Economic Lecture (11)

Businesses their Demand for Labor

(1). Businesses employ people. (2). There is an inverse relationship between demand for labor and the market wage rate. (3). If the wage rate is high then it is most costly for a business to hire extra employees. (4). When wages are lower, labor becomes relatively cheaper than capital. A fall in the wage rate might then create a substitute effect between labor and capital, and lead to an expansion in labor demand.

Why wages may differ among occupations ?

(1). Differences in labor productivity and revenue creation - workers whose efficiency is highest and ability to generate revenue for a firm should be rewarded with higher pay. City economists and analysts are often highly paid not least because they can claim annual bonuses based on performance. Top sports stars can command top wages because of their potential to generate extra revenue from ticket sales and merchandising. (2). Trade unions and their collective bargaining power - unions might exercise their bargaining power to offset the power of an employer in a particular occupation and in doing so achieve a mark-up on wages compared to those on offer to non-union members (3). Employer discrimination is a factor that cannot be ignored despite over twenty years of equal pay legislation in place

Characteristics of the oligopoly market structure (1)

(1). Interdependence- Firms operating under conditions of oligopoly are said to be interdependent , which means they cannot act independently of each other. A firm operating in a market with just a few competitors must take the potential reaction of its closest rivals into account when making its own decisions. In the case of petrol retailing, a seller like Texaco may wish increase its market share by reducing price, but it must take into account the possibility that close rivals, such as Shell and BP, who may also reduce their price in retaliation. An understanding of "game theory" and the "Prisoner's Dilemma" helps appreciate the concept of interdependence.

Some factors affecting the supply of labor

(1). The real wage rate on offer in the industry itself - higher wages raise the prospect of increased factor rewards and should boost the number of people willing and able to work (2). Overtime: Opportunities to boost earnings come through overtime payments, productivity-related pay schemes, and share option schemes (3). Substitute occupations: The real wage rate on offer in competing jobs affects the wage and earnings differential that exists between two or more occupations. For example an increase in the earnings available to trained plumbers and electricians may cause some people to switch their jobs (4). Barriers to entry: Artificial limits to an industry's labor supply (e.g. through the introduction of minimum entry requirements) can restrict labor supply and force pay levels higher - this is the case in professions such as legal services and medicine where there are strict "entry criteria"

Game Theory

(1). The study of behavior in situations of interdependence. (2). Game theory is quite useful for understanding the behavior of oligopolies. (3). A game is the study of how people behave in a strategic situations. Strategic means: in a situation in which each person, when deciding what actions to take , must consider how others might respond to that action.

Characteristics of the oligopoly market structure (2)

(2). There are few large firms. There can be two firms in the group, or three or five or even fifteen, but not a hundred.

Characteristics of the oligopoly market structure (3)

(3). Since under oligopoly, there are a few sellers, a move by one seller immediately affects the rivals. So each seller is always on the alert and keeps a close watch over the moves of its rivals in order to have a counter-move. This is true competition, "True competition consists of the life of constant struggle, rival against rival, whom one can only find under oligopoly."

Characteristics of the oligopoly market structure (4)

(4). Barriers to entry--Oligopolies and monopolies frequently maintain their position of dominance in a market might because it is too costly or difficult for potential rivals to enter the market. These hurdles are called barriers to entry and the incumbent can erect them deliberately, or they can exploit natural barriers that exist. Natural entry barriers include: (1). Economies of large scale production---If a market has significant economies of scale that have already been exploited by the incumbents, new entrants are deterred. (2). Ownership or control of a key scarce resource--Owning scarce resources that other firms would like to use creates a considerable barrier to entry, such as an airline controlling access to an airport. (3). Significant control over price(Price Makers) (4). Differentiated goods or sometimes homogenous (5). In the short run oligopolies can make profit or loss (6). In the long run oligopolies make a profit Example of oligopoly: cell phone services (duopoly - Digicel and GTT) Oligopolies produce where MR = MC

Characteristics of the oligopoly market structure (5)

