This document discusses labor markets under perfect competition. It begins by defining marginal revenue product (MRP) as the productivity of a resource in producing a good or service times the market value of that good, and marginal factor cost (MFC) as the cost of employing a resource. It states that firms will hire resources as long as MRP exceeds MFC. It then provides an example where the MRP of the first 5 workers exceeds their $6/hour MFC, so the firm would hire 5 workers. The document explains that under perfect competition, MRP represents the demand for labor and MFC represents the supply of labor. Determining how many resources to hire is done by comparing supply and demand. Over time

1. Wages and Employment in
Perfect Competition
The end of labor is to gain leisure.
-Aristotle
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2. Resources are used to produce
goods and services
Natural Resources
such as Land
Entrepreneurialism
Labor Capital
In studying resources,
we’ll focus on this
one…it is the largest
of the four, making
up 70% of all of our
income.
Resources can be
grouped into these
four categories.
When they are used
to make goods and
services, they earn
income.
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3. In this module, we’ll analyze
labor markets
We’ll start by discussing the value
of labor…we’ll call that the
Marginal Revenue Product (MRP).
We’ll then discuss the cost of
labor…we’ll call that Marginal
Factor Cost (MFC).
We’ll then use these two metrics to
determine how many employees a
firm will hire…that is called the
“hiring decision”
But first, let’s set up an
assumptions….
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4. Assume we have a perfectly
competitive labor market
Let’s first assume that firms demanding
resources are competing in a perfectly
competitive market.
That means the firms demanding
resources have no impact on price
or quantity in that market.
Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly
In other words, just because you
hire someone, that doesn’t affect the
wages of all of those employees.
A good example of this might be
cashiers. I think it is safe to say that
they all generally make the same
wage.
In the next module, we’ll get rid of
this assumption… and analyze an
imperfectly competitive labor
market.
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5. The rule for employing resources
Much like everything else we have
studied, resources are demanded (or
“hired”) to the extent that their benefit
outweighs their cost.
In technical terms, we say that any
resource for which Marginal Revenue
Product (MRP) exceeds Marginal
Factor Cost (MFC) will be hired.
Rule for hiring resource:
Continue to hire them as long as MRP>MFC
So what are MRP and MFC? Let’s explore them on the next set of slides…
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6. Marginal Revenue Product is
comprised of two things
The productivity of that resource in helping to make a
good or service1
The market value (price) of the good or service that
the resource helps produce2
This concept refers to Marginal
Product (MP)
This concept refers to Marginal
Revenue (MR)
A resource that is highly productive in
contributing to a highly valued product
will be in great demand!
2011 earnings: $195 million!
U2 has been highly productive at producing a highly
demanded good. As such, they command a huge wage.
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7. Other examples of resources that are highly
productive in producing a valuable product
Professional
athletes
Oil Rigs Mad Scientists!?!
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8. Combining the MP and MR concepts help
determine how much of a resource is demanded
These concepts can be
analyzed in conjunction by
looking at a resource’s
Marginal Revenue Product
For these examples, we’ll discuss labor
resources, but this could be any
resource (land, capital, etc)
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9. Calculating MRP
That means the first unit of labor hired
has an MRP of $14
In other words, the first hired employee
adds $14 to revenues
They produce 7 units (MP) and each
unit sells for $2
The second unit of labor hired has an
MRP of $12
As we have studied, diminishing
marginal returns has set in!
Each successive employee hired
brings in less revenue.
Note that the first person hired can
make 7 units.
Also note that those units can sell for
$2 each.
That is not because these extra people
are poor workers…it is because
diminishing marginal returns is
occurring.
Perhaps, after a certain point, the
workplace runs out of tools (or space)
and successive employees stand
around waiting for their turn.
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10. MRP data, seen graphically
This curve is downward
sloping because of
Diminishing Marginal
Returns
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11. Recall, the rule for hiring resources:
Continue as long as MRP>MFC
Employers decide to add (hire) an additional resource if that resource
adds more to revenue than it does to costs.
