Principles of Economics

Transcription

1 GLOBAL EDITION Principles of Economics The Eleventh Edition of the best-selling is a blend of the latest economic theory, institutional material, and real-world applications. It is an accessible introduction to economics and provides readers with a strong understanding of how economies function. ELEVENTH EDITION Karl E. Case Ray C. Fair Sharon M. Oster This Global Edition has been edited to include enhancements making it more relevant to students outside the United States. The editorial team at Pearson has worked closely with educators around the globe to include: This revised edition includes global coverage from the Middle East, Europe, and Asia Expanded coverage of professional skepticism as well as coverage of the global economic recession Economics in Practice boxes contain real-world examples and include discussion questions Case Fair Oster This is a special edition of an established title widely used by colleges and universities throughout the world. Pearson published this exclusive edition for the benefit of students outside the United States and Canada. If you purchased this book within the United States or Canada you should be aware that it has been imported without the approval of the Publisher or Author.

2 Real-Time Data Analysis Exercises Up-to-date macro data is a great way to engage in and understand the usefulness of macro variables and their impact on the economy. Real-Time Data Analysis exercises communicate directly with the Federal Reserve Bank of St. Louis s FRED site, so every time FRED posts new data, students see new data. End-of-chapter exercises accompanied by the Real-Time Data Analysis icon include Real-Time Data versions in MyEconLab. Select in-text figures labeled MyEconLab Real-Time Data update in the electronic version of the text using FRED data. Current News Exercises Posted weekly, we find the latest microeconomic and macroeconomic news stories, post them, and write auto-graded multi-part exercises that illustrate the economic way of thinking about the news. Interactive Homework Exercises Participate in a fun and engaging activity that helps promote active learning and mastery of important economic concepts. Pearson s experiments program is flexible and easy for instructors and students to use. For a complete list of available experiments, visit

3 CHAPTER 9 Long-Run Costs and Output Decisions 245 APPENDIX REVIEW TERMS AND CONCEPTS constant-cost industry An industry that shows no economies or diseconomies of scale as the industry grows. Such industries have flat, or horizontal, long-run supply curves. p. 244 decreasing-cost industry An industry that realizes external economies that is, average costs decrease as the industry grows. The long-run supply curve for such an industry has a negative slope. p. 244 external economies and diseconomies When industry growth results in a decrease of long-run average costs, there are external economies ; when industry growth results in an increase of long-run average costs, there are external diseconomies. p. 242 increasing-cost industry An industry that encounters external diseconomies that is, average costs increase as the industry grows. The long-run supply curve for such an industry has a positive slope. p. 244 long-run industry supply curve ( LRIS ) A graph that traces out price and total output over time as an industry expands. p. 244 APPENDIX PROBLEMS 1. In deriving the short-run industry supply curve (the sum of firms marginal cost curves), we assumed that input prices are constant because competitive firms are price-takers. This same assumption holds in the derivation of the long-run industry supply curve. Do you agree or disagree? Explain. 2. Consider an industry that exhibits external diseconomies of scale. Suppose that over the next 10 years, demand for that industry s product increases rapidly. Describe in detail the adjustments likely to follow. Use diagrams in your answer. 3. A representative firm producing cloth is earning a normal profit at a price of $10 per yard. Draw a supply and demand diagram showing equilibrium at this price. Assuming that the industry is a constant-cost industry, use the diagram to show the long-term adjustment of the industry as demand grows over time. Explain the adjustment mechanism. 4. Evaluate the following statement. It is impossible for a firm facing internal economies of scale to be in an industry which is experiencing external diseconomies. 5. Assume demand is decreasing in a contracting industry. Draw three supply and demand diagrams which reflect this, with the first representing an increasing-cost industry, the second representing a decreasing-cost industry, and the third representing a constant-cost industry. Assume that prior to the decrease in demand, the industry is in competitive long-run equilibrium. Include the long-run industry supply curve in each diagram and explain what is happening in each scenario. Specify whether each diagram represents external economies or external diseconomies. Visit to complete these exercises online and get instant feedback. Exercises that update with real-time data are marked with.

