Factor Markets

Factor Markets

Factor Markets Micro Unit IV Chapters 25, 26, and 27 The Circular Flow of Resources, Households, and Government Big Ideas about Factor, or Resource Markets 1. The economic concepts are similar to those for product markets.

2. The demand for a factor of production is derived from the demand for the good or service produced from this resource. 3. A firm tries to hire additional units of a resource up to the point where the resources marginal revenue product (MRP) is equal to its marginal resource cost (MRC). 4. In hiring labor, a perfectly competitive firm will do best if it hires up to the point where MRP = the wage rate.Wages are the marginal resource cost of labor. Big Ideas about Factor, or Resource Markets 5. If you want a high wage:

A. Make something people will pay a lot for. B. Work for a highly productive firm. C. Be in relatively short supply. D. Invest in your human capital. 6. Real wages depend on productivity. 7. Productivity depends on real or physical capital, human capital, labor quality and technology. THE DEMAND FOR LABOR

Labor markets, like other markets in the economy, are governed by the forces of supply and demand. Demand depends on Productivity of the resource in helping to create a good or service The market value or price of the good or service it helps produce The Versatility of Supply and Demand (a) The Market for Apples

(b) The Market for Apple Pickers Price of Apples Supply P Wage of Apple Pickers

Supply W Demand Demand 0

Q Quantity of Apples 0 L Quantity of Apple Pickers

Copyright2003 Southwestern/Thomson Learning THE DEMAND FOR LABOR Most labor services, rather than being final goods ready to be enjoyed by consumers, are inputs into the production of other goods. The Production Function and the Marginal Product of Labor

The production function illustrates the relationship between the quantity of inputs used and the quantity of output of a good. How the Competitive Firm Decides How Much Labor to Hire Copyright2004 South-Western The Production Function

Quantity of Apples Production function 300 280 240 180

100 0 1 2 3 4

5 Quantity of Apple Pickers Copyright2003 Southwestern/Thomson Learning The Production Function and the Marginal Product of Labor The marginal product of labor is the increase in the amount of

output from an additional unit of labor. MP = Q/L MP = (Q2 Q1)/(L2 L1) The Production Function and the Marginal Product of Labor Diminishing Marginal Product of Labor As the number of workers increases, the marginal product of labor declines. As more and more workers are hired, each additional worker

contributes less to production than the prior one. The production function becomes flatter as the number of workers rises. This property is called diminishing marginal product. The Production Function and the Marginal Product of Labor Diminishing marginal product refers to the property whereby the marginal product of an input declines as the quantity of the input increases.

The Production Function Quantity of Apples Production function 300 280 240

180 100 0 1 2 3

4 5 Quantity of Apple Pickers Copyright2003 Southwestern/Thomson Learning The Value of the Marginal Product and the Demand for Labor

The value of the marginal product of labor (Marginal Revenue Product) is the marginal product of the input multiplied by the market price of the output in a perfectly competitive product market. MRP = MP P In an imperfectly competitive product market, it is the change in TR divided by change in resource quantity.

The Value of the Marginal Product and the Demand for Labor The value of the marginal product (also known as marginal revenue product) is measured in dollars. It is the marginal benefit of hiring one more worker. It diminishes as the number of workers rises because the market price of the good is constant. The Value of the Marginal Product and the Demand for Labor

The marginal-revenue-product curve is the labor demand curve for a competitive, profit-maximizing firm. Marginal Resource Cost Marginal Resource Cost (MRC) or Marginal Factor Cost (MFC) is the extra cost for one additional unit of resource (labor, capital, etc.) Profit Maximizing Quantity of Resources

The profit maximizing rule of life MC=MB To maximize profit, the competitive, profit- maximizing firm hires workers up to the point where the marginal revenue product (MB) of labor equals the marginal resource cost (MC) MRP = MRC FYIInput Demand and

Output Supply When MRP=MRC, the firm produces an output where MC=MR The Value of the Marginal Product of Labor MRP Market Wage (MRC)

