The Demand and Supply of Resources14

Previously…

• Oligopoly– A market structure in which there are a small

number of firms– Firms interact strategically– Can be competitive (results closer to

monopolistic competition)– Can be collusive (results closer to monopoly)

• Antitrust policies– Restrain excessive market power– Give incentives to compete instead of collude– Each industry examined on a case-by-case

basis

Big Questions

1. What are the factors of production?

2. Where does the demand for labor come from?

3. Where does the supply of labor come from?

4. What are the determinants of demand and supply in the labor market?

5. What role do land and capital play in production?

The Factors of Production

• Factors of production– Inputs used in the production of goods and services– Land—physical location– Labor—employees– Capital—equipment, buildings, machinery

• Derived demand– Demand for inputs used in the production process– Demand for inputs is derived from the demand for the

output those inputs produce. Demand for labor will increase if the demand for the good the labor produces increases.

Demand for Labor

• You may be used to thinkingof yourself as a demander(consumer) and firms assuppliers (producers).

• However, in the labor market– Individuals are suppliers of labors– Firms are demanders (purchasers) of labor– The price of labor is the wage rate– A supply-demand analysis is still useful for determining

the amount of labor traded and the price of labor

Demand for Labor

• Marginal product of labor (MPL)– The change in output

associated with hiring one additional worker

– MPL will eventually be diminishing. We’ll eventually get to a point where the next worker adds less output than the previous worker.

Demand for Labor

• Value of the Marginal Product (VMP)– MPL multiplied by the price of the output it produces– Sometimes called marginal revenue product– Think of this as the total revenue generated by the

worker

Deciding How Many Laborers to Hire

Value of the Marginal Product

Changes in the Demand for Labor• Change in the demand for the product that the

firm produces will change the demand for labor• Example:

1. Your business produces sandwiches

2. The demand for sandwiches increases, pushing the sandwich prices higher and making sandwich production more profitable

3. More workers are needed to produce these sandwiches

4. More workers will have VMP > cost of labor

5. Demand for labor increases

Changes in the Demand for Labor• Changes in technology and Pproductivity

– New low-cost technology can substitute for workers– More technology will decrease the demand for labor

Changes in the Demand for Labor• Technology replacing labor: good or bad?• Short run

– May seem bad if workers lose jobs

• Long run– Society benefits! Production is cheaper and safer.

Workers will hopefully find other jobs, allowing production in other sectors to increase.

– Our society would be harmed in the long run if we tried to save jobs being replaced by technology

The Labor Demand Curve

The Supply of Labor

• The labor supply curve shows the relationship between the price of labor (wage rate) and the quantity supplied of labor

• Labor-leisure trade-off– The opportunity cost of working is giving up leisure– The opportunity cost of leisure is giving up earnings

from work– However, income is often required to enjoy leisure

Labor-Leisure Trade-off

• If wages rise, what happens?• People may be willing to work more hours

– The opportunity cost of leisure is now higher– This is called the substitution effect—when wages

increase, you substitute in labor and substitute out leisure

• People may be willing to work less hours– Suppose you just need $1,000 per week to be

satisfied. With a pay raise, you could earn this amount working fewer hours, and enjoy more leisure hours

– This is called the income effect. You use your extra income to purchase more leisure (a normal good).

Labor-Leisure Trade-off

• What is the slope of the labor supply curve? Do people work more or less when wages increase?

• At lower wages– The substitution effect usually dominates. Higher

wages lead to more working hours as leisure becomes more costly.

• At high wage levels– The income effect may dominate. This can actually

lead to a backward-bending labor supply curve. May not happen with most people and most wages.

The Labor Supply Curve

Changes in the Supply of Labor• Other employment opportunities

– If Job A increases wages, the supply of labor for Job B will shift left

– Think of workers as having substitute options for jobs. There is an inverse relationship between the wage in Job A and the supply of labor in Job B.

• Changing composition of workforce– Increase in females in workforce shifted the supply of

labor to the right. More laborers willing to work.

• Migration and immigration– People may move to or move from an area, increasing

or decreasing the supply of labor, respectively

Economics in A Day without a Mexican

• Immigration and labor markets

• What would happen if the supply of labor decreased because immigrants disappeared?

Labor Market Equilibrium

• Equilibrium in the labor market– The quantity of labor demanded is equal to the

quantity of labor supplied; occurs at equilibrium wage– Quantity supplied of labor illustrates how many

workers are willing to work at various wages– Quantity demanded of labor illustrates how many

workers firm is willing to hire at various wages

Labor Market Equilibrium

• Surplus of labor– Qs > Qd. This is unemployment!

• Shortage of labor– Qd > Qs. The number of

workers firms want to hire is greater than the number willing to work

Labor Market Equilibrium

Changes in Equilibrium

Changes in Equilibrium

Outsourcing

• Outsourcing– The shifting of jobs from within the firm to an outside

company.– Why? An outside company may have cheaper labor.

This is especially true for overseas companies.– May be done locally or globally

• Examples– GM opens a plant in Tennessee where wages are

lower than other GM plants– Textbook has labor intensive processes done

overseas where labor is cheaper

Outsourcing

• General implications– Pool of workers expands (rightward supply shift),

which lowers wages– If wages decline, domestic workers will choose to work

less, causing a decrease in employment– Firms may also relocate (even within a country) to a

place where labor is cheaper.