(5). Strategy is extremely important to firms that are interdependent. Because firms cannot act independently, they must anticipate the likely response of a rival to any given change in their price, or their non-price activity. In other words, they need to plan, and work out a range of possible options based on how they think rivals might react. Oligopolists have to make critical strategic decisions, such as: (1). Whether to compete with rivals, or collude with them. (2). Whether to raise or lower price, or keep price constant. (3). Whether to be the first firm to implement a new strategy, or whether to wait and see what rivals do. The advantages of 'going first' or 'going second' are respectively called 1st and 2nd-mover advantage. (4). Sometimes it pays to go first because a firm can generate head-start profits. 2nd mover advantage occurs when it pays to wait and see what new strategies are launched by rivals, and then try to improve on them or find ways to undermine them.

The formula for MRPL

= marginal product of labor x marginal revenue.

Prisoners' dilemma:

A particular game between two captured prisoners' that illustrates why cooperation is difficult to maintain even when it is mutually beneficial. This game provides insight into the difficulty of maintaining cooperation.

Nash equilibrium:

A stable state of a system involving the interaction of different participants, in which no participant can gain by a unilateral change of strategy if the strategies of the others remain unchanged. The story of the prisoners' dilemma contains a general lesson that applies to any group trying to maintain cooperation among its members.

Dominant strategy:

A strategy that is best for a player in a game regardless of the strategies chosen by the other players. Many times in life, people fail to cooperate with one another even when cooperation would make them all better off. An oligopoly is an example.

What defines an oligopoly market structure?

An oligopoly is a market with only a few sellers(large), each offering a product similar or identical to the others. (1). One example is the market for tennis balls. (2). Another is the world market for crude oil: A few countries in the Middle East control much of the world's oil reserves.

The uniqueness of oligopoly market

Because an oligopolistic market has only a small group of sellers, a key feature of oligopoly is the tension between cooperation and self-interest. The group of oligopolists is best off cooperating and acting like a monopolist—producing a small quantity of output and charging a price above marginal cost. Yet because each oligopolist cares about only its own profit, there are powerful incentives at work that hinder a group of firms from maintaining the monopoly outcome.

Shifts in the labor demand curve (What causes the shift)

Causes of shifts include: (1). A rise in consumer demand which means that a business needs to take on more workers. (2). A change in the price of the good or service that labor is making. (3). An increase in the productivity of labor which then makes labor more efficient than capital. (4). An employment subsidy which cuts costs and allows a business to employ more workers. (5). A change in the cost of capital equipment (a substitute for labor) e.g. consider the effects of robotic technologies.

Marginal product

Change in total product as a result of employing an additional worker.

Market structures highlighted (The four types of market structures)

Economists who study industrial organization divide markets into four types: (1). monopoly (one firm), (2). oligopoly (few firms) (3). monopolistic competition (many firms and different products) (4). perfect competition (many firms and identical products)

Oligopoly

If you go to a store to buy tennis balls, it is likely that you will come home with one of four brands: Wilson, Penn, Dunlop, or Spalding. These four companies make almost all of the tennis balls sold in the United States. Together these firms deter- mine the quantity of tennis balls produced and, given the market demand curve, the price at which tennis balls are sold. The market for tennis balls fits neither the competitive nor the monopoly model. Competition and monopoly are extreme forms of market structure Therefore, the example above is an Oligopoly.

Oligopoly market structure: Collusion and cartels (Duopoly)

Imagine a town in which only two residents—Jack and Jill—own wells that produce water safe for drinking. Each Saturday, Jack and Jill decide how many gallons of water to pump, bring the water to town, and sell it for whatever price the market will bear. To keep things simple, suppose that Jack and Jill can pump as much water as they want without cost. That is, the marginal cost of water equals zero. Therefore, jack and jill have formed a duopoly. One possibility is that Jack and Jill get together and agree on the quantity of water to produce and the price to charge for it. Such an agreement among firms over production and price is called collusion, and the group of firms acting in unison is called a cartel. Once a cartel is formed, the market is in effect served by a monopoly.