MRP (demand curve for labor) 0 Profit-maximizing quantity Quantity of Apple Pickers Copyright2003 Southwestern/Thomson Learning

Profit Max VS Least Cost Combining Capital and Labor Profit Max MRPL/PL = MRPC/PC = 1 Least Cost MPL/PL = MPC/PC What Causes the Labor Demand Curve to Shift? Output Price

Technological Change Productivity of the resource Supply of Other factors STOP HERE! STOP HERE! THE SUPPLY OF LABOR The labor supply curve reflects how workers decisions about

the labor-leisure tradeoff respond to changes in opportunity cost. An upward-sloping labor supply curve means that an increase in the wages induces workers to increase the quantity of labor they supply. Equilibrium in a Labor Market Wage (MRC) Supply

0 Quantity of Labor Copyright2003 Southwestern/Thomson Learning What Causes the Labor Supply Curve to Shift? Changes in Tastes Changes in Alternative Opportunities Immigration

EQUILIBRIUM IN THE LABOR MARKET The wage adjusts to balance the supply and demand for labor. The wage equals the value of the marginal product of labor. Equilibrium in a Labor Market Wage (price of labor) Supply

Equilibrium wage, W Demand 0 Equilibrium employment, L Quantity of

Labor Copyright2003 Southwestern/Thomson Learning EQUILIBRIUM IN THE LABOR MARKET Labor supply and labor demand determine the equilibrium wage. Shifts in the supply or demand curve for labor cause the equilibrium wage to change. A Shift in Labor Supply

Wage (price of labor) 1. An increase in labor supply . . . Supply, S S W

W 2. . . . reduces the wage . . . Demand 0 L Quantity of Labor

3. . . . and raises employment. L Copyright2003 Southwestern/Thomson Learning Shifts in Labor Supply An increase in the supply of labor : Results in a surplus of labor. Puts downward pressure on wages. Makes it profitable for firms to hire more workers. Results in diminishing marginal product.

Lowers the value of the marginal product. Gives a new equilibrium. A Shift in Labor Demand Wage (price of labor) Supply W

1. An increase in labor demand . . . W 2. . . . increases the wage . . . D Demand, D 0

L Quantity of Labor 3. . . . and increases employment. L Copyright2003 Southwestern/Thomson Learning Shifts in Labor Demand An increase in the demand for labor :

Makes it profitable for firms to hire more workers. Puts upward pressure on wages. Raises the value of the marginal product. Gives a new equilibrium. Productivity and Wage Growth in the United States. Copyright2004 South-Western OTHER FACTORS OF PRODUCTION: LAND

AND CAPITAL Capital refers to the equipment and structures used to produce goods and services. The economys capital represents the accumulation of goods produced in the past that are being used in the present to produce new goods and services. OTHER FACTORS OF PRODUCTION: LAND AND CAPITAL

Prices of Land and Capital The purchase price is what a person pays to own a factor of production indefinitely. The rental price is what a person pays to use a factor of production for a limited period of time. Equilibrium in the Markets for Land and Capital The rental price of land and the rental price of capital are determined by supply and demand.

The firm increases the quantity hired until the value of the factors marginal product equals the factors price. The Markets for Land and Capital (a) The Market for Land Rental Price of Land

(b) The Market for Capital Rental Price of Capital Supply P Supply

P Demand Demand 0 Q Quantity of

Land 0 Q Quantity of Capital Copyright2003 Southwestern/Thomson Learning

Equilibrium in the Markets for Land and Capital Each factors rental price must equal the value of its marginal product. They each earn the value of their marginal contribution to the production process. Linkages among the Factors of Production Factors of production are used together. The marginal product of any one factor depends on the

quantities of all factors that are available. Linkages among the Factors of Production A change in the supply of one factor alters the earnings of all the factors. Linkages among the Factors of Production A change in earnings of any factor can be found by analyzing the impact of the event on the value of the marginal product

of that factor. Competition vs. Monopsony The Effects of Resource Market Structure on Wages and Employment The Supply of and Demand for Labor in a Competitive Labor Market Unit 4 : Microeconomics National Council on Economic Education

