
Decreasing
supply
Increasing
resource price
Resource price rose
higher than r
Increasing
supply
Decreasing
resource price