PAM_2000_Fall_2008_Chapter_15 - • Title: Solidarity...

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Unformatted text preview: • Title: Solidarity Forever • Artist: Pete Seeger • Economic concept: labor union as cartel, need for cartel enforcement and cooperation to increase producer (labor) surplus • Representative lyrics: When the union's inspiration through the workers' blood shall run, There can be no power greater anywhere beneath the sun; Yet what force on earth is weaker than the feeble strength of one, But the union makes us strong. PAM 200: Intermediate Microeconomics Prof. John Cawley Chapter 15: Factor Markets and Vertical Integration 1 Where We Are Consumer Theory Individual Demand Market Demand Theory of Production Costs of Production Factor Markets Prices Perfect Competition Imperfect Competition: Monopoly Monopolistic Competition Oligopoly General Equilibrium Market Imperfections Strategy Game Theory Outline • Competitive factor market – How a firm can choose optimal quantity of a factor – How changes in output prices affect factor demand – Factor market equilibrium • Monopsony • Vertical Integration 2 Factor Markets • Firms rely on factor markets for some inputs: – Labor: L – Capital: K – Materials: M • In factor markets: – Firms producing finished goods are the consumers – Suppliers are individuals (for L), other firms (for M), or both (for K) • In this lecture we’ll focus on labor markets – Next lecture: capital markets • We’ll apply concepts from output markets to input (or factor) markets: – Movement along demand curve – Shift of demand curve Optimal Number of Workers to Hire • Hire labor until last laborer’s addition to revenue equals cost of hiring the last laborer – Hire until MB of labor = MC of labor • Cost of adding laborer: wage W • Benefit of adding laborer: marginal revenue product of labor MRPL = MPL * MR = Δq Δ R Δ R * = ΔL Δq ΔL 3 Costs and Benefits of Labor • Hiring an extra worker raises the firm’s profit if: MRPL > W • Hiring an extra worker lowers the firm’s profit if: MRPL < W • Firm maximizes profits by hiring workers until for the last worker: MRPL = W – This is the first of the 2 equivalent profit-maximizing conditions Demand and Supply of Labor • A firm’s demand curve for labor is its marginal revenue product of labor curve – The maximum a firm will pay for additional labor is the extra revenue generated by the additional labor L QD = MRPL = MPL * MR • Demand for labor usually downward sloping because of diminishing marginal returns • From individual firm’s perspective, supply of labor is perfectly elastic at the prevailing wage when labor market is perfectly competitive – Firm can hire as many workers as it desires at that wage • Where labor demand = labor supply, MRPL = W 4 Demand and Supply of Labor Wage, MRPL Labor supply curve W Labor Demand Curve= MRPL Q* Q of Labor Why Are Inner-City School Teachers Paid Less Than Actors? • Marginal worker is paid a wage equal to marginal revenue product of labor W = MRPL = MPL * MR • Actors have higher MRPL because MR generated by an extra hour of TV much higher than MR generated by an extra hour of lecture • In a free market, workers aren’t paid based on what is “right” or “fair” but based on how much extra revenue they generate for their employer 5 How Changes in Wages and Prices Affect Labor Demand • Recall that a firm’s demand curve for labor is its MRPL curve • If labor supply curve shifts down (wage falls): – Causes movement along the labor demand curve – Firm hires more workers until MRPL falls to equal new, lower wage • If price of output falls: – MRPL falls because MRPL=MPL*MR – Causes shift of the labor demand curve – Firm will fire workers until MRPL rises to equal wage Movement Along the Labor Demand Curve After Labor Supply Shifts Down Wage, MRPL D=P*MPL W1 S1 W2 S2 Q(W1) Q(W2) Q of Labor 6 Shift of the Labor Demand Curve After Price of Output Good Falls Wage, MRPL D1=P1*MPL D2=P2*MPL W S Q(P2) Q( P1) Q of Labor Equilibrium in Factor Market • So far, studied a single firm’s demand for labor • To determine market demand for labor, aggregate individual firm labor demand across all firms – Aggregate over all firms in an industry – Aggregate over all industries • Intersection of market demand curve for labor and market supply curve for labor determines equilibrium market wage and quantity of labor employed – Recall Chapter 5: deriving labor supply curves • Technological innovation that increases MPL will shift out the labor demand curve (MRPL): result is more jobs at higher wages! 7 Monopsony Firm Type Monopoly Definition Only seller in a market New Curve Marginal Revenue Curve: twice as steep as Demand Curve Likely Result Sells fewer units at higher price than in competitive equilibrium Marginal Buys fewer Expenditure Curve: units at lower twice as steep as price than in Supply Curve competitive equilibrium Monopsony Only buyer in a market Monopsony Behavior • Just as all firms sell output until MR=MC, all employers hire workers until marginal revenue product = marginal expenditure • Employer in perfectly competitive labor market faces horizontal labor supply curve; employer has no ability to affect wages – Marginal expenditure equal to wage • Monopsonist employer faces upward-sloping labor supply curve; can affect wages (this is monopsony power) – Marginal expenditure not equal to wage – Hiring more workers raises wages for all workers – Will hire fewer workers than a firm in a competitive labor market 8 Marginal Expenditure for a Firm In a Competitive Labor Market Wage W* Labor Supply curve A B