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Lecture 4

ECO202Y - Lecture 4.pdf

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Masoud Anjomshoa

✤ So far: production functions and labour market▯ ✤ Focus: Factor prices in the labour market▯ ✤ Labour market = demand and supply of market, and labour market equilibrium▯ ✤ Everything about labour market also applies to capital goods because as we talk about factor prices, we are actually saying what are the prices of the factor of production - doesn’t matter if it is labour or capital or any other factor of production▯ ✤ Factors of production = capital, labour▯ ✤ Assumptions: ▯ 1. Labour markets are competitive (competitive = wages set by the point where supply and demand intersect) ▯ 2. All workers (labour) are homogenous 3. ▯ 3. Capital stock is fixed (SR) 4. ▯ 4. Firms are attempting to max profits and individuals/consumers are attempting maximize their utility▯ ✤ Demand for labour = think from the perspective of a business (how would you make a decision about hiring more workers or laying off some workers?) = what are the cost associated by hiring a worker, compare that with the benefit with hiring additional workers▯ ✤ Cost of hiring a worker marginal worker) = nominal wage rate (W) (what we are paying the worker wage + benefits - total labour compensation cost associated with the worker)▯ ✤ Real Wage Rate (w) = Nominal Wage Rate (W) / General Price Level = Purchasing power of that wage rate▯ ✤ How would we graph this marginal cost of hiring this worker?▯ ✤ y-axis = real wage rate (w)▯ ✤ x-axis = number of workers▯ ✤ Remember: assumption that #4 = any one firm, whether I hire a worker or not hire a worker is not going to affect the wage rate▯ ✤ Marginal Cost of hiring the next worker is independent of the size of the labour market▯ ✤ Benefits of hiring a new worker = a new worker is going to be able to produce additional output which will create revenue for the company▯ ✤ What is the revenue that the additional worker is going to bring in? = value of the marginal product of labour = marginal revenue product of labour = price we can sell our product at (general price level) * marginal product of labour = total revenue▯ ✤ marginal revenue / price level = marginal product of labour (what the benefit to the firm is of hiring a new worker)▯ ✤ It is easy to determine what the MP of Labour is▯ ✤ As we increase employment, output grow at a slow rate = marginal product of labour is downward sloping = diminishing MP = gives us the benefit of hiring more labour▯ ✤ If we have a lot of workers, as we add more, the incremental (marginal) benefit is going to be much lower and vice versa▯ ✤ What is a profit maximizing firm going to do? Set the nominal wage = value of the MP of labour => real wage = MP of labour▯ ✤ We want to hire workers upto the point where marginal benefit = marginal cost▯ ✤ Beyond that, we want to get rid of the additional works, until we reach the mb = mc again▯ ✤ MC > benefit => reduce workers to increase profits▯ ✤ benefit > MC => hire workers to increase profits▯ ✤ MC = benefit => real wage = MP => max profit▯ ✤ ▯ ✤ We are on the MP of labour curve **▯ ✤ Labour demand curve = relationship between real wage and quantity of labour demanded▯ ✤ EQLM condition = we want to be where real wage = MP of labour▯ ✤ To be at EQLM, move along the demand curve of labour▯ ✤ MP of labour curve = demand for labour curve▯ ✤ What can cause the demand of labour curve to move? = MP of labour = what changes the production function = 1. change in the capital stock, 2. supply or technology or productivity shock▯ ✤ Supply of labour = supplied by workers who individuals/consumers who wish to maximize their utility = think about how individuals determine how much to supply to the market based on the current real wage▯ ✤ Involves determining the cost associated with working and benefits associated with working▯ ✤ Think about = what happens when real wage increases▯ ✤ = substitution effect = the return for working more hours has increased, work more, substituting out of non-work time into more work time = incentive to work more = SUPPLY of labour has increased▯ ✤ = income effect = we are consuming a bundle of goods and services, and one of those goods includes non-working time = i could work the same number of hours as before and my income can go up, and now i can consume more, and i don’t have work more either = SUPPLY
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