The theory of competitive labor markets

In the theory of competitive labor markets, the demand curve for labor comes from the estimated marginal revenue product of labor (MRPL)

Demand for Labor

Many factors influence how many people a business is willing and able to take on. But we start with the most obvious - The Wage Rate or Salary (1). There is an inverse relationship between the demand for labor and the wage rate that a business needs to pay as they take on more workers (2). If the wage rate is high, it is more costly to hire extra employees (3). When wages are lower, labor becomes relatively cheaper than for example using capital inputs. A fall in the wage rate might create a substitution effect and lead to an expansion in labor demand.

Collusion

Such an agreement among firms over production and price is called collusion

Labor as a derived demand

The demand for all factor inputs, including labor, is a derived demand i.e. the demand depends on the demand for the products they produce: (1). When the economy is expanding, we see a rise in demand for labor providing that the rise in output is greater than the increase in labor productivity. (2). During a recession or a slowdown, the aggregate demand for labor will decline as businesses look to cut their operations costs and scale back on production. (3). In a recession, business failures, plant closures and short term redundancies lead to a reduction in the derived demand for labor. (4). In fast-growing markets, there is often a strong rise in demand for labor - for example an increase in demand for new apps for smart phones and tablets causes an increase in labor demand and then higher wage rates for app programmers

What does the Demand for Labor Curve show?

The demand for labor shows how many workers an employer is willing and able to hire at a given wage rate in a given time period.

Cartel

The group of firms acting in unison is called a cartel. Once a cartel is formed, the market is in effect served by a monopoly.

The labor supply curve

The labor supply curve for any industry or occupation will be upward sloping. This is because, as wages rise, other workers enter this industry attracted by the incentive of higher rewards. They may have moved from other industries or they may not have previously held a job, such as housewives or the unemployed The extent to which a rise in the prevailing wage or salary in an occupation leads to an expansion in the supply of labor, depends on the elasticity of labor supply.

Labor supply

The labor supply is the number of hours people are willing and able to supply at a given wage rate. This is the number of workers willing and able to work in a particular job or industry for a given wage •The labour supply curve for any industry or occupation will be upward sloping. This is because, as wages rise, other workers enter this industry attracted by the incentive of higher rewards. They may have moved from other industries or they may not have previously held a job, such as housewives or the unemployed •The extent to which a rise in the prevailing wage or salary in an occupation leads to an expansion in the supply of labour, depends on the elasticity of labour supply.

Shifts in the labor demand curve

The number of people employed at each wage level can change and in the next diagram we see an outward shift of the labor demand curve. The curve shifts when there is a change in the conditions of demand in the jobs market. For example: (1). A rise in the level of consumer demand for a product which means that a business needs to take on more workers. (2). An increase in the productivity of labor which makes using labor more cost efficient than using capital equipment (3). A government employment subsidy which allows a business to employ more workers (4). The labor demand curve would shift inwards during a recession when sales of goods and services are in decline, business profits are falling and many employers cannot afford to keep on their payrolls as many workers. The result is often labor redundancies and an overall decline in the demand for labor at each wage rate.

Wage Differentials

There is a wide gulf in pay and earnings rates between jobs. There are many reasons why wages may differ: (1). Compensating wage differentials - higher pay can often be some reward for risk-taking in certain jobs, working in poor conditions and having to work unsocial hours. (2). A reward for human capital - in a competitive labor market equilibrium, wage differentials compensate workers for (opportunity and direct) costs of human capital acquisition. There is an opportunity cost in acquiring qualifications - measured by the current earnings foregone by staying in full or part-time education. (3). Different skill levels - the gap between poorly skilled and highly skilled workers gets wider each year. One reason is that the market demand for skilled labor grows more quickly than the demand for semi-skilled workers. This pushes up pay levels. Highly skilled workers are often in inelastic supply and rising demand forces up the "going wage rate" in an industry.

Marginal revenue product of labor (MRPL)

This is the extra revenue generated when an additional worker is employed.