ECO339H1 Chapter Notes - Chapter 5: Marginal Revenue Productivity Theory Of Wages, Marginal Product, Marginal Revenue

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CHAPTER 5 – DEMAND FOR LABOUR IN

COMPETITIVE LABOUR MARKETS

• The demand for a factor is necessarily linked to the demand for the goods and services

that the factor is used to produce

• The demand for factors is called a derived demand

• The short run is defined as a period during which one or more factors of production,

referred to as fixed factors, cannot be varied

• The long run is defined as a period during which the firm can adjust all of its input

• By the demand for labour we mean the quantity of labour services the firm would choose

to employ at each wage

• Desired quantity will depend on both the firm’s objectives and its constraints

• Assume that the firm’s objective is to maximize profits

• The firm is constrained by the demand conditions in its product markets, the supply

conditions in its factor markets, and its production function, which shows the maximum

output attainable for various combinations of inputs, given the existing state of technical

knowledge

CATEGORIZING THE STRUCTURE OF PRODUCT AND LABOUR MARKETS

• Because the demand for labour is derived from the output produced by the firm, the way

in which the firm behaves in the product market can have an impact on the demand for

labour, and hence ultimately on wage and employment decisions

• The firm’s product market behaviour depends on the structure of the industry to which

the firm belongs

• The four main market structures are (1) perfect competition, (2) monopolistic

competition, (3) oligopoly, and (4) monopoly

• The degree of competition the firm faces in hiring labour, these factor market structures

are (1) perfect competition, (2) monopsonistic competition, (3) oligopsony, and (4)

monopsony

• The structure of the labour market affects the labour supply curve that the firm faces

• The supply curve of labour to an individual firm shows the amount of a specific type of

labour that the firm could employ at various wage rates

• The product and labour market categorizations are independent in that there is no

necessary relationship between the structure of the product market in which the firm sells

its output and the labour market in which it buys labour services

• At least 16 different combinations of product and labour market structure that can bear on

the wage and employment decision at the level of the firm

DEMAND FOR LABOUR IN THE SHORT RUN

• In the short run, the amount of capital is fixed

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• The quantity of labour services can be varied by changing either the number of

employees or hours worked by each employee, or both

• The demand for labour in the short run can be derived by examining the firm’s short-run

output and employment decisions

• Two decision rules follow from the assumption of profit maximization:

o Because the costs associated with the fixed factor must be paid whether or not the

firm, the firm will operate as long as it can cover its variable costs

o If the firm produces at all, it should produce the quantity Q * at which MR = MC

• Fixed costs are sunk costs, and their magnitude should not affect what is the currently

most profitable thing to do

• If the firm is a price-taker, the marginal revenue of another unit sold is the prevailing

market price

• If the firm is a monopolist, or operates in a less than perfectly competitive product

market, marginal revenue will be a decreasing function of output

• With capital fixed, the marginal cost of producing another unit of output is the wage

times the amount of labour required to produce that output

• The total revenue associated with the amount of an input employed is called the total

revenue product (TRP) of that input

• The change in total revenue associated with a change in the amount of the input

employed is called the marginal revenue product (MRP)

• The profit-maximizing decision rules for the employment of the variable input can be

stated as follows:

o The firm should produce, providing the total revenue product of the variable input

exceeds the total costs associated with that input; otherwise, the firm should shut

down operations

o If the firm produces at all, it should expand employment of the variable input to

the point at which its marginal revenue product equals its marginal cost

• The firm will employ labour until its marginal revenue product equals the wage rate,

which implies that the firm’s short-run labour demand curve is its marginal revenue

product of labour curve

•

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• The short-run labour demand curve is downward sloping because of diminishing

marginal returns to labour

• The change in the productivity of labour that occurs does so because of changes in the

amount of the variable factor combined with a given amount of the fixed factor, not

because the firm is utilizing inferior labour

WAGES, THE MARGINAL PRODUCTIVITY OF LABOUR, AND

COMPETITION IN THE PRODUCT MARKET

• The marginal revenue product of labour (MRP N) equals the marginal revenue of output

(MR Q) times the marginal physical product of labour (MPP N )

• There is a relationship between wages and the marginal productivity of labour

• The marginal revenue of output depends on the market structure in the product market

• For a competitive firm:

o MPP N aka value of the marginal product of labour

• Because the firm can sell additional (or fewer) units of output without affecting the

market price, the marginal revenue of output equals the product price

• A firm that is competitive in both the product and the labour market will thus employ

labour services until the value of the marginal product of labour just equals the wage

• Demand for labour (perfect competition):

• Demand for labour (monopolist)