L1 L2 Quantity of Labor Marginal Expenditure for a Monopsonist Wage Labor Supply Curve W2 C W1 A B L1 L2 Quantity of Labor 9 Monopsony Wage ME, Marginal expenditure Labor Supply ME WC WM em ec Demand=MRPL 0 QM QC Quantity Labor Welfare Effects of Monopsony p, $ per unit Marginal expenditure A ME B pc pm D F Demand=MRPL Qm Qc Q, Units per day C E Supply 10 Monopsony Price Discrimination • Monopsonists may price discriminate: negotiate wage separately for each worker • If price discrimination is perfect: – No DWL relative to perfectly competitive labor market – No employee surplus; everyone works for their reservation wage – All surplus is captured by employers • Example: baseball during “reserve clause” – Owners negotiated separately with each player – Player had choice of accepting offer or quitting sport Examples of Monopsony • Examples of monopsony employers: – Hospitals as (near) total employer of nurses – Major League Baseball before 1975 • Congress exempted MLB from antitrust laws • “Reserve clause” bound players to one team for life – Major League Baseball collusion 1985-1988 • Examples of monopsonists in other markets: – US government as sole buyer from defense contractors – Wal-Mart has some monopsony power as buyer on wholesale market 11 Vertical Integration • To sell a good or service requires many stages of production and sales • For example, stages of producing pizza: – – – – Grow wheat and tomatoes, raise cows Mill wheat into flour, make tomato sauce, make cheese Assemble and bake pizzas Deliver pizzas to customers’ homes Vertical Organization of Production Inputs Materials M Labor L Upstream Final good q = f (M , L) Downstream Consumers q 12 Vertical Integration • A firm that participates in more than one successive stage of production is said to be vertically integrated • Vertically integrated is a relative term; all firms are to some extent vertically integrated • Backward integration: firm begins to produce own inputs to production • Forward integration: firm begins to produce more finished goods • Vertical integration is in contrast to horizontal integration, which is increasing market share in a single stage of production (e.g. merger of firms engaging in same stage of production of same product) How Vertically Integrated Should A Firm Be? • Question: How many of these different tasks should firms perform themselves? – Equivalently, how many should be outsourced? – This is a critical question: how much should a firm try to do by itself? • Ronald Coase, in The Nature of the Firm (1937) answered: “…a firm will tend to expand until the costs of organizing an extra transaction within the firm become equal to the costs of an exchange on the open market.” 13 How Vertically Integrated Should A Firm Be? • In other words, it’s all about transaction costs – A firm should vertically integrate in order to do things that are cheaper to coordinate within the firm – A firm should leave to others the aspects of production that can be done more cheaply outside of the firm Fads in Vertical Integration • In practice, there tend to be cycles in vertical integration: – Merger movements: firms vertically integrate to manufacture own inputs, sell directly to customers – Outsourcing: firms shrink to “core competencies”, selling or spinning off other aspects of production 14 Possible Benefits of Vertical Integration • • • • Lowering transaction costs (Coase’s explanation) Ensuring a steady supply Correct market failures like externalities Avoiding government intervention – Avoid price controls by selling to self • To lower taxes – Can set a “transfer price” for internally produced materials • Increase own firm’s market power – Monopolize inputs to further control finished product market • Eliminate other firms’ market power – Eliminate DWL by integrating if both factor market and finished good market are monopolies • Better information feedback from retail to manufacturer – e.g. Zara Possible Costs of Vertical Integration • Cost of supplying own factors of production may be higher than buying them on the open market • As firm gets larger, difficulties of managing it increase • Firm may face substantial legal costs to mergers and acquisitions 15 Firms Highly Vertically Integrated • Standard Oil (1870-1911): oil wells, pipelines, refineries, barrels, railroads, tankers, retailers. Controlled about 90% of refined oil in U.S. in 1900. • Ford Motor Co.’s River Rouge plant: iron ore went in one end, Model A cars drove out the other end • Purdue Chicken: soybean plants, feed mixing plans, chicken farms, processing plants, advertising Firms Minimally Vertically Integrated • Cisco Systems (communication equipment): a “virtual company” that exercises “command and control” over vast network of outsourced production – During 1990s was the most highly valued company in the world • Dell Computer: production model is to cut inventory and sunk capital to minimal levels and outsource all manufacturing 16 • Title: Talking Union • Artist: Pete Seeger • Economic concept: labor union as cartel, need for cartel enforcement and cooperation to increase producer (labor) surplus • Representative lyrics: The boss won't listen when one guy squawks, But he's got to listen when the union talks. He'd better, be mighty lonely Everybody decide to walk out on him. 17 ...
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This note was uploaded on 05/30/2009 for the course PAM 2000 taught by Professor Evans,t. during the Spring '07 term at Cornell University (Engineering School).

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