CHAPTER 15

Factor Markets and Vertical Integration

MULTIPLE CHOICE Choose the one alternative that best completes the statement or answers the question. 1) If a firm is a price taker in both the labor market and the output market, it will A) earn zero economic profit in the short run. B) hire labor until the marginal product of labor equals zero. C) hire labor until the marginal revenue product equals the output price. D) hire labor until the marginal revenue product equals the wage rate. Answer: D Diff: 1 Topic: Competitive Factor Markets 2) Suppose the marginal product of labor equals 1/L. If the firm can sell its output for $10 per unit, and the wage is $1 per unit, how many units of labor will the firm hire? A) 0 B) 1 C) 10 D) 100 Answer: C Diff: 1 Topic: Competitive Factor Markets 3) Suppose the marginal product of labor equals 1/L. If the wage is $1 per unit of labor, what is the short-run effect on the firm's labor demand if the price of output were to double? A) The firm will demand half as much labor. B) The firm will demand twice as much labor. C) The firm will demand the same quantity of labor. D) There is not enough information to determine. Answer: B Diff: 2 Topic: Competitive Factor Markets 4) In the short run, the competitive firm will hire more labor if A) the wage rate increases. B) the price the firm receives for the output increases. C) the price the firm receives for the output decreases. D) a specific tax is imposed on the output. Answer: B Diff: 1

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Chapter 15/Factor Markets and Vertical Integration

Topic: Competitive Factor Markets Figure 15.1

5) Figure 15.1 shows a competitive firm's demand for labor assuming that the firm's output sells for $1 per unit. If the wage is $5 per hour, the firm will hire A) 10 units of labor per hour. B) 5 units of labor per hour. C) 2.5 units of labor per hour. D) 0 units of labor per hour. Answer: B Diff: 0 Topic: Competitive Factor Markets 6) Figure 15.1 shows a competitive firm's demand for labor assuming that the firm's output sells for $1 per unit. If the wage is $5 per hour, a ten cent specific tax on the good sold by the firm will cause the firm to A) demand less labor. B) demand more labor. C) offer its workers only $4.90 per hour. D) hire 0 units of labor per hour. Answer: A Diff: 1 Topic: Competitive Factor Markets 7) If a competitive firm faces a competitive labor market, it will hire labor until A) w = p. B) w = MPL. C) w = MPL * p. D) MPL =0. Answer: C Diff: 0
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Chapter 15/Factor Markets and Vertical Integration

Topic: Competitive Factor Markets 8) If a firm buys its labor in a competitive market, then a short-run increase in the price of the firm's output will cause the firm to A) offer a higher wage. B) hire fewer workers. C) hire more workers. D) offer a lower wage. Answer: C Diff: 1 Topic: Competitive Factor Markets 9) If wages for a certain type of labor were higher in one market than in another, then A) the differential would exist into the long run. B) labor would move from the high wage market to the low wage market until wages were equal. C) labor would move from the low wage market to the high wage market until wages were equal. D) firms would not be acting as profit maximizers. Answer: C Diff: 1 Topic: Competitive Factor Markets 10) In the short run, a competitive firm has a marginal product of labor, MPL = 5L-.5. The output price is $10 per unit and the wage is $7 per hour. The short-run labor demand curve for the firm is A) 5L-.5. B) 15L-.5. C) 35L-.5. D) 50L-.5. Answer: D Diff: 1 Topic: Competitive Factor Markets 11) A firm's demand for labor is downward sloping because of A) diminishing marginal productivity of labor. B) diminishing marginal utility. C) price pressure. D) worker's increased willingness to work at a higher wages. Answer: A Diff: 1 Topic: Competitive Factor Markets

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Chapter 15/Factor Markets and Vertical Integration

12) In the short run, which one of the following causes a competitive firm to hire more labor? A) an increase in wage rate B) an increase in the output price C) a specific tax imposed on the firm's output D) a decrease in the output price Answer: B Diff: 1 Topic: Competitive Factor Markets 13) The long-run labor demand curve is relatively flatter than the short-run labor demand curve because, in the short run, A) the wage rate is fixed. B) the firm cannot vary the amount of capital used. C) the firm is a price taker. D) All of the above. Answer: B Diff: 1 Topic: Competitive Factor Markets 14) A monopoly's demand curve for labor A) is below that of a competitive market. B) is the same as that of a competitive market. C) is above that of a competitive market. D) equals p * MPL. Answer: A Diff: 1 Topic: Effect of Monopolies on Factor Markets 15) For a monopoly, the value of the next worker equals A) MR * MPL. B) p * MPL. C) MPL. D) w/MPL. Answer: A Diff: 1 Topic: Effect of Monopolies on Factor Markets

