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Factor Markets

Factor Markets. aka Resource Markets … aka Input Markets. Question: Factors of Production. If you decide to open a pizza shop in Millersville, what factors of production will you need? Labor Land Capital (Physical & Human)

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Factor Markets

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  1. Factor Markets aka Resource Markets… aka Input Markets

  2. Question:Factors of Production • If you decide to open a pizza shop in Millersville, what factors of production will you need? • Labor • Land • Capital (Physical & Human) • If demand increases for your pizza, how will that affect your demand for any of these factors??

  3. The Factor Market • The following terms describe the PRICE paid by firms to hire each type of factor/resource: • Labor - WAGES • Land - RENT • Capital - INTEREST

  4. The Labor Market • **The AP Exam will usually use Labor in their examples, so we will often use labor as well. But know that these ideas would be the same for hiring Capital or Land as well.

  5. The Labor Market • When firms decide what combination of resources to use to create their product, they must “hire” these resources from a factor market. • One big difference between the labor market and the product market is, in the LABOR MARKET: • households are the ‘sellers’ • firms are the ‘buyers’

  6. Labor Market Graph

  7. Adjusting for Inflation • Wage – The price of labor defined as currency per unit of labor worked. • NOMINAL Wage – The price of labor not adjusted for inflation. • REAL wage – The price of labor adjusted for inflation; Economists use the CPI to adjust numbers from prices/wages from different times into a consistent unit of measure (ie. “2010 dollars”)

  8. Average Wage (1964-2006)

  9. Wage Trends Other US labor market trends: • Workers with higher skills are paid more than unskilled workers. This gap is increasing. • College graduates earn more than high school graduates and the gap has been increasing. • Women, on average, are paid lower than men, although the gap has become more narrow over the years.

  10. Derived Factor Demand • The factor market is a DERIVED MARKET. This means that the demand for the product determines the demand for the factor (ie. labor). • For example: If consumers demand morepizza, firms will demand more labor, ovens, etc. to produce the pizza. • However, if consumers demand less pizza, firms will demand less labor, ovens, etc. to produce the pizza.

  11. Draw: Market & Factor Graphs

  12. MRP = MRC Rule • MRP (Marginal Revenue Product) • MRP = ∆ TR / ∆ Q of Factor • MRP = MP x MR (or MP x P … in Perf. Competitive Labor Market) • Definition: Additional REVENUE created by hiring one additional unit of a resource (land, LABOR, capital) • MFC (Marginal Factor Cost) [aka MRC] • MFC = ∆ TC of that factor / ∆ Q of Factor • Also: MFC = Wage (W) of additional worker when dealing with LABOR. • Definition: The cost of hiring an additional unit of a resource. (WAGE, interest, …)

  13. Optimal Employment Rule • When only ONE resource is variable • AP Exam will use *LABOR* most often. • Firms will ALWAYS profit-maximize when it hires until MRP = MFC (or as close as they can get). • But never when MFC is greater than MRP • In other words, firms will continue to hire labor as long as the MFC is not greater than its MRP.

  14. Least-Cost Rule • A firm is always minimizing its cost at a specific output when the last dollar spent on one factor and the last dollar spent on another factor both result in the same Marginal product. For example, using Labor (L) & Capital (K) MPL/PL = MPK/PK

  15. Practice Question Taken from 2000 Exam:

  16. Individual Labor Supply Curve(backward bending) • Shows trade-off between income and leisure. • Why does it bend backwards when wage is above W2? • For you… what do you think your W2 is? S

  17. MRP (Marginal Revenue Product) • As a firm increases the # of workers per day, it can produce more widgets per day. Assume that the fixed cost = $10, and labor is the only Variable Cost. Selling Price = $2/widget, and each worker is paid $100/day.

  18. MRP (Marginal Revenue Product) • As a firm increases the # of workers per day, it can produce more widgets per day. Assume that the fixed cost = $10, and labor is the only Variable Cost. Selling Price = $2/widget, and each worker is paid $100/day.

  19. MRP (Marginal Revenue Product) • As a firm increases the # of workers per day, it can produce more widgets per day. Assume that the fixed cost = $10, and labor is the only Variable Cost. Selling Price = $2/widget, and each worker is paid $100/day.

  20. MRP (Marginal Revenue Product) • As a firm increases the # of workers per day, it can produce more widgets per day. Assume that the fixed cost = $10, and labor is the only Variable Cost. Selling Price = $2/widget, and each worker is paid $100/day.

  21. MRP (Marginal Revenue Product) • Now, assume that the selling price remains at $2/widget, but the wage for each worker increases to $125 per day. • How many workers should this profit-maximizing firm hire?