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5 Input Demand: The Labor and Land Markets 10 In 2011 the average yearly wage for a welder was $37,920, while the average yearly wage for a computer programmer was $76,010. What determines these wages? Why is the price for an acre of land in Toledo, Ohio, less than it is in San Francisco, California? It should not surprise you to learn that the same forces of supply and demand that determine the prices of the goods and services we consume can also be used to explain what happens in the markets for inputs like labor, land, and capital. These input markets are the subject of our next two chapters. In this chapter we set out a basic framework and discuss labor and land, while in Chapter 11 we tackle the more complicated topic of capital and investment. Input Markets: Basic Concepts As we begin to discuss the market for labor and land, four concepts will be important to understand: derived demand, complementary and substitutable inputs, diminishing returns, and marginal revenue product. Once we outline these four concepts, we will be in a position to look at supply and demand in input markets. Demand for Inputs: A Derived Demand When we looked at the Blue Velvet Car Wash in Chapter 9, we saw that the number and price of car washes depended on, among other things, how much drivers liked getting their cars washed (the demand curve). If we want to explain the price of ice cream, knowing that most people have a sweet tooth would be helpful. Now think about the demand for a welder. Why might someone have a demand for a welder? In input markets, the reason we demand something is not because it is itself useful, but because it can be used to produce something else that we want. We demand a welder because he or she is needed to make a car and that car has value. The central difference between the demand for final goods and services and the demand for an input is that input demand is a derived demand. The higher the demand for cars, the higher the demand for welders. LEARNING OBJECTIVES Define four basic concepts of input markets Discuss the conditions that affect supply and demand in labor markets Describe the relationship between supply and demand in land markets Identify factors that trigger shifts in factor demand curves CHAPTER OUTLINE Input Markets: Basic Concepts p. 247 Demand for Inputs: A Derived Demand Inputs: Complementary and Substitutable Diminishing Returns Marginal Revenue Product Labor Markets p. 250 A Firm Using Only One Variable Factor of Production: Labor A Firm Employing Two Variable Factors of Production in the Short and Long Run Many Labor Markets Land Markets p. 256 Rent and the Value of Output Produced on Land The Firm s Profit-Maximizing Condition in Input Markets p. 258 Input Demand Curves p. 259 Shifts in Factor Demand Curves Looking Ahead p. 260 derived demand The demand for resources (inputs) that is dependent on the demand for the outputs those resources can be used to produce. 247

6 248 PART II The Market System: Choices Made by Households and Firms Inputs are demanded by a firm if and only if households demand the good or service provided by that firm. productivity of an input The amount of output produced per unit of that input. Valuing an input requires us to look at the output that the input is used to produce. The productivity of an input is the amount of output produced per unit of that input. When a large amount of output is produced per unit of an input, the input is said to exhibit high productivity. When only a small amount of output is produced per unit of the input, the input is said to exhibit low productivity. In the press, we often read about conflicts between labor unions and manufacturing firms. But understanding that labor demand is a derived demand shows us the common ground between labor and management: An increase in the demand for a product potentially improves the position not only of owners of the firm producing that good, but also the position of workers providing labor input. Inputs: Complementary and Substitutable Inputs can be complementary or substitutable. Two inputs used together may enhance, or complement, each other. For example, a new machine is often useless without someone to run it. Machines can also be substituted for labor, or labor can be substituted for machines. All this means that a firm s input demands are tightly linked to one another. An increase or decrease in wages naturally causes the demand for labor to change, but it may also have an effect on the demand for capital or land. If we are to understand the demand for inputs, therefore, we must understand the connections among labor, capital, and land. marginal product of labor ( MP L ) The additional output produced by 1 additional unit of labor. Diminishing Returns Recall that the short run is the period during which some fixed factor of production limits a firm s capacity to expand. Under these conditions, the firm that decides to increase output will eventually encounter diminishing returns. Stated more formally, a fixed scale of plant means that the marginal product of variable inputs eventually declines. Recall also that marginal product of labor (MP L ) is the additional output produced if a firm hires 1 additional unit of labor. For example, if a firm pays for 400 hours of labor per week 10 workers working 40 hours each and asks one worker to stay an extra hour, the product of the 401st hour is the marginal product of labor for that firm. In Chapter 7, we talked at some length about declining marginal product at a sandwich shop. The first three columns of Table 10.1 reproduce some of the production data from that shop. You may remember that the shop has only one grill, at which only two or three people can work comfortably. In this example, the grill is the fixed factor of production in the short run. Labor is the variable factor. The first worker can produce 10 sandwiches per hour, and the second worker can produce 15 (column 3 of Table 10.1 ). The second worker can produce more because the TABLE 10.1 Marginal Revenue Product per Hour of Labor in Sandwich Production (One Grill) (1) Total Labor Units (Employees) (2) Total Product (Sandwiches per Hour) (3) Marginal Product of Labor ( MP L ) (Sandwiches per Hour) (4) Price ( P X ) (Value Added per Sandwich) a (5) Marginal Revenue Product ( MP L * P X ) (per Hour) $0.50 $ a The price is essentially profit per sandwich; see discussion in text.

