ECON 262 - Notes on Supply and Demand of Resources

ECON 262

Supply and Demand of Resources

Resources or Factors of Production:

Derived Demand (review):

Probably the most interesting “resource” or factor is labor. Why? Because workers are “human resources” – resources with unique characteristics.

Unique Features of Labor Markets (How do labor markets differ from other markets?)

1. Multiplicity of markets –

For Example: Geography

a. Local -

b. National -

c. International -

Another Example: Skill Type

a. Medical doctor –

b. Construction worker –

c. Waitress -

2. Nonstandard Workers (Contract) - Every worker is unique - so every contract is unique. Each person must contract as a separate resource. A firm can contract to buy 100 hammers, but can’t contract to “hire” 100 workers in the same way. Although unions try to make this happen (to some degree).

3. Continuity of Employment – Much more difficult to stop “hiring” a person than it is to stop buying hammers.

4. Workers deliver themselves along with their labor –

Person vs. Hammer!

There are Three Basic Actors in Labor Markets

1. Firms: also make choices - who to hire? How much to pay? What working conditions? What mix of pay (money vs. benefits/perks)?

Labor Demand:

2. Workers: have choices and preferences.

Decisions workers make: Am I going to work or not? What training will I get? Should I enter the workforce now or train?

Should I work full or part time?

Labor Supply:

3. Government: Regulations, laws - the rules of the game.

Let’s look at Labor Demand first:

Derived Demand and the Marginal Product of Labor

Recall that total product is the total output of a firm.

Marginal product of an input (such as labor) is the additional product that a resource or input adds to the total output of the firm.

Also recall that the marginal revenue product (or the value of the marginal product to the firm) is the marginal product of the input times the output price.

MRP of labor = MP of labor x the output price (for a given time frame)

So how does this relate to derived demand?

Output price:

Also recall – that a firm wants to hire a person as long as the employees MRP is greater than the wage paid to the employee. OR – as the theory goes, the firm will hire employees up to the point where MRP = wage.

Let’s graph the MRP and the quantity of people hired:

GRAPH

Recall that as a firm hires more people (in the short run), eventually diminishing marginal returns (or product) will set in. Why?

So the MRP falls as more people are hired. If we bring in the wage rate – that will tell the firm how many people they will demand for hire.

Therefore, the firm’s MRP curve (downward sloping portion) is the firm’s demand for labor curve. The firm will always hire along with curve (theoretically). It will not hire a person whole MRP is below the wage paid (unless they are forced to by the government).

What will change the quantity demanded and the demand for labor?

1. Quantity demand (movement along the labor demand curve) - if the wage falls, more people will be hired.

2. Change in the demand for the output (shift the labor demand curve).

3. Change in labor productivity (shift the labor demand curve) – MRP will be higher for each worker. This can happen, for example, because the firm employees more capital – which increases the productivity of the workers.

But what about when capital or technology is a substitute for workers?

In the short-run, this can decrease the demand for labor. But in the long run, the increase in productivity (and cost savings) will increase output – thereby increasing overall the need for more workers (in other markets, for example). So overall, in the long run, technology and capital investment increases job growth.

To summarize, if lab or becomes more productive, the MRP curve shifts to the right, driving up both wages and employment.

Now let’s look at Labor Supply:

People supply labor. They have a choice:

Labor/leisure trade-off:

Substitution Effect:

Income Effect:

The backward bending supply curve of labor:

GRAPH:

Typically, we assume that the substitution effect outweighs the income effect – such that the labor supply curve is upward sloping.

GRAPH:

Changes in the Supply of Labor:

1. Changes in quantity supplied of labor (movement along the curve): An increase in the wage makes leisure more expensive – people work more:

2. Change in the working population (shift in the curve):

a. Labor force participation:

This can be different for men vs. women, for example.

b. Immigration (supply in an area):

c. Migration (changes in supply in an area):

d. Other employment opportunities (supply in one market vs. another:

Supply and Demand – Market Clearing

The importance of flexible wages:

DO ICE

A Couple of Issues in Labor Markets

1. Outsourcing:

Definition: outsourcing of labor occurs when a firm shifts jobs to an outside company, usually overseas, where the cost of labor is lower.