DEMAND FOR LABOUR IN THE LONG RUN

• In the long run the firm can vary all of its inputs

ISOQUANTS, ISOCOSTS, AND COST MINIMIZATION

• Capital and labour are chosen together to maximize profits

• For any level of desired output, there will be a corresponding isoquant offering the menu

of combinations of capital and labour that could be employed to produce the level of

output

• Higher levels of output will require higher levels of inputs, and isoquants corresponding

to higher output levels → top left

• The slope of the isoquant represents the marginal rate of technical substitution

(MRTS) between the inputs

o The MRTS reflects the ease with which capital and labour can be substituted to

produce a given level of output

• Isoquants exhibit diminishing MRTS, as it becomes harder to substitute away from a

factor when there is less of it

• The firm’s objective will be to choose the least expensive combination of capital and

labour along the isoquant

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Document Summary

If the firm is a price-taker, the marginal revenue of another unit sold is the prevailing market price. In the long run the firm can vary all of its inputs. Deriving the firm"s labour demand schedule: the effect of a cost increase on output: The relationship between short run and long run labour. In the short run, the amount of capital is fixed no substitution effect: the response to a wage change will be larger in the long run than in the short run, all things being equal. Availability of substitute inputs: the derived demand for labour will be inelastic, the adverse employment effect of an exogenous wage increase will be small, if alternative inputs cannot be substituted easily for the higher-price labour. Isoquant that is more an l-shaped as opposed to a negatively sloped straight line the marginal rate of technical substitution between other inputs and labour is small: this factor relates to the magnitudes of the substitution effect.

Related Questions

A competitive firmâs short-run demand for labor will rise when the price of its product rises.

	True
	False

As the wage rate rises, the marginal revenue product of labor increases.

	True
	False

A competitive firmâs demand for labor always slopes down in the short-run, but may slope upwards or downwards in the long run.

	True
	False

When labor an capital are complements in production, a higher wage will cause a firm to use more capital in the long run.

	True
	False

If labor is a regressive factor, then a firmâs long-run demand for labor may or may not be downward sloping.

	True
	False

The short-run demand curve for labor for a firm in any type of market for its output coincides with

	the upward-sloping portion of the marginal revenue product curve.
	the downward-sloping portion of the marginal revenue product curve.

	the downward-sloping portion of the marginal product curve.
	the marginal labor cost curve.

An increase in the price of labor will, in the short run, cause a competitive firmâs

	marginal cost to increase, the quantity it sells to decrease, and therefore reduce the quantity of labor demanded.
	price of its output to increase, leaving the quantity of labor demanded unchanged.

	marginal revenue product of labor to decrease, and therefore reduce demand for labor.
	marginal revenue product of labor to increase, and therefore increase demand for labor.

Which of the following would cause the firmâs short-run demand curve for labor to shift to the right?

	A decrease in the wage rate.
	An increase in the price of the firmâs product.

	An increase in the rental rate paid to capital.
	A decrease in the amount of complementary capital available.

If increased capital usage reduces the firmâs short-run demand for labor, then

	labor is a regressive factor.
	labor and capital are complements in production.

	labor and capital are substitutes in production.
	labor is a Giffen factor.

When is the law of demand violated for labor? That is, with regards to the law of labor demand, when does an increase in the wage not lead to a reduction in the quantity of labor demanded?

	Never.
	When the substitution and scale effects are in opposition, with the scale effect being the larger.

	When labor is a regressive factor.
	When labor earns zero economic rent.

If the wage rate rises, then the firmâs long-run marginal costs change, which in turn affects the firmâs output level and its employment of labor. This phenomenon is known as

	the substitution effect.
	the scale effect.

	the regressive-factor effect.
	the factor-price effect.

When will the scale effect of a wage increase cause a reduction in the quantity of labor demanded?

	Always.
	When labor is not a regressive factor.

	When labor and capital are substitutes in production.
	When labor and capital are complements in production.

Consider the usual case where a higher wage rate increases a firmsâ marginal costs. In this case, the industryâs demand curve for labor

	is more wage inelastic than the individual firmsâ demand curves would indicate.
	coincides with the horizontal sum of individual firmsâ demand curves.

	contains only substitution effects but no scale effects.
	is horizontal at the going wage rate.

To maximize profits, a monopolist will hire the quantity of labor at which marginal revenue product of labor

	is downward sloping and equal to the market wage rate.
	is downward sloping and equal to marginal labor cost.

	minus marginal labor cost is maximized.
	is maximized.

A firmâs revenue minus its factor payments equals

	zero.
	the profits or losses earned by the firm.

	the quasi-rents earned by the factors of production.
	the firmâs total revenue.

As the amount of labor used in production increases, total product

	increases at low levels of labor and decreases at higher levels of labor.
	increases at high levels of labor and decreases at low levels of labor.

	always increases.
	always decreases.