In other words, they hire any resource where that resource’s MRP is
greater than its Marginal Factor Cost (MFC)
Again, for these examples, we’ll
discuss labor resources, but this could
be any resource (land, capital, etc).
On the next slide, we’ll calculate the MFC in a
perfectly competitive labor market…
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12. Marginal resource costs are
determined by each resource’s wage
Note that the first unit of labor hired
cost $6/hr.
Each successive unit of labor also
costs $6.
Let’s assume employees cost $6 per
hour.
In reality, wages for employees doing the same
work may differ slightly. The perfectly competitive
labor market assumption means they do not.
That means that after you hire the first
employee, total costs are $6 per hour.
The MFC measures the amount that
employee has INCREASED total
costs…in this case, it is $6.
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13. So how many units of labor
should this firm hire?
The first employee has
an MRP of $14 and an
MFC of $6. Clearly,
she is a good hire.
The second employee
also has an MRP of
$12 and an MFC of
$6. Clearly, he is a
good hire.
The third employee
also has an MRP of
$10 and costs $6.
Clearly, she is a good
hire.
The fourth employee
also has an MRP of $8
and costs $6. Clearly,
he is an attractive hire.
The fifth employee
also has an MRP of $6
and costs $6. He is
the last attractive hire.Each additional
employee would cost
more than they
generate and would
not be hired.
It depends on the wage.
Let’s assume the market
has set the wage at $6
Each employee costs
$6/hr. Therefore, the
MFC curve is displayed
here.
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14. We completed this analysis….
the hiring decision
We asked ourselves,
“How many
employees should I
hire?”
We then compared
each employees MRP
and MFC.
After doing so, we
determined that the
first 5 employees
have an MRP that is
greater (or equal to)
MRC.
In this case, we’d hire
5 employees!
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Here we see how a firm
makes a decision (how
many people to hire) based
on marginal benefits (MRP)
and marginal costs (MFC).
That is a key learning
outcome!

15. MRP=Demand
Given this information, we see
that if wages are $14, one
employee is hired.
Given this information, we see
that if wages are $12, two
employees are hired.
Given this information, we see
that if wages are $10, three
employees are hired.
If that is true, then the MRP
represents the relationship
between employees
demanded and their price.
In other words, the MRP curve
represents demand for labor.
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16. MFC=Supply
Given this information, we see
that at $6, the employer may
hire as many workers as they
want.
This refers to the idea of a
perfectly competitive labor
market.
Regardless of how many
employees the employer hires,
they will not impact price or
quantity in that market.
If that is true, then the MFC
represents the relationship
between employees supplied
and their price.
In other words, the MFC
represents the supply of labor.
We’ll analyze imperfectly competitive
labor markets in a future moduleSlide 16 of 28

17. Once again, we look to
supply and demand
If MRP=demand for
labor and MFC =
supply of labor, then
determining the
number of resources
to hire is done by
comparing supply and
demand!
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18. So why do some resources
command such huge wages?
Because their Marginal Revenue Product is so high.
They generate A LOT of revenue!
Is it fair? Socially, I don’t know, but
economically, it is.
Each resource (including you) should
be paid at or near your MRP.
Are you?
Each of these resources is very productive at
producing a highly demanded product.
Therefore, they command very high wages. Put
another way…Their MRP exceeds a very high MFC.
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19. May 2011-May 2012
Floyd Mayweather $85 million
Manny Pacquaio $62 million
Tiger Woods $59.4 million
LeBron James $53 million
Roger Federer $52.7 million
Kobe Bryant $52.3 million
Phil Mickelson $47.8 million
David Beckham $46 million
Cristiano Ronaldo $42.5 million
Peyton Manning $42.4 million
Real world application of
High Marginal Revenue Product
Can you
guess
the top five?
Top athletes are paid
so much because they
have a very high MRP.
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20. Individual Exercise
How many employees should be hired? _____________
What do you think your MRP (per day) is where you work?_________
Fill in the blank cells and answer the questions
below. Click to see the answers
5
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21. Over time…things can change!
