The Circular Flow:

Factor Market

Goods Market

Goods + Services=Households to firms  factor market

Goods +Services=Households to firms   goods market

Demand for a factor is derived from the demand for final product.

**If demand for automobiles increases, their price increases; and demand for auto workers will increase.**

see set 16 slide 5

The income earned by the owner of a factor of production equals the equilibrium price multiplied by the equilibrium quantity.

See set 16 slide 6

Individual Firm Level

Decision on factor use

Profit-Maximizing hiring rule for any factor of production says hire to the point where:

called Value of Marginal Product or VMP

VMP=MP x P

Demand curve for the factor

see Set 16 slide 8

MC=W

Marginal Cost=Wage

No one firm can influence the price of labor

 Firm hiring in a competitive labor market feels like it is facing a horizontal (perfectly elastic) supply of labor curve.

The supply of labor curve is identical to its marginal cost of hiring curve, and is set at the level of the going market wage.

S=MC

one competitive firm

If wage changes, firm always hires to point where VMP=W

VMP curve is the demand curve for labor for firm

The return a factor earns in competitive market should be equal to VMP, or the value of what it is contributing to a fim's revenues in equilibrium

the lowest wage rate that someone is willing to work at

At or above, people will increase the amount of labor hours they supply as the wage increases

At very high wages, people may want to take more leisure, causing labor supply curve to bend backwards

Substitution effect: When people work more as their wages go up, i.e they substitute their leasure for income

Income effect: At high wages, when people are richer and decide to buy more

**If the quantity of labor hours supplied becomes less as wages go up in this high wage range, then we say the income effect has outweighed the substitution effect. That's when a worker's labor supply curve will bend back.

Change in the price of the firm's output

Changes in the prices of other factors of production (substitutes and compliments)

Changes in technolog & capital (a long run factor)

**So anything that shifts the demand or supply for the final product the factor produces will change the price of the product**

Population

Labor Force participation

Labor Force Participation Rate= No. in work Force/Total Population

Hours of work

Technological Change and Capital Accumulation (labor saving devices at home)

Seller's Side: Unions

Buyer's Side: Monopsony

*We still assume that the firm which is hiring is selling its commodities in a competitive product market*

AFL (american federation of labor)****craft unionism****organizes by skill.

CIO(congress of industrial organizations)****founded in 1930's***industrial unionism****organizes across skill

1955 AFL-CIO

Pro-Labor

insured rights of workers to organize, bargain collectively, and to strike

forces company to bargain in good faith

established the National Labor Relations Board to investigate "unfair labor practices"

Anti-Labor

outlawed "closed shop", but not "union shop"

20 states have "right to work" laws

provides for 80 day cooling off period when national security is involved

Non-Competitive Labor Market:

Monopsony

A single buyer of labor in a market

Faces the total market supply and demand for labor

EX: a company town

the gap between VMP and Wm is called monopsonistic exploitation

Monopsony causes fewer people to be hired and wages to be lower

a human-made resource that is used to produce other commodities

Physical Capital: Plant and Equipment

Human Capital: Skill or Training

An act that results in the formation of capital

In deciding to purchase capital, a firm must compare the cost of the capital today to its returns which come in the future

PV=future amount/(1+r)   r=interest rate

PV=Future amount/(1+r)^n  n=years

the p.v. of any sum will be smaller the further in the future the sum is gotten (and vice versa)

the p.v. of any sum will be smaller the higher the interest rate is (and vice versa)

The "capitalized value" of an asset is the p.v. of the stream of earnings or returns that asset will yield 

IF p.v. of future returns>today's purchase price then 

BUY

If p.v. of future returns<today's purchase price the

DON'T BUY

If a factor of production gets paid more than is necessary to keep it from moving to another use it is earning economic rent

Opportunity cost is the amount just necesary to prevent a factor from moving to another use

Common with entertainment and sports areas

The steeper (more inelastic) the supply curve a factor,the greater will be its economic rent

The ratio of the area between the 45 degree line of equality and the Lorenz curve to the entire area beneath the 45 degree line

Ranges between zero and one

Zero is the most equal; one is the least equal

When a cost or benefit arises from production and falls on someone other than the producer

External costs

Common.

Ex: Noise from aircraft and trucks, polluted rivers and lakes, the destruction of animal habitat, air pollution in major cities from auto exhaust

External benefits

Less common

EX: Honey and fruit production. Bees pollinate the fruit orchard. Bees use pollen to make honey

External Costs

Common part of everyday life

EX: Smoking in confined area poses a health risk to others; noisy parties or loud car steroes disturb others

External Benefits

Common

EX: Flu vaccination, everyone you come in contact with benefits. Building restoration, everyone gets to see it

External Costs

If present, usually too much of a commodity is produced or consumed

External benefits

If present, usualy too little of a commodity is produced or consumed

A measure of market power

is the fraction of total market sales controlled by the industry's largest firms

4-firm concentration ratio

It is the square of the percentage market share for each firm summed over the largest 50 firms

EX:

HHI=50^2+25^2+15^2+10^2

Lots of firms competing

Free entry and exit

Product differentation

The steepness of demand depends on the number of close substitutes

Monopolistic Competition

Short Run

Monopolistic Competition

Long Run

Firms produce to left of min point of their average cost curve

Capacity output is where ATC is at its minimum, ie where MC crosses ATC

Firms are producing with "excess capacity"

If they increased output, they could get to lower per unit cost

Firms produce where P>MC because they mark-up more than competitive firms

Greek for few sellers

Products are usually differentiated, but there are close substitutes

Barriers to entry

Price-setters

They know that their competitions will react to what they do. Strategic behavior

Collusion is illegal , but frequetly there is tacit collusion

These profits can persist to the long run because of barriers to entry

P>MC

Cost advantages for existing firms

advertising-creates brand loyalties

product proliferation

predatory pricing

Put limitations on price discrimination, interlocking directories, and buying up the stock of a competitors when these practices are a monopoly threat

Excluded unions from antotrust prosecution

Only one seller in a market

Rare

Marginal Revenue lies below demand 

Monopoly

Marginal Revenue and Elasticity

The price elasticity of demand falls as we move down a downward sloping linear demand curve

A monopolist never produces in the inelastic range of demand. In inelastic range, by going to smaller Q and higher P, total revenue (TR) will rise.

Profit=TR-TC

Always set price from the demand curve, and P>MC

Profit will last in long run because there is no entry by competitors

They can also make a loss

Special cases of Monopoly

Price discrimination

Charging different prices to different customers for the same commodity (when there are no differences in production costs)

**Must have monopoly power**

**Must identify at least two different types of demanders**

**Must be able to keep the two demanders seperate so the community can't be resold**

Takes away some consumer surplus

Charging different price to every customer

Price will follow demand curve

Completely eliminates consumer surplus

MR=P

Demand curve is identical to MR Curve

Will produce where P=MC for last unit

Output increases

=profit/amount of invested capital

denominator is called rate base

Many firms-selling identical products

No restrictions on entry or exit

Established firms have no advantage over new ones

Sellers and buyers are well informed about prices