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Chapter 15/Factor Markets and Vertical Integration

16) The demand for a monopoly's output is p = 100 - Q. The firm's production function is Q = 2L. Which of the following is the firm's demand for labor? A) w = 200 - 8L B) w = 200 - 4L C) w = 100 - L D) w = 2L Answer: A Diff: 1 Topic: Effect of Monopolies on Factor Markets 17) If the labor market is competitive, a monopoly output market will result in A) a lower wage than that of a competitive output market. B) a higher wage than that of a competitive output market. C) less labor hired than in a competitive output market. D) more labor hired than in a competitive output market. Answer: C Diff: 1 Topic: Effect of Monopolies on Factor Markets 18) Monopolization of either the labor market or the output market results in A) higher wages than when both are competitive. B) a higher output price than when both are competitive. C) a higher level of output than when both are competitive. D) All of the above. Answer: B Diff: 2 Topic: Effect of Monopolies on Factor Markets 19) Monopolization of both the labor market and the output market results in A) higher wages than when both are competitive. B) a higher output price than when both are competitive. C) a lower level of output than when both are competitive. D) All of the above. Answer: D Diff: 2 Topic: Effect of Monopolies on Factor Markets

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Chapter 15/Factor Markets and Vertical Integration

20) In a market where one unit of labor produces one unit of output, consumers prefer A) a competitive labor market and a monopoly output market. B) a competitive output market and a monopoly labor market. C) a monopoly output market and a monopoly labor market. D) None of the abovethey are indifferent between A and B. Answer: D Diff: 1 Topic: Effects of Monopolies on Factor Markets 21) Firm A is a monopoly. The demand for its output is p = 90 - Q. Production is such that Q = L. Firm A hires only unionized labor. The marginal cost to the union is $10 per unit of labor. The union will sell A) 20 units of labor at a wage of $10. B) 20 units of labor at a wage of $40. C) 20 units of labor at a wage of $50. D) 20 units of labor at a wage of $70. Answer: C Diff: 2 Topic: Effect of Monopolies on Factor Markets 22) Firm A is a monopoly. The demand for its output is p = 90 - Q. Production is such that Q = L. Firm A hires labor in a competitive market where the wage is $10. Firm A will hire A) 10 units of labor. B) 20 units of labor. C) 30 units of labor. D) 40 units of labor. Answer: D Diff: 1 Topic: Effect of Monopolies on Factor Markets 23) Monopolization of the labor market restricts output because A) fewer workers offer their services. B) the higher wage raises the firm's marginal cost. C) monopolized workers are less productive. D) a monopolized labor market means there is also a monopolized output market. Answer: B Diff: 1 Topic: Effect of Monopolies on Factor Markets

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Chapter 15/Factor Markets and Vertical Integration

24) For a monopsonist, the labor supply curve is upward sloping because A) the monopsonist must compete with other industries for that labor. B) the monopsonist requires that the laborers are highly skilled. C) the monopsonist is the only buyer in that labor market. D) the monopsonist restricts the supply of labor. Answer: C Diff: 1 Topic: Monopsony 25) Because the labor supply curve for a monopsonist is upward sloping, the monopsonist A) hires zero units of labor. B) chooses the perfectly competitive quantity of labor. C) must increase the wage to attract more units of labor. D) must take the wage as given by the market. Answer: C Diff: 1 Topic: Monopsony 26) Under monopsony, the wage rate A) equals the marginal product of labor. B) equals the marginal revenue product of labor. C) is less than the marginal revenue product of labor. D) is greater than it would be under perfect competition. Answer: C Diff: 1 Topic: Monopsony 27) If a firm buys some labor in a competitive market and some labor as a monopsonist, the firm is most likely to A) pay the same wage to both types of labor. B) pay a lower wage to the labor purchased in the competitive market. C) pay a higher wage to the labor purchased in the competitive market. D) not exercise any of its monopsony power. Answer: C Diff: 1 Topic: Monopsony

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Chapter 15/Factor Markets and Vertical Integration