A profit-maximizing price taker will produce at a level where

	the wage equals the marginal product of labor.
	the marginal revenue product of labor equals the price of their output.

	the wage rate equals the price of their output.
	the marginal revenue product of labor equals the wage rate.

If the wage rate is $10 per hour and one worker can produce 2 units of output per hour, then the marginal cost of production is

	$5.
	$10.

	$20.
	The answer cannot be determined from the information given.

A firmâs long-run demand for labor is more wage-elastic than its short-run demand for labor.

	True
	False

A monopsonistâs short-run demand curve for labor coincides with its marginal revenue product of labor curve.

	True
	False

Workers will receive higher wages when an employer faces an upward-sloping supply curve for labor.

	True
	False

The profit an owner receives is equivalent to the rent received for her entrepreneurial services.

	True
	False

When high levels of labor are employed, total production tends to increase at a decreasing rate.

	True
	False

The substitution effect on labor always decreases the quantity of labor demanded when the wage rate increases.

	True
	False

A firmâs marginal revenue product of labor equals the marginal product of labor multiplied by the per-unit cost of labor.

	True
	False

Tastes and preferences are relevant to individual choices for consumption but not relevant to choices for supplying labor.

	True
	False

A higher wage will always cause a worker to increase the quantity of labor supplied.

	True
	False

The substitution and income effects of a wage increase both cause consumption to rise.

	True
	False

A workerâs labor supply may either rise or fall when nonlabor income increases, depending on whether the substitution effect or the income effect dominates.

	True
	False

When an increase in marginal productivity increases workersâ nonlabor income, the effect on the quantity of labor supplied is ambiguous/uncertain.

	True
	False

A technological improvement that is permanent is more likely to raise employment than one that is temporary.

	True
	False

Other factors being constant, firms that provide on-the-job training to workers will tend to pay higher wages.

	True
	False

If there is discrimination, employers engage in it a cost.

	True
	False

Human capital tends to increase over the course of a personâs life.

	True
	False

In the indifference curve budget line model of labor supply,

	labor is measured along the horizontal axis and leisure is measured along the vertical axis.
	labor is measured along the horizontal axis and consumption is measured along the vertical axis.

	consumption is measured along the horizontal axis and labor is measured along the vertical axis.
	consumption is measured along the horizontal axis and leisure is measured along the vertical axis.

In the indifference curve budget line model of labor supply, the slope of the indifference curve is used to measure

	the wage rate.
	laborâs marginal product.

	the workerâs nonlabor income.
	the marginal value of leisure.

If a worker has chosen a quantity of labor where the marginal value of leisure exceeds the wage rate, she would be better off by

	choosing less leisure.
	providing fewer hours of labor.

	providing more hours of labor.
	staying at this combination of labor and consumption.

When there is an increase in the wage rate there will be

	both a substitution effect and an income effect.
	only a substitution effect.

	only a substitution effect.
	either a substitution effect or an income effect.

When the wage rate rises, the substitution effect leads a worker to

	increase consumption while the income effect leads to a decrease in consumption.
	decrease consumption while the income effect leads to an increase in consumption.

	increase consumption, as does the income effect.
	substitution sleep for other leisure.

Consider the indifference curve budget line model of labor supply, and assume consumption and leisure are both normal goods. A higher wage rate would result in

	more consumption and less leisure.
	a reduction in the workerâs marginal value of leisure.

	reduced consumption if the income effect is larger than the substitution effect.
	increased labor only if the substitution effect outweighs the income effect.

When the wage rate rises, a worker chooses to replace some leisure hours with work hours, even if he would remain equally well off. This phenomenon is known as

	compensating differential.
	the income effect.

	the substitution effect.
	intertemporal substitution.

Which of the following will shift a workerâs labor supply curve to the left?

	Higher nonlabor income.
	A lower wage rate, assuming the substitution effect dominates the income effect.

	New machinery that substitutes for labor and lowers its marginal product.
	A decrease in the marginal value of leisure.

Which of the following would cause a rightward shift in the labor demand curve?

	Manna from heaven.
	A rise in the wage rate.

	A rise in workersâ marginal productivity.
	A decline in workersâ nonlabor incomes.

When some jobs are inherently more risky or unpleasant than other jobs, different workers will be paid different wages because of

	differences in human capital.
	differing access to capital.

	compensating differentials
	discrimination.

Discrimination is difficult to measure empirically because

	it is hard to measure and control for differences in marginal productivity.
	data on racial and gender differences is rarely available.

	discrimination is practiced by very few employers.
	economists find no significant wage differentials due to gender or race.

Intertemporal substitution dictates that

	people will work less in periods of high productivity.
	people will spend more in periods of high productivity.

	people will work more in periods of high productivity.
	people will spend less in periods of high productivity.

