MicroEconomics theory and application 12th by browning an zupan chapter 17

Prepared by Dr Della Lee Sue, Marist College MICROECONOMICS: Theory & Applications Chapter 17: Wages, Rent Interest, and Profit By Edgar K Browning & Mark A Zupan John Wiley & Sons, Inc 12th Edition, Copyright 2015 Copyright © 2015 John Wiley & Sons, Inc All rights reserved Learning Objectives      Investigate a worker's decision concerning how many work hours to supply Examine the income and substitution effects of a higher wage rate and whether the net result of a wage increase involves a worker supplying more work hours Analyze the general level of wage rates and why wages differ among jobs Explain why wage rates differ among jobs Define what economists mean by the term rent (continued) Copyright © 2015 John Wiley & Sons, Inc All rights reserved Learning Objectives    (continued) Explore selling or monopoly power in intake markets and show how unions attempt to exercise such power in labor markets Explain how the interest rate is determined through the interplay of the supply of and demand of capital Investigate investment and the marginal productivity of capital (continued) Copyright © 2015 John Wiley & Sons, Inc All rights reserved Learning Objectives   (continued) Describe the relation between saving, investment, and the interest rate Overview why interest rates differ across specific credit markets Copyright © 2015 John Wiley & Sons, Inc All rights reserved Investigate a worker's decision concerning how many work hours to supply 17.1 THE INCOME―LEISURE CHOICE OF THE WORKER Copyright © 2015 John Wiley & Sons, Inc All rights reserved The Income-Leisure Choice of the Worker       Leisure – the portion of a worker’s time when he or she is not receiving compensation from an employer Income – not assumed to be fixed; hourly wage is fixed but the number of hours worked can vary Budget line – slope reflects wage rate received per hour of work Tradeoff: income versus leisure time Optimal choice: equality between marginal valuation of worker’s leisure time and market valuation of the individual’s work time (i.e., wage rate) Optimal point: tangency between budget line and an indifference curve Copyright © 2015 John Wiley & Sons, Inc All rights reserved Figure 17.1 - Income-Leisure Choice of the Worker Copyright © 2015 John Wiley & Sons, Inc All rights reserved Is the Income-Leisure Model Plausible?   Common objection:  workers not really have the ability to vary their work hours Justifications:  Options to workers that give them control over how much they work: overtime, vacation leave, leave without pay, moonlighting, sick leave, early retirement  The model is fundamentally correct analytically  The model provides a basis for analyzing work effort decisions involving groups of workers, not necessarily one specific worker Copyright © 2015 John Wiley & Sons, Inc All rights reserved Examine the income and substitution effects of a higher wage rate and whether the net result of a wage increase involves a worker supplying more work hours 17.2 THE SUPPLY OF HOURS OF WORK Copyright © 2015 John Wiley & Sons, Inc All rights reserved The Supply of Hours of Work Question: Does a higher wage always lead a workers to work more? Substitution effect - a higher wage rate encourages more work Income effect - a higher wage rate encourages less work Total effect - the sum of the effects: the larger effect will determine whether there is an increase or a decrease in work hours Copyright © 2015 John Wiley & Sons, Inc All rights reserved 10 Some Alternative Views of Unions and an Assessment of the Impact of Unions on Worker Productivity  Unions protect workers’ rights and wages, counteracting the monopsony power possessed by input-buying firms  Unions set up effective grievance procedures  Unions give workers a “voice” with their employers  Empirical evidence: union workers receive higher wages but are also more productive than nonunion workers, controlling for other factors Copyright © 2015 John Wiley & Sons, Inc All rights reserved 30 Explain how the interest rate is determined through the interplay of the supply of and demand of capital 17.7 BORROWING, LENDING, AND THE INTEREST RATE Copyright © 2015 John Wiley & Sons, Inc All rights reserved 31 Borrowing, Lending, and the Interest Rate  Interest rate - defined as:    Supply of loanable funds: (savers)     The price paid by borrowers for the use of funds The rate of return earned by capital as an input in the production process Substitution effect: higher interest rate encourages more saving Income effect: higher interest rate increases real incomes of savers => encourages present consumption and less saving Supply curve is upward-sloping but may become backward-bending at sufficiently high interest rates Demand for loanable funds: (borrowers)   Substitution effect: higher interest rates inhibit borrowing Income effect: higher interest rate reduces real income of borrowers => borrowers cannot afford to borrow as much Copyright © 2015 John Wiley & Sons, Inc All rights reserved 32 Figure 17.9 – A Borrowing - Lending Equilibrium Copyright © 2015 John Wiley & Sons, Inc All rights reserved 33 Investigate investment and the marginal productivity of capital 17.8 INVESTMENT AND THE MARGINAL PRODUCTIVITY OF CAPITAL Copyright © 2015 John Wiley & Sons, Inc All rights reserved 34 Investment and the Marginal Productivity of Capital   Gross marginal productivity – the total addition to productivity that capital investment contributes Net marginal productivity – the total addition to productivity that capital investment contributes, less the cost of capital Copyright © 2015 John Wiley & Sons, Inc All rights reserved 35 The Investment Demand Curve  Investment demand curve – the relationship between the rate of return generated and various levels of investment  The rate of return on capital investment tends to equal the interest rate for borrowed funds  Investment demand curve:  reflects what investors expect the outcome of investment projects to be will shift if expectations change Copyright © 2015 John Wiley & Sons, Inc All rights reserved 36 Figure 17.10 - Investment Demand Curve Copyright © 2015 John Wiley & Sons, Inc All rights reserved 37 Describe the relation between saving, investment, and the interest rate 17.9 SAVING, INVESTING, AND THE INTEREST RATE Copyright © 2015 John Wiley & Sons, Inc All rights reserved 38 Saving, Investment, and the Interest Rate  Demand for saver-supplied funds:  Households with demand for consumer loans  Firms and persons with investment projects  Total demand – horizontal sum of these two demands  Interest rate is determined by many closely interrelated markets Copyright © 2015 John Wiley & Sons, Inc All rights reserved 39 Figure 17.11 – The Equilibrium Levels of Saving, Investment, Consumer Loans, and the Interest Rate Copyright © 2015 John Wiley & Sons, Inc All rights reserved 40 Figure 17.12 - The Level of Investment and Productive Capacity Copyright © 2015 John Wiley & Sons, Inc All rights reserved 41 Equalization of Rates of Return  Tendency: capital is allocated across firms and industries so that the rate of return is equal  Why?  Owners of capital have an incentive to shift their investments to industries where the return is higher => output in that industry will expand and price falls until the industry earns a normal profit  Adjustments occur until all industries earn a normal profit Copyright © 2015 John Wiley & Sons, Inc All rights reserved 42 Overview why interest rates differ across specific credit markets 17.10 WHY INTEREST RATES DIFFER Copyright © 2015 John Wiley & Sons, Inc All rights reserved 43 Why Interest Rates Differ  Reasons:  Difference in risk  Differences in the duration of the loan  Cost of administering loans  Differences in tax treatment  Differences in interest rates are less pronounced than differences in wage rates Copyright © 2015 John Wiley & Sons, Inc All rights reserved 44 ... that are created by the forces of supply and demand when workers view some jobs as intrinsically more attractive than others  Differences in human capital investment – the process by which people... how the interest rate is determined through the interplay of the supply of and demand of capital 17. 7 BORROWING, LENDING, AND THE INTEREST RATE Copyright © 2015 John Wiley & Sons, Inc All rights... marginal valuation of worker’s leisure time and market valuation of the individual’s work time (i.e., wage rate) Optimal point: tangency between budget line and an indifference curve Copyright © 2015