28) For the monopsonist, marginal expenditure is greater than the wage rate because the monopsonist A) pays a wage higher than that paid in a competitive market. B) chooses the perfectly competitive quantity of labor. C) must increase the wage to all units of labor to attract more units of labor. D) must take the wage as given by the market. Answer: C Diff: 1 Topic: Monopsony 29) If a firm takes the wage as given, then the supply curve of labor to that firm is A) horizontal. B) vertical. C) upward sloping. D) downward sloping. Answer: A Diff: 1 Topic: Monopsony 30) If a firm takes the wage as given, then the firm's marginal expenditure on labor curve is A) above the labor supply curve. B) below the labor supply curve. C) the same as the labor supply curve. D) upward sloping. Answer: C Diff: 1 Topic: Monopsony 31) If the supply of labor to a monopsonist is everywhere unit elastic, then the wage will equal A) the marginal expenditure. B) one-half of the marginal expenditure. C) the marginal revenue product of labor. D) one. Answer: B Diff: 2 Topic: Monopsony

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Chapter 15/Factor Markets and Vertical Integration

32) If the supply of labor to a monopsonist is everywhere unit elastic, and the marginal expenditure equals $1, then the wage will equal A) $0.50. B) $0.75. C) $1.00. D) $2.00. Answer: A Diff: 2 Topic: Monopsony 33) Which of the following would be most able to act like a monopsonist? A) a hospital in a small isolated town B) a hospital in a very big city C) a law firm in Washington, D.C. D) a computer software firm in Silicon Valley Answer: A Diff: 1 Topic: Monopsony 34) Universities are able to act as monopsonists in the market for professors because A) a university usually does not consider hiring faculty members from another institution. B) faculty members usually have to move to a different city when changing universities. C) students like all of their professors. D) senior faculty members are willing to move to a new university at any cost. Answer: B Diff: 1 Topic: Monopsony 35) Relative to a competitive labor market, monopsony A) is also efficient. B) creates a deadweight loss because it pays an excessive wage. C) creates a deadweight loss because the wage is below the marginal revenue product of labor. D) creates a deadweight loss because the wage is above the marginal revenue product of labor. Answer: C Diff: 2 Topic: Monopsony 36) The gap between the value a monopsony places on the last worker hired and the wage paid will increase when A) the supply curve becomes more elastic at the optimum. B) the supply curve becomes less elastic at the optimum. C) the supply curve becomes horizontal. D) the value of the last unit of labor hired is greater than the cost.

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Chapter 15/Factor Markets and Vertical Integration

Answer: B Diff: 1 Topic: Monopsony 37) Which one of the following is an example of forward integration? A) A radio producer acquires an automobile producer. B) An automobile producer acquires a tire producer. C) A dairy farmer purchases a cow. D) A cereal producer acquires a candy producer. Answer: A Diff: 0 Topic: Vertical Integration 38) Which one of the following is an example of backward integration? A) A radio producer acquires an automobile producer. B) An automobile producer acquires a tire producer. C) A dairy farmer purchases a cow. D) A cereal producer acquires a candy producer. Answer: B Diff: 0 Topic: Vertical Integration 39) Many small companies do not handle their own payroll records. They hire a company that specializes in payroll accounting. This is an example of A) forward integration. B) vertical restraint. C) outsourcing. D) intervention. Answer: C Diff: 0 Topic: Vertical Integration 40) A firm may decide to vertically integrate backward if A) the transaction costs of dealing with the supplier are very low. B) the transaction costs of dealing with the supplier are very high. C) the cost of managing the new division would be very high. D) there are many suppliers from which to choose. Answer: B Diff: 1 Topic: Vertical Integration

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Chapter 15/Factor Markets and Vertical Integration