A decrease in the wage rate causes the budget line to

	become flatter.
	become steeper.

	shift upward.
	shift downward.

An increase in the marginal productivity of labor will tend to

	shift the labor supply curve rightward if the change is temporary.
	result in an increase in employment if the change is temporary.

	result in an increase in employment if the change is permanent.
	all of the above.

A downward shift in a workerâs budget line is a result of

	an increase in the wage rate.
	a decrease in the wage rate.

	an increase in nonlabor income.
	a decrease in nonlabor income

One deficiency of the labor-leisure indifference curve analysis is that because indifference curves are always tangent to the workerâs budget line, the model cannot explain why some people choose not to work.

	True
	False

pinkcheetah77

MC Qu. 020 In a market economy:

In a market economy:

the government owns the means of production so that it can produce what is in society's best interest.

businesses design their plans to maximize their profit and the market is relied upon to see that individual self-interest is consistent with society's interest.

workers are directed by government planning boards to produce what is in society's best interest.

government sets prices to make necessities affordable because it is in society's best interest to make necessities affordable.

MC Qu. 022 Suppose that at the current price consumers would ...

Suppose that at the current price consumers would like to purchase 10 million large-screen televisions and 15 million are available. When the market coordinates the demand and supply for large-screen televisions, the price of large-screen televisions will:

rise.

fall.

stay the same.

be fixed by the government.

MC Qu. 036 Most economies today are:

Most economies today are:

pure market economies.

differentiated primarily by the degree to which they depend on markets.

differentiated primarily by who owns the means of production.

socialist.

MC Qu. 047 Households are on the:

Households are on the:

the supply side of factor markets and the demand side of goods markets.

the demand side of factor markets and the supply side of goods markets.

the supply side of both factor markets and goods markets.

the demand side of both factor markets and goods markets.

MC Qu. 050 Governments do all of the following except:

Governments do all of the following except:

oversee the interaction of households and businesses in the goods and factor markets.

demand labor services from households in the factor market.

demand for goods and services from businesses in the goods market.

supply labor services to businesses in the factor market.

MC Qu. 054 Businesses fail because:

Businesses fail because:

they follow the principle of consumer sovereignty too closely.

the invisible hand determines that they are not producing something socially valuable.

they earn excessive profits.

entrepreneurship is present.

MC Qu. 066 A business is most likely to be characterized as a...

A business is most likely to be characterized as a corporation if:

it has two or more owners, with each owner liable for every other owner's actions.

it has only one owner.

it is legally treated as a person and owned by stockholders who are liable for the actions of the corporate "person" regardless of their investment

each owner is liable only to the extent of his or her own investment.

MC Qu. 074 Which of the following statements is correct?

Which of the following statements is correct?

Stockholders are legally liable for all the debt of a corporation.

A corporation is a business that is legally owned by its employees.

Corporations are legal entities that, in law, are treated as persons.

Most large companies and many small companies in the United States are not corporations.

MC Qu. 095 Government regulation of working conditions is an ...

Government regulation of working conditions is an example of:

government as a referee.

government as owner.

government as an actor.

government as a dictator.

10. MC Qu. 104 Which of the following would most likely generate ...

Which of the following would most likely generate a negative externality?

education

a lighthouse

cigarette smoke

employment

magentasnail731

Hi !! i was studying for final exam for eco Few more question i don't really get
Q6) When each firm is producing its capacity and there is full employment, this shows:

1. An inflationary gap

2. all of the above

3. a deflationary gap

4. the long run AS curve

Q7) According to the RBA, the rate of unemployment is beginning to edge higher. Which of the following causes of unemployment is not associated with an excess supply of labour?

1. Efficiency wages
2. Job Search

3. Minimum wage laws
4. Unions

Q8) According to the RBA, public spending is scheduled to be subdued. Public spending is

1. The amount of income that businesses have left after paying for the factors of production

2. the amount of tax revenue that the government has left after paying for its spending

3. the amount of income that households have left after paying their taxes and paying for their consumption

4. always equal to investment

Q9) The demand for loanable funds is downward-sloping because:
1. As the interest rate falls, the demand for loanable funds falls

2. As the interest rate rises, the quantity of loanable funds demanded rises

3. as the interest rate falls, the demand for loanable fund increases

4. as the interest rate rises the quantity of loanable funds demand falls.

Q10) Suppose that the government decides to issue an investment tax credit to encourage more investment spending. Then this:
1. Shifts the demand curve for loanable fund to the right

2. does not affect the interest rate

3. reduces the supply of loanable funds

4. lowers the interest rate

ECO339H1 Chapter Notes - Chapter 5: Marginal Revenue Productivity Theory Of Wages, Marginal Product, Marginal Revenue

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