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
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

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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.

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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.

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Learning Objectives



(continued)

Describe the relation between saving, investment, and the
interest rate.
Overview why interest rates differ across specific credit
markets.

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Investigate a worker's decision concerning how many work hours to
supply.

17.1 THE INCOME―LEISURE CHOICE
OF THE WORKER

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The Income-Leisure Choice of the
Worker
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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

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Figure 17.1 - Income-Leisure Choice of
the Worker

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Is the Income-Leisure Model Plausible?




Common objection:
 workers do 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.

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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

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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.

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Figure 17.2 - Worker’s Response to a
Change in the Wage Rate

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Is a Backward-Bending Labor Supply
Curve Possible?


If the normal income effect of a higher wage rate exceeds
the substitution effect => fewer hours worked at a higher
wage



That is, a supply curve of work hours can be backwardbending beyond some wage rate



Reason: Leisure is a normal good so income effect and
substitution effect work in opposing directions

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Figure 17.3 – An Individual Worker’s
Weekly Supply of Work

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The Market Supply Curve
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

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A market supply curve of work hours is obtained by
horizontally summing the individual supply curves of all
workers competing in a given labor market.
Like the individual supply curve, the market supply curve
can slope upward, bend backward, or show a combination
of the two.
The elasticity of the supply curve of labor to a specific job
or industry depends upon how the number of workers varies
with wage rates in those occupations.

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Analyze the general level of wage rates and why wages differ among
jobs.

17.3 THE CENTRAL LEVEL OF WAGE
RATES

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The General Level of Wage Rates


The aggregate demand curve for labor reflects the marginal productivity of labor
to the economy as a whole.



Real wages are higher in developed countries than in less developed countries
because the (marginal) productivity of labor is greater



Why is the (marginal) productivity of labor greater?
 Because of the factors determining the position of the demand curve:
 capital
 technology
 skills
 climate
 efficiency in allocating resources
 political stability
 attitudes toward work

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Figure 17.4 – Determination of the
General Wage Level

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Table 17.1

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Explain why wage rates differ among jobs.

17.4 WHY WAGES DIFFER

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Why Wages Differ


Assumptions behind the equalization of wage rates across
firms or industries:
 workers are identical
 workers evaluate the desirability of jobs only in terms of
money wage rates



Without these assumptions, wage rates can differ
 among jobs
 among people employed in the same line of work

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Figure 17.5 – Equilibrium Wage
Differences

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Reasons Why Wages Differ


Compensating wage differentials – differences in wages
paid 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 augment their earning capacity



Differences in workers’ abilities

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Define what economists mean by the term rent.

17.5 ECONOMIC RENT

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Economic Rent


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Economic rent – that portion of the payment to an

input supplier in excess of the minimum amount
necessary to retain the input in its present use
Accrues to suppliers in input markets
Analogous to producer surplus in output markets
Whenever the supply curve of an input slopes upward,
part of the payment to inputs will be rent.
The more inelastic the supply curve, the larger is the
rent as a fraction of the total payment to an input.

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Figure 17.6 - Economic Rent with a
Vertical Supply Curve

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