41) Which of the following would lead a firm to vertically integrate forward? A) The firm is unable to monitor the behavior of the companies that retail its product. B) The firm is very often taken advantage of by a monopoly supplier. C) The firm has grown so large that it is inefficiently managed. D) The firm is able to control the companies that retail its product. Answer: A Diff: 1 Topic: Vertical Integration 42) Which of the following would lead a firm to vertically integrate backward? A) The firm is unable to monitor the behavior of the companies that retail its product. B) The firm cannot rely on suppliers to deliver the necessary inputs on a timely basis. C) The firm has grown so large that it is inefficiently managed. D) The firm is able to control the companies from which it purchases inputs. Answer: B Diff: 1 Topic: Vertical Integration 43) Which of the following would lead a firm to vertically integrate forward? A) The company produces its product in a jurisdiction with high taxes, but final consumers are located in a jurisdiction with low taxes. B) The firm is very often taken advantage of by a monopoly supplier. C) The firm has grown so large that it is inefficiently managed. D) The firm is able to control the companies that retail its product. Answer: A Diff: 1 Topic: Vertical Integration 44) A firm will continue to vertically integrate backward until A) all costs of producing the next input equal all costs of dealing with suppliers of that input. B) the firm has full internal control of all inputs. C) the government stops the firm. D) profit equals zero. Answer: A Diff: 1 Topic: Vertical Integration 45) If an upstream monopoly and a downstream monopoly vertically integrate into a profit-maximizing monopoly, then the total amount of deadweight loss in the industry A) will increase. B) will decrease. C) will remain unchanged. D) cannot be determined.

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Chapter 15/Factor Markets and Vertical Integration

Answer: B Diff: 1 Topic: Vertical Integration TRUE/FALSE/EXPLAIN 1) If the price of a competitive firm's output increases, the firm responds in the short run by demanding more labor. Answer: True. The firm wishes to sell more output and can do so only by hiring more labor. Diff: 0 Topic: Competitive Factor Markets 2) If the competitive firm maximizes profit by selecting labor rather than output, it will earn greater economic profit. Answer: False. Whether the firm maximizes profit by selecting output or labor, the resulting profit is the same. Since MC = w/MP, setting MC = p is the same as setting w = p * MP. Diff: 1 Topic: Competitive Factor Markets 3) If a firm has market power in the output market but buys labor in a competitive market, it will hire the same quantity of labor that a competitive firm will. Answer: False. Since the firm has market power, it must lower price if it wishes to sell more. It will wish to sell fewer units than a competitive firm, and, therefore, hire less labor than a competitive firm does. Diff: 1 Topic: Effect of Monopolies on Factor Markets 4) If a monopolist in the output market purchases its monopoly supplier of labor, consumers benefit. Answer: True. The firm now pays a competitive price for its labor instead of the monopoly price. This lower wage shifts the firm's marginal cost curve downward. The result is a lower price charged to consumers. Diff: 1 Topic: Effect of Monopolies on Factor Markets 5) Because of market power, wages are higher under monopsony than under competitive conditions. Answer: False. Because of market power, the monopsonist pays a lower wage than is paid in a competitive market. Diff: 1 Topic: Monopsony

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Chapter 15/Factor Markets and Vertical Integration

PROBLEMS 1) How does a competitive firm's demand for labor react to a specific tax on each unit of output it sells? Answer: The price the firm receives for each unit of output is now p' - t instead of p where p' is new price paid by consumers. Assuming that p' does not exceed p by the full amount of the tax, the demand for labor shifts downward and intersects the wage line at a lower quantity of labor. Diff: 1 Topic: Competitive Factor Markets 2) XYZ Co. operates in a competitive market. Its production function is q = L K . The exponents, and , are both less than 1. The firm's capital is fixed, and it takes the wage and price as given. Derive the firm's short-run demand for labor as a function of K, w, and p. How does the firm react to an increase in the wage rate? Answer: MPL= L -1K . The firm sets w = p(L -1K ). Rearranging to solve for L yields L = (w/pK )1/( -1). Since < 1, L increases when p and K increase, and decreases when w increases. Diff: 2 Topic: Competitive Factor Markets 3) XYZ Co. operates in a competitive market. Its marginal product of labor is 1/L, and it takes the wage and price as given. Derive the firm's short-run demand for labor as a function of w and p. How much labor will the firm hire if w = 2 and p = 10? Answer: Setting w = p * MPL yields w = p/L or L = p/w. At w = 2 and p = 10, the firm hires 5 units of labor. Diff: 1 Topic: Competitive Factor Markets 4) Suppose there are profit maximizing, competitive buyers and sellers of labor in an industry, and the amount of capital is fixed for each firm. Explain under what condition the output price will equal the wage rate. Answer: The profit-maximizing buyer of labor sets the output price equal to the marginal cost of producing an additional unit of output. The marginal cost of output when capital is fixed equals the wage rate divided by the marginal product of labor. If the marginal product of labor equals one, then the output price will equal the wage rate. Diff: 1 Topic: Competitive Factor Markets 5) Why is the short-run demand curve for labor downward sloping? Answer: The firm will pay another unit of labor as much as the amount that the firm benefits from having another unit of labor. This amount is equal to MR * MP. As more labor is hired,

