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Lecture 12

ECO105Y1 Lecture Notes - Lecture 12: Marginal Revenue Productivity Theory Of Wages, Marginal Revenue, Economic Rent

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Avi Cohen

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Lecture 12 Inputs, Incomes, and Inequality
Incomes are determined by prices and quantities in input markets, where households
supply business labor, capital, land, and entrepreneurship in exchange for wages,
interest, rent, and profits
In input markets, households are sellers and businesses are buyers
Inputs include; labor, entrepreneurship, capital, and land
Income is what you earn, a flow i.e. amount per unit of time
o Income for labor, capital, and land = price of input x quantity of input
o For flow variables, you need to know the unit of time i.e. if I were to say I earn
$50, ou ould’t ko if that’s good eough uless I tell ou hethe I ea
this amount per hour/per year/per month
Wealth is the total value of assets you own, and a stock variable
o Fixed amount at a moment, for instance the amount in your bank account right
What determines income of an input
o Marginal revenue product for labor
For maximum profit, businesses should hire additional labour when
marginal revenue product is greater than marginal cost
To hire labor, business must pay the market wage reflecting the best
opportunity cost of the input owner i.e. you must match the employees
next best alternative
Business demand for labor is derived demand demand for output and
profits usiess a die hiig lao i.e. ou’e usig ou laou to
derive profits and revenues
Marginal product additional output from hiring one more unit of labor
i.e. if I hire you, what is the additional amount of product you can
As you add workers, each additional worker experiences diminishing
marginal productivity i.e. as you add more of a variable input to fixed
inputs, marginal product of variable input eventually diminishes
Marginal revenue product is the additional revenue from selling output
produced by an additional laborer
MRP=Marginal Product x Price of Output
Marginal Revenue Product diminishes for additional laborers
E.g. I hire my first worker who produces 6 webpages for me, and I sell
each at $15. My MRP will be 6x15=90. But as I hire a second worker,
he/she will exhibit diminishing marginal productivity i.e. 5 so my MRP
then will be 5x15=75.
Based on above details, how much should I hire, and how much money
should I give them?
Pretend I need to pay $50 per hour. My first employee is making
me $90 in MRP and this is greater than the wage so yes, I would
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hire my first worker. My second worker makes me $75 in MRP,
and that too is greater than the wage so yes, I will pay my second
o Present value for capital
Present value is a stock concept
Less than the future amount because future revenues are discounted to
adjust for forgone interest
Capital earns interest
On the cost side, you must assess depreciation i.e. it depreciates over
On the benefit side, the benefits of an investment is spread out over
many years
Present value tells you what money earned in the future is worth today.
Peset alue opaes the pie ou pa fo toda’s iestet agaist
the iestet’s future earnings
Fo a sat hoie, the peset alue of the iestet’s futue eaigs
is geate tha the iestet’s pie toda
Present value = 
o Economic rent for land
Land is anything in inelastic supply for instance, it could apply to
This income is called economic rent, and is determined by demand alone
Economic rent is a function of demand alone
For most products and services, high input prices cause high output
prices to cover costs so a business can earn a normal rate of return. This
is not the case for inelastic supply. Here, high output prices cause high
input prices
For instance, take Yorkville land probable having large rent. Merchants
charge high prices for goods they sell, but this is not because of the high
rent. The causation is actually reversed. Who is going to rent the land in
Yorkville? Someone who is willing to pay high prices they know there
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