AS time moves on, demand for a
resource can change.
Perhaps that is due to changes in
productivity, fashion, or some other
factor.
When these changes occur, it can
affect the hiring decision.
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22. Many factors affect resource demand
As the characteristics of
a resource change, it’s
MRP can shift.
The last few slides
describes some factors
that can affect resource
demand.
In other words, they are
‘determinants of
resource demand”.
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23. Examples of determinants of
demand for resources
• Changes in product demand
– An increase in a product’s demand will increase the
demand for resources to make it
• Changes in productivity
– An increase in a resource’s productivity will increase its
demand
• Changes in prices of other resources
– Results will vary depending on whether the change in
price is for a good that is a substitute or a compliment.
71%
’90-’10
201%
’90-’10
Has the use of
ethanol in gas
affect prices of
corn
products?
Change in
employment
As our population ages, we have seen an
increase in demand for health care workers.
Change in real spending on
equipment and software
As technology has made workers more
productive, demand for computers and
software (capital) has escalated.
The next few slides will describe these
differences
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24. Demand for a resource can be affected
by prices of substitute resources
MRC
2 3
Since total costs are equal, I suspect that you would be indifferent as to
which scenario is better.
MRC
2 3
Demand for labor Demand for capital
Assume you own a landscaping company and these are your alternatives.
In each alternative, the same amount of work can be accomplished.
But if the price of labor went up, would you still be indifferent or would the
second scenario be more attractive?
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25. Real world example: the ATM
Originally the ATM was
implemented because they can
handle transactions at a fourth
the cost of a human teller.
At a lower cost, ATMs were
substituted for human tellers.
Eventually, their popularity
caught on to the extent that
now banks charge fees.
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26. Demand for a resource can be affected
by prices of complementary resources
MFC
2000 3000
A decrease in computer prices
has resulted in an increase in
demand for a complimentary
resource (computer
programmers)
With declining computer costs,
demand for computer
programmers has skyrocketed.
In fact, demand for computer
programmers increased 243%
between 1990 and 2010.
Assuming this Marginal Factor
Costs, a higher MRP will result
in more workers being hired!
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27. In Summary
Producers employ (hire) resources to the
extent that they are beneficial.
This benefit can be measured by
analyzing the Marginal Revenue Product
(MRP) and the Marginal Factor Cost
(MFC) of a resource.
When the MRP is greater than or equal to
the MFC, that resource Is attractive.
Keep in mind however, that over time,
changes in a resources MRP or MFC can
occur…changing the hiring decision.
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28. Credits
Slide 1: http://www.flickr.com/photos/53558245@N02/4978362207/
Slide 3: http://www.flickr.com/photos/kylemacdonald/5341665045/
Slide 4: http://www.flickr.com/photos/bioversity/8554603872/
Slide 5:http://www.flickr.com/photos/madebytess/276639499/
Slide 6: http://commons.wikimedia.org/wiki/File:2005-11-21_U2_@_MSG_by_ZG.JPG
Slide 7: http://commons.wikimedia.org/wiki/File:LeBron_James_2.jpg, ,
http://commons.wikimedia.org/wiki/File:Oil_Platform_Emmy_HB_CA_Photo_D_Ramey_Logan.jpg
http://commons.wikimedia.org/wiki/File:Mad_scientist.svg
Slide 17: http://commons.wikimedia.org/wiki/File:Tiger_Woods_2007.jpg, ,
http://commons.wikimedia.org/wiki/File:Rihanna_5,_2012.jpg
http://commons.wikimedia.org/wiki/File:Alan_Greenspan,_IMF_116greenspan2lg.jpg
Slide 21: http://www.flickr.com/photos/extremeezine/3277771465/
Slide 25: https://commons.wikimedia.org/wiki/File:ATM_750x1300.jpg
Slide 26: http://doctormo.deviantart.com/art/Computer-Programmer-Ink-346207753
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