The Supply of and the Demand for Labor in a Competitive Market Why is the market labor demand curve downward sloping? Why is the market labor supply curve upward sloping? Why is the labor supply to a firm horizontal? The firm can hire all the labor

it wants at the market wage; it does not have to raise the wage to attract more labor. Monopsony A monopsony is the sole buyer of labor and must offer a higher wage to attract more workers. The basic hiring rule applies to any firm, regardless of whether it

buys labor in a perfectly competitive or a monopsonistic labor market: Hire where MRP = MRC. Since the firm pays the market wage to all workers in a perfectly competitive labor market, that firm can also use the hiring rule of MRP = wage. A monopsony must stick with the MRP = MRC rule because the wage is less than the MRC for a monopsonist. The firms marginal resource cost from adding another unit of labor is greater than the wage paid to that labor unit.

A Monopsonistic Labor Market The firm determines its profit-maximizing quantity of labor where MRP = MRC. Its optimal wage comes from the labor supply curve at that quantity of labor. Unit 4 : Microeconomics National Council on Economic Education

Economic Rent and Return for Other Factors of Production The Determination of Economic Rent Unit 4 : Microeconomics National Council on Economic Education Why is the supply curve for land vertical?

What determines the amount of rent if the supply of land is perfectly inelastic (vertical)? What effect will an increase in the demand for land have on the amount of land available? The Unique Aspect of Economic Rent Determination of rent, like wages, occurs within context of supply & demand factors and institutional circumstances

Economic rent: The price paid for the use of land and other natural resources, the supply of which is fixed (perfectly inelastic) The Unique Aspect of Economic Rent Rent usually accorded special treatment because of inelasticity of supply of land and other natural resources The Unique Aspect of Economic Rent This aspect of natural resources has attracted attention of

economists since days of the Physiocrats, has led to controversial issues in economic theory and public policy Physiocrats believed wealth of nations came solely from agriculture and land development, agricultural goods should be highly priced Other examples: Henry Georges single-tax movement, urbanrenewal programs, obscene profits of landlords and oil industry The Unique Aspect of Economic Rent

MAJOR THEORITCAL POINT TO UNDERSTAND: when the supply of a factor is perfectly inelastic, price paid to that factor cannot provide incentive to produce more Economists refer to such a factor as a surplus or as economic rent. Amount of economic rent received by owners of land and other factors fixed in supply is determined by productivity of each factor

Unique Aspect of Economic Rent Henry George and others argued that, since a tax on land or any other factor with fixed supply doesnt affect amount of that factor available to society, all economic rent could be taxed away with no cost to society Unique Aspect of Economic Rent Critics of this theory point out that rent is a cost to individuals

because the supply of land for any one use is not perfectly inelastic. Users of land, just as with other factors of production, must bid the land away from alternative uses Therefore, rent is merely a cost of production Lets talk about it Scenario 1: Agricultural land near a large city was selling for $3,000 an acre last year. Now a subdivision is being developed on this

land, and it is selling for $50,000 an acre. Why did the price rise so dramatically? Do you think it is fair that the owners of this land reaped such a large and sudden return for no effort on their part? Lets talk about it Scenario 2: A professional basketball player earns $850,000 a year. The next-best alternative for this player might be as a high school coach for $40,000 a year. Should $810,000 of his current salary

be considered wages or rent (an economic surplus)? If a large part of the wages and salaries of many highly paid athletes, entertainers and others is considered as economic-surplus payments (not necessary to attract people into a particular line of work), does this suggest that such incomes should be taxed heavily? Interest Rates in Market Economies The interest rate is the price paid for the use of money (loanable funds).

Like other prices, the price of money (an interest rate) is determined by the supply of and demand for loanable funds. A real interest rate is the nominal rate of interest minus inflation. Real interest rates influence investment decisions.

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