Supply of LaborFactor CompetitiveFactor MonopsonyFactor MonopolyDemand of SupplyCite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 1 1 Supply of Labor 14.01 Principles of Microeconomics, Fall 2007 Chia-Hui Chen December 3, 2007 Lecture 31 Factor Market Outline 1. Chap 14: Supply of Labor 2. Chap 14: Demand of Labor 1 Supply of Labor We derive the supply of labor by solving consumers’ utility maximization prob-lems. Two variables determining the utility are leisure (L), which is measured by hours, and income (Y ); the prices are w and 1 respectively. To maximize u(L, Y ), we have ∂u ∂L = w. ∂u ∂Y If w increases, on one hand, higher wages encourage people to work more (point A to point B), which is a substitution effect; on the other hand, higher wages allow the worker to purchase mor e goo ds , including leisure, which reduces work hours (po int B to p oint C), which is an income effect (see Figure 1). When the wage is higher, if the substitution effect ex c eeds the income e ffect, labor supply incre ases, and leisure decreases; if the income effect exceeds the substitution effect, labor supply decreases, and leisure increases (see Figure 2). Like pro duct markets, competitive, monopolistic, and monopsonistic mar-kets are types of factor markets. In a competitive factor market, if the product market is also competitive, M RPL = P × M PL. If the product market is monopolistic, 1 M RPL = M R × M PL = P (1 − ) × M PL. |ed|Y 10 9 8 7 6 5 4 3 2 1 0 A B C Substitution Effect Income Effect 2 3 4 5 6 7 8 9 10 11 12 L 10 9 8 7 Supply of LaborIncome Effect > Substitution Effect6 Wage5 4 Income Effect < Substitution Effect 3 2 1 0 3 3.5 4 4.5 5 5.5 6 6.5 7 7.5 8 Hours of Work per Day Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 2 1 Supply of Labor Figure 1: Substitution Effect and Income Effect of Labor Supply. Figure 2: Backward-Bending Supply of Lab or.w 10 9 8 7 6 5 4 3 2 1 0 S* w =P× MPL DL L L* 0 1 2 3 4 5 6 7 8 9 10 L Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 1.1 Factor Competitive 3 Figure 3: Competitive Factor Market. 1.1 Factor Competitive Competitive market is most efficient, and there is no deadweight loss (see Fig-ure 3). When M R < P , both w and L decrease; the market is then not a s efficient as competitive market, and has deadweight loss (see Figure 4). 1.2 Factor Monopsony Marginal Value equals the demand. Mar ginal Expenditure ∂PS (Q)Q ∂PSM E = = Q + PS > PS . ∂Q ∂Q Because L is determined by M E = M V, we can see that ′ ∗ w < w , and ′ L < L∗ (see Figure 5). One example of factor monopsonis t is the government hiring soldier s.w 10 9 8 S7 6 * w 5 L P× MP,4 Lw3 2 1 D =MR× MPL*L LL, 0 0 1 2 3 4 5 6 7 8 9 10 L w 10 9 ME 8 S=AE7 6 * w 5 4 ,w3 2 1 D=MV L, L* 0 0 1 2 3 4 5 6 7 8 9 10 L Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 1.2 Factor Monopsony 4 Figure 4: Noncompetitive Factor Market. Figure 5: Monopsonistic Factor Market.Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 1.3 Factor Monopoly 5 0 1 2 3 4 5 6 7 8 9 10 w Economic Rent SL w 0 0.5 1 1.5 2 2.5 3 3.5 4 L 1.3 Factor Monopoly An example of monopoly power in factor markets involves labor unions. Economic rent is the difference between payments to a factor of production and the minimum payment that must be spent to obtain the factor; it is like producer surplus in a product market (se e Figure 6). Figure 6: Ec onomic Rent. When some workers lose their jobs, remaining workers have higher wages. If the union tries to maximize the number of workers hired, it s hould set the wage and labor employed w ∗ and L∗; if the union tries to maximize economic rent, it sho uld set the wage and labor employed w1 and L1. ∗ w1 > w , and L1 < L∗ (see Figure 7). It is hard to say which one is better for the workers. Now consider a model of union workers and non-union workers. Assume the demand for union workers is DU , and the demand for non-union workers is DN U . The total market demand DL = DU + DN U is fixed.Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 1.3 Factor Monopoly 6 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 w w * L * SL DL L, w, MR Economic Rent L Figure 7: Monopoly Power of Sellers of Labor. When a monopolistic union raise s the wage rate in the unionized sector of the economy from w ∗ to wU , employment in that sector falls; for the total supply of labor to remain unchanged, the number of no n-union workers increases and the wage in the non-unionized sec tor must fall from w ∗ to wN U (see Figure 8). Assume the total supply of workers is 60; the demands for nonunion and union workers are 1 wN U = 30 − LN U ,2 wU = 30 − LU . • When the union does not intervene, wN U = wU = w. Thus LN U = 60 − 2w, and LU = 30 − w. Then L = 90 − 3w = 60, which gives w = 10,w10 9 8 7 6 5 4 3 2 1 0 w * SL DL DU DNU wNU wU 0 1 2 3 4 5 6 7 8 9 10 Number of Workers Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 1.3 Factor Monopoly 7 Figure 8: Wage