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# Pricing Input market And Capital and time

Pricing Input market And Capital and time
Published on: Mar 4, 2016
Published in: Economy & Finance

#### Transcripts - Pricing Input market And Capital and time

• 1. GRADUATE MICROECONOMIC S Presented by : Hanik Inayatur Rohmah Rohmad Adi Siaman PART 7 Pricing in Input Market Capital And Time
• 2. • Pricing in Input Market Hanik • Capital And Time Adis • Until time ended or no more to discussed Discussion •  Go Home
• 3. Pricing in Input Market
• 4. PRICING IN INPUT MARKETS Input prices are also determined by the forces of demand and supply
• 5. PROFIT-MAXIMIZING BEHAVIOR AND THE HIRING OF INPUTS Profit maximizing-firm will hire additional units of any input up to the point at which the additional revenue from hiring one more unit of the input is exactly equal to the cost of hiring that unit MEK = MRK MEL = MRL
• 6. PRICE-TAKING BEHAVIOR v = MEK = MRK w = MEL = MRL v = rental rate w = wage rate
• 7. MARGINAL REVENUE PRODUCT Analyzing the additional revenue yielded by hiring one more unit of an input, we should: 1. Ask how much output the additional input can produce 2. How much the value of the sale of the output that has been produced
• 8. MARGINAL REVENUE PRODUCT ……continued Profit maximizing rules become: v = MEK = MRK = MPK . MR w = MEL = MRL = MPL . MR MP = input’s marginal physical productivity MR = marginal revenue
• 9. MARGINAL VALUE PRODUCT (MVP)  firm sells its output in competitive market  firm also a price taker in goods market MR = P Profit maximizing rules become: v = MPK . P w = MPL . P MVP
• 10. MVP ….continued The final condition for maximum profit: v = MVPK w = MVPL
• 11. RESPONSE TO CHANGES IN INPUT PRICES SINGLE VARIABLE INPUT CASE
• 12. SINGLE VARIABLE INPUT CASE a numerical example
• 13. RESPONSE TO CHANGES IN INPUT PRICES TWO VARIABLE INPUT CASE It is more complex:  if w falls, there will be a change in labor input and capital input → new cost- minimizing combination of inputs If capital input changes, the entire MPL function shifts
• 14. TWO VARIABLE INPUT CASE ….continued The total effect on the quantity of L hired caused by a fall of wage can be decomposed to two components: • Substitution effect • Output effect
• 15. Substitution effect: in the theory of production, the substitution of one input for another while holding output constant in response to a change in the input’s price Output effect: the effect of an input price change on the amount of the input that the firm hires that results from a
• 16. SUMMARY OF FIRM’S DEMAND FOR LABOR A profit-maximizing firm will increase its hiring of labor for two reasons:  The firm will substitute the now-cheaper labor for other inputs that are now relatively more expensive → substitution effect  The wage decline will reduce the firm’s marginal costs → output increased → hiring of all inputs increased → output effect
• 17. RESPONSIVENESS OF INPUT DEMAND TO PRICE CHANGES • Ease of substitution The decrease in the hiring of labor from a rise in w will depend on how easy it is for firms to substitute other factors of production for labor. • Costs and the output effect In competitive market, wage rate ↑ → firm’s cost ↑ → price of good ↑ → people purchase of that good ↓→ production ↓ → labor demand ↓
• 18. The size of the output effect will depend on: • How large the increase in marginal costs brought about by the wage rate increase is → how “important” labor is to total production costs • How much the quantity demanded will be reduced by a rising price → how price-elastic the demand for the product is
• 19. INPUT SUPPLY • Labor individual • Capital equipment other firms • Natural resources ground
• 20. LABOR SUPPLY AND WAGES People want to maximize their utility. Individuals will balance the monetary rewards from working against the psychic benefits of other, nonpaid activities In general, we might expect that a higher wage rate will make people voluntarily agree to work overtime or they might retire later or they might do less at home.
• 21. EQUILIBRIUM INPUT PRICE DETERMINATION
• 22. Factors that shift input demand and supply curve
• 23. MONOPSONY (a single buyer)  Monopsony is a condition in which one firm is the only hirer in a particular input market  Monopsonist facing an upward-sloping supply curve for an input The marginal expense will exceed the market price of the input (for example: MEL > w)  Marginal expense is the cost of hiring one more unit of an input
• 24. A numerical example Suppose that: • Yellowstone National Park is the only hirer of bear wardens. • The number of people willing to take this job (L) is a simple positive function of the hourly wage (w) given by L = ½ w
• 25. MONOPSONIST’S INPUT CHOICE a monopsonist will hire an input up to the point at which the additional revenue and additional cost of hiring one more unit are equal MEL = MVPL (for the case of labor)
