1 Economics of Public Policy – Labor Market Equilibrium – Economics of Health Care – Public Goods
Feb 02, 2016
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Economics of Public Policy
– Labor Market Equilibrium
– Economics of Health Care
– Public Goods
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Labor Market Equilibrium
Understand the relationship between wages and the marginal productivity of workers
Analyze how wages and employment are determined in competitive labor markets
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The Labor Market
• Marginal product of labor (MP)– The additional output a firm gets by employing one
additional unit of labor• Value of marginal product of labor (VMP)
– The dollar value of the additional output a firm gets by employing one additional unit of labor
• In a competitive market,
wage = VMP
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Adiron Woodworking Company
• Makes cutting boards from free scrap wood– Price of a cutting board is $20
• Going wage is $350 per week
# of Workers Output
0 0
1 30
2 55
3 76
4 94
5 108
MP
30
25
21
18
14
VMP
$600
500
420
360
280
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Adiron Woodworking Company
• The company will hire workers until the value of the marginal product of the last worker is equal to the wage– Cost-Benefit Principle– Workers earn $350 per week
• Adiron will hire four workers– The fifth worker costs
more ($350) than the benefits he delivers ($280)
# of Workers VMP
1 $600
2 500
3 420
4 360
5 280
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Demand for Labor
Wag
e ($
/hou
r)W
age
($/h
our)
Firm 1
Firm 2
Work hours/day
100
12
50
12
D1 = VMP1
D2 = VMP2
150
6
6
100
Total Employment
Wag
e ($
/hou
r)
Market
150
12D = VMP1 +
VMP2
250
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Individual Labor Supply
• Individuals trade-off income and leisure– More work hours means more income AND less
leisure• Suppose the wage increases
– Substitution effect: work more• Leisure is more expensive
– Income effect: work less• Purchasing power increases for a given work
schedule– A higher wage may increase or decrease the quantity
of labor supplied by the individual
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Labor Supply of Programmers
• Labor supply for a single profession has a positive slope– Higher wages attract
workers from other careers
• An increase in wages from W1 to W2 increases quantity of labor supplied from L1 to L2
– Movement along the labor supply curve
Employment of programmers(work-hours/year)
L1
W1
L2
W2
S
Wag
e ($
/hou
r)
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Equilibrium in the Labor Market of Programmers
• Demand for programmers increases from D1 to D2
– Initial impact is a shortage of programmers at W1
– In the short-run, wages are bid up to W3
• In the long run– Movement up the supply
curve and down the demand curve
– Quantity of labor supplied increases from L1 to L2
– Wages settle at W2
Employment of programmers(work-hours/year)
S
L1
W1
D1
L2
W2
W3
D2
10
Health Care Delivery
• Health care spending has grown faster than income– Up from 4% of national income in 1940 to
14% in 2005– Part of the increase is due to improved quality
of tests, procedures, drugs, etc.– Part is due to the third-party payment system
• Growth in use of insurance for payments– Employer-provided and government-provided
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Health Care Delivery
• Cost-benefit test assures efficient allocation of health care– Perform a service only if the benefit exceeds the cost
• Costs are easy to measure• Benefits are complicated
– Usual measure is willingness to pay marginal cost• Some patients are unable to pay for basic services
– Society assumes some responsibility via government-provided insurance
– Confused by third-party payment system
The Demand for Hospital Care
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• Price of hospital room is$300 per day– If David pays, MC to
him is $300– David equates marginal
cost and marginal benefit and stays one day
– If insurance pays, MC to David is zero• He stays 3 days
Length of hospital stay (days)
D
3
300
Pric
e ($
/day
)
1
Full Insurance Coverage Creates Waste
• If David pays, stay is 1 day• If insurance pays, stay is 3 days
– Extra benefit of 2nd and 3rd day to David is $300
– Extra cost is 2 days times $300 per day = $600
– $300 surplus lost
Alternative Coverage Scheme
• Insurance company pays David $700– Insurance company
saves $200 compared to a 3-day stay
• David stays 1 day– Pays hospital $300– David keeps $400
• The $300 benefit he would get from staying 3 days PLUS $100 pure surplus
• Total surplus increases $300
Length of hospital stay (days)
D
3
300
Pric
e ($
/day
)
1
Policy Implications
• Research shows that when individuals pay for their health care, they consume less
• An more efficient system can be designed– Adopt a system of high deductible health
insurance– Use stipend payments for the poor
• An efficient policy will increase the size of the health care pie
Public Goods
• Government is the only organization with the power to compel actions– Taxes– Military service– Imprison people
• All other institutions – family, business, charitable organizations, etc. – rely on voluntary transactions
• Government decisions can be analyzed using economic principles
Public Goods
• Public good is a good that is both nonrival and nonexcludable– A nonrival good is one whose consumption by one
person does not diminish its availability to others• National defense ; Economics lectures
– A non-excludable good is one that is difficult or costly to exclude non-payers from consuming• Over-the-air broadcasts; Fireworks displays
• A pure public good is, to a high degree, both nonrival and nonexcludable.
Public Goods and Government
• A collective good is a good or service that, to at least some degree, is nonrival but excludable– Sometimes provided by government
• A good is a pure private good if – Non-payers can easily be excluded and – Each unit consumed by one person means one less
unit available for others• A pure commons good is a rival good that is
nonexcludable Fish in open water
Types of Goods
Paying for Public Goods
• Not everyone benefits equally from a public good or service.
• Example– Prentice and Wilson have adjacent properties
• Fighting zebra mussel infestation• New device to control mussels is $1,000 to serve
both properties• Wilson's income is higher and value device at $800• Prentice values device at $400
Paying for Public Goods
• Equal sharing of costs with a head tax• A head tax is a tax that collects the same amount
from every taxpayer• Result: no new device
– $500 is more than Prentice's reservation price• Prentice vetoes device
• A regressive tax has a tax rate that varies inversely with income• A proportional income tax requires all taxpayers to pay the same
proportion of their incomes in taxes• A progressive tax takes a larger share of higher incomes as tax