Outsourcing can occur within a country, however. Example - GM introduced its Saturn division in 1985. It build an entirely new production facility in Tennessee, where wages were substantially lower than those in Detroit.

Short-run implications of outsourcing:

Outsourced jobs are not lost - they are relocated form high-labor cost areas to low-labor-cost areas. Outsourcing also creates benefits for firms in the form of lower production costs (that's why they do it). The lower costs translate into lower prices for consumers and also help the firms that outsource to compete in the domestic and international markets.

If other countries are outsourcing too -- then outsourcing by the United States may not mean jobs are lost in the short run (overall). Obviously, some workers are "displaced" and must move into another job market. This is why some people think it decreases overall unemployment.

Long-run implications of outsourcing:

In the long run outsourcing benefits domestic consumers and producers. In fact, outsourcing is a key component of international trade. Lower costs help firms expand production -- which means more job creation. Consumers save money, helping other industries be productive -- also leading to more job creation.

Also -- foreign workers have more money to spend in the United States, increasing exports and the number of jobs in the export industries.

Therefore -- overall employment increases with outsourcing in the long run.

2. Discrimination:

Remember: employers discriminate in every hiring decision. Most (but not all) would agree that to discriminate with respect to differences in productivity is not a “bad” thing.

But some would disagree - why?

When it comes to discriminating on the basis of sex (or gender), (or religion, even looks, etc.) disagreement abounds. This is true among men and women on the street, as well as among economists.

Definitions: These are loosely based upon definitions by Thomas Sowell in Markets and Minorities (he applies them to race – I am broadening them to include sex).

Pure Discrimination: the offering of different contract terms (including none at all) to a person based solely on group membership, not based on any other criteria usually used otherwise (such as prior experience, education, etc.). In other words pure discrimination exists whenever there is no economic (i.e. productivity) justification for offering different contract terms to one person over another. In this case, for example – an employer may perceive a female applicant to be more qualified for a job than a male applicant but still refuse to give her the job (this is your basic sexist or bigot).

Institutional Discrimination: the offering of different contract terms (including none at all) to an individual subjectively perceived as being less qualified than someone else solely because of group membership. The perception is not based on objective facts, but is based on presumptions about behavior. The presumptions generally have no basis in reality today but persist because of past behavior and/or cultural norms (women for example), laws, and other institutions.

Statistical Discrimination: the offering of different contract terms (including none at all) to someone based on statistical averages of the relevant criteria for a job (for example: years of experience, skills, education, etc.). The statistical averages arise because of actual or objective differences between actions of people who are categorized into different groups. Under this kind of discrimination, people are not judged as individuals – but are seen as “the average” member of a group. Any given individual within the group may not behave as the “average” member does but will be judged as the average. Those individuals below the average may actually benefit from this type of discrimination, while those above the average will bear a cost.

Economic Discrimination: the offering of different contract terms (including none at all) to a person, judged as an individual, because the person does not meet the relevant criteria for the job AND the reasons for this lack of qualifications are related to the fact that he or she is a member of a group. For example – there may be no females qualified to be a linebacker in the NFL. As differences among groups decrease – economic discrimination will decrease.

Does economic discrimination apply to race? Age? Sexual orientation? Religion?

Are all of these definitions of discrimination bad? What do you think?

Markets go a long way towards decreasing pure discrimination and institutional discrimination. Why?

Statistical discrimination exists because of the behavior of individuals within a group. As the statistics change, the "discrimination" will change.

Many economists argue that laws that force employers to employ a certain number of people in a group, etc. actually end up harming those in the group.

Example: If a woman is more likely to sue an employer on the basis of discrimination, which can be very costly, a firm is less likely to hire women -- or will look for the absolute best they can find. These women will earn higher wages, but leave the rest without opportunities.