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Chapter 15/Factor Markets and Vertical Integration

both MR and MP decline. Thus, since the value of the marginal unit of labor declines as more labor is hired, the demand curve is downward sloping. Diff: 1 Topic: Competitive Factor Markets 6) Assume that the market demand for a good is p = 100 - Q. Assume that the marginal product of labor is 1 and the firm can get all the labor it needs at a wage equal to 5. Compare the quantity of labor hired if the output market is competitive with the quantity hired if the output market is a monopoly. Answer: If the output market is competitive, then price will equal marginal cost, which is 5. Output is 95, requiring 95 units of labor. If a monopoly controls the output market, the firm sets w = 5 = (100 - 2L), or L = 47.5. Thus, the monopoly hires half as much labor and produces half as much output as a competitive market would. Diff: 1 Topic: Effect of Monopolies on Factor Markets 7) Suppose the labor market is competitive, the supply curve of labor is upward sloping, and the amount of capital is fixed. If the output market changes from a competitive market to a monopoly, what is the effect on its demand for labor? Explain. Answer: A monopoly will decrease output from the competitive level and thus hire fewer workers. This reduction in the demand curve for labor will result in lower wages. Diff: 1 Topic: Effect of Monopolies on Factor Markets 8) Explain why consumers benefit from a merger between a monopoly producer and its monopoly supplier of labor. Answer: A monopoly supplier of labor sells labor at an inflated wage. If the output monopoly purchases the monopoly source of labor, it will internally price labor at the competitive wage. Diff: 1 Topic: Effect of Monopolies on Factor Markets 9) Suppose n identical Cournot firms purchase labor in a competitive labor market. How is the market demand for labor affected by the number of firms in the market? Answer: Each firm chooses a quantity of labor demanded such that w = p(1 + 1/n)MPL. As n increases, the demand for labor curve from the individual firm shifts leftward. With the increase in the number of firms, however, market demand shifts rightward. Diff: 2 Topic: Effect of Monopolies on Factor Markets 10) Why does a monopsonist's marginal expenditure curve lie above the labor supply curve?

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Chapter 15/Factor Markets and Vertical Integration

Answer: To hire additional labor, the monopsonist must increase the wage paid to all units of labor. Thus, the marginal expenditure of the next unit of labor is the higher wage plus the wage increase paid to all previously hired labor. Diff: 2 Topic: Monopsony 11) Suppose a monopoly producer is also a monopsonist in the labor market. Demand for the output is p = 100 - Q. The production function is Q = L, and the labor supply curve is w = 10 + L. How much labor does the firm hire? What wage is paid? Answer: The firm's marginal revenue product of labor is MRP = 100 - 2L. Marginal expenditure is 10 + 2L. Setting them equal yields 10 + 2L = 100 - 2L or L = 90/4 = 22.5 units of labor, for which the firm will pay a wage of (10 + L) = 32.5. Diff: 1 Topic: Monopsony 12) Suppose that a mining company employs 80% of the available laborers in a town. Explain what will happen to the number of laborers hired and the wage rate paid by the mine if a minimum wage is set at the competitive level. Answer: The mine was operating as a monopsony. The competitive minimum wage will result in the mine hiring a competitive level of laborers at the higher competitive wage. Diff: 1 Topic: Monopsony 13) Firm A currently purchases an input from a competitive market. It can always find a firm that has the needed supplies. Firm B deals with a monopoly supplier. The supplier raises price at times of peak demand. Are there any reasons why firm A might be more likely to vertically integrate backwards than firm B? Answer: Other things equal, firm B is more likely to vertically integrate backwards. Some factors which may make firm A more likely to vertically integrate backwards would be if firm A faces higher transaction costs in finding a supplier or if firm A purchases inputs and sells output in different jurisdictions that have different tax rules. Diff: 1 Topic: Vertical Integration 14) Explain why Alcoa, when it was virtually the only aluminum producer, would purchase all the bauxite, an essential input in aluminum production, in a wide geographic area. Answer: By integrating backward, Alcoa gained control of an essential input. This allowed Alcoa to restrict aluminum production by potential competitors, which increased Alcoa's market power. Diff: 1 Topic: Vertical Integration

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