• 26. A graphical demonstration
• 27. Causes of Monopsony A firm must possess considerable power in the market for a particular input. This cannot occur in competitive market
• 28. BILATERAL MONOPOLY A market in which both suppliers and demanders have monopoly power. Pricing is indeterminate in such market
• 29. Capital And Time
• 30. Time Periods and the Flow of Economic Transactions Transaction across periods Durable goods Borrow or lend the goods
• 31. Individual Savings as The Supply of Loans Effect of individual savings Frees up resources that can be used to produce investment goods Provide funds for firms to finance investment goods
• 32. Two-Period Model of Saving C0 : consumption this year. C1 :consumption in the following year. r : real interest rate Because the consumers goal is to maximize utility they can choose to consume this year (C0) or next year (C1) C0 = Y C1 = (1 + r)Y Utility is maximized: • at C* 0, C* 1 where the MRS equals (1 + r) and touch the budget line •where the rate which this person is willing to trade C0 for C1. 0 1 0 C 1 C* (1+r) Y CC* Y U2 U1 U3
• 33. Substitution and Income Effects of a Change in r Effect of Increase in r Income effect : The preferred consumption point move from S to C 0**, C1 ** (decreases saving) Substitution effect: Increases savings (C0 falls from C0 * to C0 **) Budget line upward The effect is ambiguous depend on which effect is stronger and how much r rise
• 34. Firms’ Demand for Capital and Loans Firm’s Goal • Maximize Profit Add the rent of capital equipment • Until Marginal Revenue = Rental rate of Equipment
• 35. Rental Rates and Interest Rates .)( CostsBorrowingonDepreciatirateRental PrdrPdP v   P : price d : rate of depreciation r : real interest rate
• 36. Inverse Relation of Demand and Interest Rate .)( CostsBorrowingonDepreciatirateRental PrdrPdP v  
• 37. Ownership of Capital Equipment Two Businesses of Ownerships Produce Goods Lease capital equipment to themselves
• 38. Determination of the Real Interest Rate • The supply of loans assumed to be an upward sloping function of the interest rate, r. • The demand for loans is negatively related to the interest rate. • Higher rates increase the equipment rental rate. • Q*, r* is the equilibrium, with the rate that links economic time periods together. S D r* Quantity of loans per period Q* Real interest rate
• 39. Changes in the Real Interest Rate The increased demand causes an increase in the real interest rate. Factors that increases firms’ demand for capital equipment which will increase the demand for loans : Technical progress that makes equipment more productive Declines in the equipment market prices Optimistic views of the demand for products
• 40. Changes in the Real Interest Rate Factors that affect savings by individuals which will shift the supply curve of loans Government-provided pension plans Reduce individuals’ current savings which increases the real interest rate Reductions in taxes on savings Increase the supply of loans and decrease the real interest rate
• 41. Present Discounted Value Transactions at different times Cannot be compared directly Because of the interest that is received or paid Time value of money
• 42. Next year Today Present Discounted Value
• 43. Single-Period Discounting \$ 1 today (1+r) \$ 1 next year Present value of \$1 next year \$ 1 today (1+r) Present value of \$1 next year \$1 (1+0,05) \$0,95
• 44. Present Value Interest Rate Years until Payment Is Received 1 Percent 3 Percent 5 Percent 10 Percent 1 \$.99010 \$.97087 \$.95238 \$.90909 5 .95147 .86281 .78351 .62093 10 .90531 .74405 .61391 .38555 100 .36969 .05203 .00760 .00007 . )1( 1\$ yearsnin\$1ofValuePresent n r 
• 45. Present Value and Economic Motives Firm’s Goal •Maximize the profit Over the time •Maximize the present value of all future profits Or stated as •Maximize the present value of the firm
• 46. Pricing of Exhaustible Resources Scarcity Cost the opportunity costs of future production foregone because current production depletes exhaustible resources
• 47. The Size of Scarcity Costs • The actual value depends upon the future resource price. – For example, suppose the firm believes that copper will sell for \$1 per pound in 10 years. – Selling one pound today will mean \$1 foregone in the future since copper supply is fixed. – If r = 5 percent, the present value equals \$0.61. – If production marginal costs = \$0.35 per pound, scarcity costs = \$0.26 per pound (\$0.61-\$0.35).
• 48. Time Pattern of Resource Prices Equilibrium could only occur if the price increase equaled the real rate of interest. No change in real production cost / Firm’s expectation in future prices Price of resources rise only at real rate of interest Rarely happen Resource price rose slower than r Decreasing supply Increasing resource price Resource price rose higher than r Increasing supply Decreasing resource price