Chapter 15
Factor Markets and
Vertical Integration
Factor markets
• For completeness - firms hire labour from
workers/consumers
• Consumers use income to buy from firms
• Workers make labour supply decisions
• Firms make decisions on how much to
produce and sell
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Questions
• How do firms decide how much labour (and
other inputs) to hire?
• Related questions:
– why do some jobs pay more than others?
– what determines the distribution of (earned)
income?
– what is the effect of trade unions?
– why do men earn more than women?
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How much labour to hire?
• Where to start?
• Keep it simple, look at one input at a time
• Hence look at the demand for labour,
holding capital (and any other inputs)
constant
• Hence this is the short run
• Relax this assumption later
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The usual assumptions...
• Firms try to maximise profits
• The firm will only hire an additional worker
if she generates extra profit
– marginal revenue from labour > marginal cost
of labour
• Marginal revenue from labour = extra
output  price of output
• Marginal cost of labour = wage
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Marginal product of labour
• The additional output of the worker is the
marginal product of labour - MPL
• Price of output = marginal revenue - MR
• The additional revenue the worker generates
is the marginal revenue product of labour
- MRPL = MR  MPL
• For the competitive firm, MR = P, so we
refer to the value marginal product of
labour - VMPL = P  MPL
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Table 15.1 Marginal Product of Labor, Marginal
Revenue Product of Labor, and Marginal Cost
Should be VMPL, but never mind!
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Maximising profit
• As long as MRPL > w, the firm should
continue hiring more workers
• The optimum is therefore...
– MRPL = w
• At the margin, workers are paid what they
are worth. David Beckham is worth
£70,000 (or whatever!) per week.
• (No exploitation, etc. This is a competitive
economy.)
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Diagrams
MPL ,
APL
Q
MP
L
APL
AP
L
MP
L
L
Production function
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L
Marginal and average
products
15-9
MRPL curve
VMPL = p  MPL
w,
VMP
MRPL = MR  MPL
w
LM
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LC
L
15-10
Labour demand and supply - same as
previous diagram
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Re-interpretation - MC = MR
• w = MR  MPL
• Re-write as w/MPL = MR
• Note the LHS is the firm’s MC:
– if w = 10, MPL = 2...
– MC of one unit of output is 10/2 = 5.
• Hence firm is setting MC = MR
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Wages change... obvious effect
Think about
the minimum
wage...
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The long run... capital not fixed
• What difference does it make?
• Wage falls  labour demand increases,
with capital fixed
• But... this is an inefficient way to expand,
surely the firm would change capital too?
• MC falls, but not as much as it could, if
capital can vary too.
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• If K can vary too, MC falls by more, so
output increases by more, so demand for
labour increases by more.
• Hence, the long run demand curve for
labour is flatter (more elastic) than the
short run curve
• Firms may take time to fully adjust to
changing wage levels.
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Figure 15.3
Labor Demand of a Thread Mill
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Market demand for labour
• Above we examined the demand of a single
firm. What about the market demand for
labour?
• We do not horizontally sum the firms’
labour demand curves
• Why not...
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•
•
•
•
Wage falls...
Each firm’s labour demand rises...
Each firm produces more output...
So the market price of output falls...
• Hence, MPL falls...
• The moderates the rise in labour demand. It
is less than the sum of the firms’ effects in
isolation.
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Figure 15.4a
Market Demand for Labor
Wage falls from
$25 to $10.
Firm’s labour
demand rises
from 50 to 90.
But, price falls
too...
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Figure 15.4b
Market Demand for Labor
Market demand
curve
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Market imperfections
• Labour/input markets are not always
competitive
Seller/
workers
Many
One
Buyer/employer
Many
One
PC, monopoly monopsony
monopoly
Bilateral
union
monopoly
• We examine monopsony
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Monopsony
• A single buyer faces multiple sellers, the
reverse of monopoly.
–
–
–
–
Big employer in a small, isolated town
NHS and nurses/doctors
BBC buying football programmes
Tesco buying food from farmers
• How do we analyse monopsony?
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Adapt the monopoly analysis
• Market power is held by the buyer, not the
seller
• Hence it is the reverse of monopoly
• Rather than the seller facing a downward
sloping demand curve...
• The buyer faces an upward sloping supply
(e.g. of labour) curve.
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Figure 15.9a Monopsony
Hint: it’s the
monopoly diagram
upside down!
The wage (price of
input) is reduced
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15-24
Monopsony in buying televised
football
Year
1983
1985
1986
1988
1992
1996
Length of
contract
B'caster
2 years
6 months
2 years
4 years
5 years
5 years
BBC/ITV
BBC/ITV
BBC/ITV
ITV
BBC/Sky
Sky
Live
matches per
season
10
6
14
18
60
60
Annual
rights fee
£m per live
match
2.6
1.3
3.1
11.0
42.8
170.0
0.26
0.22
0.22
0.61
0.71
2.83
Source: Baimbridge et al, Satellite TV and the Demand for Football: a Whole New
Ball Game? SJPE, 43 (3) 1996
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Implications of monopsony
• Nurses and doctors are paid less because of
the NHS (though doctors can do private
work and nurses are beginning to use
agencies)
• Sky is the best thing that happened for (top)
football clubs
• Farmers are worse off because of the power
of Tesco, etc. (though they have the CAP!)
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The minimum wage again
Demand for
labour
increases
ME
supply
wMW
wM
demand
LM LMW
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Summary and conclusions
• Factor demand is an extension of what we
have done before.
• Maximising agents - look at the results
• Wages reflect marginal products, in perfect
markets
• Imperfect markets can alter our predictions
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Things to think about
• Why are wages in Third World countries so
low?
• Should football league clubs be allowed to
sell their own TV rights?
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