Outsourcing Globally

• Global results of outsourcing– Ability to outsource increases pool of workers– Decreases wages for domestic workers– Unemployment in the industry rises

• Outsourcing winners– Workers in country with increased labor demand– Firm that is hiring cheaper labor

• Outsourcing losers– Workers who may have lost their job or experienced

wage reductions

Shifting Labor Market Equilibrium

Outsourcing in the Long Run• In the short run, it appears that outsourcing can

be painful for some individuals• Outsourcing in the long run

– Allows specialization– Increases efficiency– Lowers costs (and prices)– Helps firms and consumers

• Are workers helped?– Outsourcing relocates jobs to efficient workers– Increases labor demand in the long run

Economics in Outsourced

• This great clip shows what can happen when jobs can be outsourced to use cheaper labor

• Some jobs may be lost, but prices will fall due to lower costs

Monopsony

• Monopsony– A market situation in which there is only one buyer– Contrast with monopoly, where there is one seller

• Monopsony results– Monopsonist has market power– Pushes prices down– Monopsonist labor buyer will push wages low– (If people only have one choice of employment, that

employer will pay low wages)

Monopsony and the WNBA

• NBA– Teams are all owned separately– Many competing purchasers of NBA labor– Higher wages– Average salary of NBA player in 2011

was $5.15 million

• WNBA– At first, teams are all owned by the NBA– One purchaser of WNBA labor (monopsony)– Lower wages– Salary cap for WNBA TEAM in 2013 was $869,000

The Market for Land

• Supply of land is fixed, so supply is perfectly inelastic (vertical)– Increases in demand result in price increases, but

not quantity increases

The Market for Land

• Economic rent– The difference between what a factor of production

earns and its next-best alternative– Ability of investors to beat their opportunity costs

• Economic rent example– Apartment near campus has higher price than

apartment 10 miles from campus– Higher demand for living near campus

Supply and Demand for Land

The Market for Capital

• Demand for capital– Determined by the value of

marginal product of capital– Also a derived demand—

firm demands as much capital as is required to make the product of the goods it sells

– Downward sloping—marginal product declines with increased amounts of capital employed

When to Use More Labor, Land, or Capital• A firm can decide the best of use of its resources

by comparing the VMP per dollar spent on each of the three inputs– If the firm is going to spend more on inputs, it wants to

spend money on the most productive input– The firm wants to maximize revenue per dollar spent

• Connection to firm behavior?– Relatively less productive inputs will be used less or

sold in exchange for relatively more productive inputs– Countries with cheaper (or more productive) labor will

use more labor– This is true for land and capital as well

Land, Labor, and Capital Example

Summary

• The demand for each factor of production is a derived demand that stems from a firm’s desire to supply a good in another market.

• Labor demand is contingent upon the value of the marginal product that is produced, and the value of the marginal product is equivalent to the firm’s labor demand curve.

• The supply of labor depends on the wage rate that is offered, and also on each person’s goals and other opportunities. At high-wage levels the income effect may become larger than the substitution effect and cause the supply curve to bend backward.

Summary

• Labor markets reconcile the forces of demand and supply into a wage signal that conveys information to both sides of the market

• At wages above the equilibrium, the supply of workers exceeds the demand for labor. This results in a surplus of available workers.

• At wages below the equilibrium, the demand for labor exceeds the available supply of workers and a shortage develops

Summary

• Outsourcing– There is no definitive result for outsourcing of labor in

the short run.– In the long run, outsourcing moves jobs to workers

who are more productive, and thus increases the overall productivity of workers everywhere.

• A monopsonist in the labor market is able to leverage market power by paying workers less.

• Economic rent is the difference between what a factor of production earns and what it could earn in the next-best alternative.

Practice What You Know

The demand for labor will increase ifA. The wage rate decreasesB. If there is a decrease in the number of

firms hiringC. The demand for the product produced by

the labor increasesD. If labor becomes less productive

Practice What You Know

A firm will keep hiring workers as long as the wages paid to workers is less than the

A. Wages the workers could earn elsewhereB. Price of the goods being producedC. Marginal Product of Labor (MPL)D. Value of Marginal Product (VMP)

Practice What You Know

What could lead to a backward-bending labor supply curve?

A. The income effect dominating the substitution effect at high wages

B. The substitution effect dominating the income effect at high wages

C. Laborers always working more hours when wages are higher

D. Firms choosing to hire less workers when market wages are higher

Practice What You Know

What is true about outsourcing?A. Outsourcing generally helps the firm by

raising the price of the goods soldB. Outsourcing may decrease wages for

domestic workersC. Outsourcing will decrease the overall

supply of workers that a firm can employD. There are no significant economic trade-

offs with regards to outsourcing

Practice What You Know

What is true about monopsony?A. Unlike a monopolist, a monopsonist has no

market powerB. Monopsony exists when there is one seller

of a good, service, or resourceC. If a market becomes monopsonized, there

will be an increase in the demand for labor.D. A monopsonist has the incentive to use

market power to lower the price of a resource