MIT 14 01 - Dominant Firm Model and Factor Market

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Dominant Firm ModelFactor MarketDemand of LaborCite 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 Dominant Firm Model 14.01 Principles of Microeconomics, Fall 2007 Chia-Hui Chen November 30, 2007 Lecture 30 Dominant Firm Model and Factor Market Outline 1. Chap 12, 13: Dominant Firm Model 2. Chap 14: Factor Market 1 Dominant Firm Model The dominant firm model is the model that in some oligopolistic markets, one large firm has a major share of total sales, and a group of smaller firms supplies the remainder of the market. The large firm has power to set a price that maximizes its own profits. A dominant firm exists because it has lower marginal cost than the other fringe firms. Assume the fringe firms’ tota l supply is SF , the market demand is DM , then the dominant firm’s dema nd is (see Figure 1) DD = DM − SF . Knowing DD, we can derive M RD. The do mina nt firm produces at a quantity QD that satisfies M RD = M CD. Correspondingly, the price is P ∗ . The fringe firm’s supply curve thus shows QF . Furthermore, the total quantity is QT = QF + QD. Example (OPEC). O PEC is an example of a successful c artel, which can be regarded as a dominant firm. Cartels ar e more likely to succeed if • demand is inelastic, and • supply of non-Cartel producers is inela stic.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 2 Factor Market P 10 9 8 7 6 5 4 3 2 0 1 0 1 2 3 4 5 6 7 8 9 10 SF DM DD MRD QF QD MCDP * QT Q Figure 1: Dominant Firm Model. 2 Factor Market The last chapters were about product ma rket, or output market, in which • individuals are buyers, and • firms are producers; we start to discuss factor markets, or input markets, in which • individuals are producers, and • firms are buyers. Firms need labor and capital to produce. Outline 1. Demand of Labor 2. Supply of Labor 2.1 Demand of Labor Demands of labor are different in short run and long run markets, and condi-tional and unconditional market (see Table 1). Firms use labor and capital as input.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 Demand of Labor 3 Short Run Conditional Output price fixed Other factors fixed Unconditional Output Price varies Other input factors fixed Long Run Output price fixed Other input factors vary Output Price varies Other Inputs vary Table 1: Demand of Labor. Short Run Demand of Labor. Only labor is variable. The prices fo r L and K are w and r respectively. Define marginal revenue product of labor M RPL to be additional revenue from an additional unit of labo r. M PL is the additiona l output obtained from an a dditional unit of labor; M R is the additional r e venue from an additional unit of o utput. Therefore, dR dR ∂Q M RPL = = = M R × MPL. dL dQ ∂L Firm choo ses Q such that w = M RPL(L), so the marginal revenue and marginal cost at hiring one more unit of labor are the same. • If output market is competitive, M R = P ; if it is not competitive, M R < P (see Figure 2 and 3). • Given w, we derive the firm’s demand for labor from w = M RPL(L). M RPL decreases in L; therefor e, M RPL is the firm’s short run de-mand curve. Long Run Demand of Labor. Both K and L are variable. w decreases then M C decreases, Q increases, and L increases. With higher L, M PK increases, so the firm uses more K, and then M PL increases further, and the firm hires more labor. Thus, the demand of labor is more elastic than that in short run (see Figure 5).10 9 6 78 × MR 5 MP × P4 LMPLCompetitive3 Not Competitive2 1 0 0 1 2 3 4 5 6 7 8 9 10 L P 10 9 0 1 2 3 4 5 6 7 8 9 10 L 0 1 2 3 4 5 6 7 8 W DL=MPL× MR 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 Demand of Labor 4 Figure 2: Marginal Revenue Product of Labor. Figure 3: Marginal Revenue Product of Labor in Comp e titive 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]. 2.1 Demand of Labor 5 W 10 9 7 6 D5 4 3 2 1 0 8 0 1 2 3 4 5 6 7 8 9 10 L L Figure 4: Marginal Revenue Product of Labor Increases in Price. 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 W DL MRPL , MRPL L Figure 5: Marginal Revenue Product of Labor in Long Run.W 10 9 8 7 6 MRP5 4 3 2 1 0 0 1 2 3 4 5 6 7 8 9 10 L DLL , MRPL 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 Demand of Labor 6 Figure 6: Unconditional on Output Market Price. Unconditional on Output Market Price. The discussion before was based on the assumption that the output price is fixed. Now consider the case when the output price is unco nditional so that it is not fixed. If w decreases, L increases and Q increases, and so P decreases; with M RPL decreases, Q and L decrease. The demand is less elastic than when output P is fixed (see Figure


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MIT 14 01 - Dominant Firm Model and Factor Market

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