7 CHAPTER 10 Input Demand: The Labor and Land Markets 249 ECONOMICS IN PRACTICE Do Managers Matter? Many of you will likely someday go on to work as managers in firms. As you study productivity and think about your future, you might wonder about how managers, like the one you will become, can affect the productivity of the people who work for them. A recent field experiment run by several economists (and former consultants) has some interesting things to say about this. Bloom, Eifert, Mahajan, McKenzie, and Roberts, economists from a range of places including Stanford University and the World Bank, recently published a paper describing a field experiment they ran on a group of large Indian textile firms. 1 Using a sample of several dozen firms, the researchers randomly sorted those firms into one of two groups. In the treatment group firm managers received five months of extensive management training from a large international consulting group. They were taught a range of operational practices that earlier research had suggested might be effective. A second, control group received a shorter period of diagnostic consulting, with no training. The results? Within the first year after treatment, productivity in the treated plants increased by 17%. One of the authors of this textbook teaches MBA students and was very pleased to read these results! THINKING PRACTICALLY 1. Many of the firms treated had multiple plants. After the researchers left, what do you think they did about training in their other plants? 1 Nicholas Bloom, Benn Eifert, Aprajit Mahajan, David McKenzie, and John Roberts, "Does Management Matter: Evidence from India. Quarterly Journal of Economics, 2013, first worker is busy answering the phone and taking care of customers, as well as making sandwiches. After the second worker, however, marginal product declines. The third worker adds only 10 sandwiches per hour because the grill gets crowded. The fourth worker can squeeze in quickly while the others are serving or wrapping, but he or she adds only five additional sandwiches each hour, and so on. In this case, the grill s capacity ultimately limits output. To see how the firm might make a rational choice about how many workers to hire, we need to know more about the value of the firm s product and the cost of labor. Marginal Revenue Product The marginal revenue product ( MRP ) of a variable input is the additional revenue a firm earns by employing 1 additional unit of that input, ceteris paribus. If labor is the variable factor, for example, hiring an additional unit will lead to added output (the marginal product of labor). The sale of that added output will yield revenue. Marginal revenue product is the revenue produced by selling the good or service that is produced by the marginal unit of labor. In a competitive firm, marginal revenue product is the value of a factor s marginal product. By using labor as our variable factor, we can state this proposition more formally by saying that if MP L is the marginal product of labor and P X is the price of output, then the marginal revenue product of labor is marginal revenue product (MRP) The additional revenue a firm earns by employing 1 additional unit of an input, ceteris paribus. MRP L = MP L * P X When calculating marginal revenue product, we need to be precise about what is being produced. A sandwich shop sells sandwiches, but it does not produce the bread, meat, cheese, mustard, and mayonnaise that go into the sandwiches. What the shop is producing is sandwich cooking and assembly services. The shop is adding value to the meat, bread, and other ingredients by preparing and putting them all together in ready-to-eat form. With this in mind, let us assume that each finished sandwich in our shop sells for $0.50 over and above the costs of its ingredients. Thus, the price of the service the shop is selling is $0.50 per sandwich, and the only variable cost of providing that service is that of the labor used to put the sandwiches together. Thus, if X is the product of our shop, P X = $0.50. Table 10.1, column 5, calculates the marginal revenue product of each worker if the shop charges $0.50 per sandwich over and above the costs of its ingredients. The first worker produces