Question

Suppose you are researching a firm that dominates the labor market in a small town.

a. What is the significance of studying this firm's resource pricing (for local people, for the firm itself, etc.)?

b. In the context of derived demand, why might it be important for workers at the firm that the firm's product has strong market performance?

c. Now assume the firm decides to increase employment by 1,000 workers. What does this decision reveal about the firm's marginal revenue product (MRP) and marginal resource cost (MRC)?

d. Next, assume the price for capital goods that the firm buys decreases. If capital goods and labor are substitute resources, what might this do to the firm's demand for workers?

e. If the firm's MRPL= $40, PL = $10, MRPC = $200; PC = $200, is it maximizing its profits? If not, state which resource(s) should be used in larger amounts and which resource(s) should be used in smaller amounts.

f. Finally, suppose there is mass migration into the small town where the firm operates. Due to the resulting increase in labor supply, what will happen to the firm's quantity of workers demanded? In this case, will the substitution effect and output effect move in the same direction or in opposite directions? Why?

Answer 1

Answer:

(a) The research may provide insight into the supply of labor in the town, which will help the firm to determine the marginal cost of labor (MCL or wage rate). From viewpoint of the workers, the research will help them to understand the firm's product price, demand for labor and marginal revenue product of labor (MRPL). Together, these information will help determine equilibrium in labor market.

(b) Labor demand is the firm's MRPL function,, which is the product of Marginal product of labor (MPL) and output price. The higher the output price, the higher the MRPL and the higher the demand for labor, driving up the wage rate. Strong market performance by the firm increases demand for the firm's product, increasing output price.

(c) Increase in labor demand will increase the MRC (Wage rate), and increase the MRPL. The equilibrium wage rate and quantity of labor will both increase.

(d) Lower price of capital goods, a substitute for labor, will increase the quantity demanded of capital and decrease the demand for labor.

(e) Profit is maximized when (MPL / PL) = (MPC / PC), where

MPL = MRPL / PL & MPC = MRPC / PC. Therefore, the condition states that

MRPL / PL² = MRPC / PC²

MRPL / PL² = $40 / $100 = 0.4

MRPC / PC² = $200 / $40,000 = 0.005

Therefore, [(MRPL / PL²) > (MRPC / PC²)] , signifing that less of labor and more of capital should be used until the two ratios equalize.