  22. Labor Market: Perfectly Competitive

  23. Labor Market: Monopsony

  24. Question #1 Which of the following situations illustrates the concept of derived demand? • If P of orange juice increases, D for apple juice increases • If D for shoes increases, then D for shoelaces increases. • If P of cars increases, D for gasoline increases. • If D for taxi rides increases, D for taxi drivers increases. • If S of hot dogs increases, D for hot dog buns increases.

  25. Question #2 Each worker hired adds less to total output than the worker before, according to the: • Law of Demand • Law of Diminishing Returns • Law of Diminishing Marginal Utility • Least-Cost Rule • Principle of Derived Demand

  26. Question #3 Marginal Revenue Product measures the additional: • Output produced from hiring one more worker. • Income to the firm from producing one more product. • Cost to the firm for producing one more product. • Wage required to hire one more worker. • Income to the firm from hiring one more worker.

  27. Question #4 In order to maximize profit, the firm should hire the number of workers where the: • Marginal cost equals the marginal revenue • Marginal revenue product equals the marginal cost • Wage equals the product price • Marginal factor cost equals the marginal revenue product • Marginal revenue equals the marginal factor cost.

  28. Question #5 What is the marginal product of the third worker? • 15 units • 60 units • 35 units • 20 units • 30 units

  29. Question #6 If the firm sells its products for $10 each, and the wage per worker is $100/day, how many workers should the firm hire to maximize profits?

  30. Question #7 A firm selling products in a monopoly product market finds its marginal revenue product falling much more quickly than a firm selling in a perfectly competitive product market, because in addition to diminishing returns, • The government is required to regulate the product. • The firm becomes inefficient by trying to sell too many units of output. • The firm must lower the price of all products in order to sell more units. • Workers tend to earn higher wages in monopoly product firms. • Consumers prefer not to buy from monopolies.

  31. Question #8 The demand for Tyrone’s auto repair shop would increase if: • The cost of capital for a complementary good significantly fell. • The cost of capital for a substitute good significantly fell. • Wages of auto repair workers significantly fell. • Mild weather resulted in fewer car crashes this winter. • Workers at the auto repair shop became less productive.

  32. Question #9 When the wage increases 5 percent, the quantity of workers hired falls 1 percent. This indicates that the demand for labor is • Perfectly inelastic • Relatively inelastic • Unit elastic • Relatively elastic • Perfectly elastic

  33. Question #10 According to the profit-maximizing rule for hiring resources, the firm should hire labor and capital until the marginal revenue product for each equals the: • Market price of the product. • Quantity of labor and capital hired. • Price ceiling for the product. • Profit per unit for each. • Marginal Resource Cost

  34. Question #1 Which of the following situations illustrates the concept of derived demand? • If P of orange juice increases, D for apple juice increases • If D for shoes increases, then D for shoelaces increases. • If P of cars increases, D for gasoline increases. • If D for taxi rides increases, D for taxi drivers increases. • If S of hot dogs increases, D for hot dog buns increases.

  35. Question #2 Each worker hired adds less to total output than the worker before, according to the: • Law of Demand • Law of Diminishing Returns • Law of Diminishing Marginal Utility • Least-Cost Rule • Principle of Derived Demand

  36. Question #3 Marginal Revenue Product measures the additional: • Output produced from hiring one more worker. • Revenue to the firm from producing one more product. • Cost to the firm for producing one more product. • Wage required to hire one more worker. • Revenue to the firm from hiring one more worker.

  37. Question #4 In order to maximize profit, the firm should hire the number of workers where the: • Marginal cost equals the marginal revenue • Marginal revenue product equals the marginal cost • Wage equals the product price • Marginal factor cost equals the marginal revenue product • Marginal factor equals the marginal resource cost.

  38. Question #5 What is the marginal product of the third worker? • 15 units • 60 units • 35 units • 20 units • 30 units

  39. Question #6 If the firm sells its products for $10 each, and the wage per worker is $100/day, how many workers should the firm hire to maximize profits? 4 Workers Because… MRP= 10 X $10 MFC = $100

  40. Question #7 A firm selling products in a monopoly product market finds its marginal revenue product falling much more quickly than a firm selling in a perfectly competitive product market, because in addition to diminishing returns, • The government is required to regulate the product. • The firm becomes inefficient by trying to sell too many units of output. • The firm must lower the price of all products in order to sell more units. • Workers tend to earn higher wages in monopoly product firms. • Consumers prefer not to buy from monopolies.

  41. Question #8 The demand for Tyrone’s auto repair shop would increase if: • The cost of capital for a complementary good significantly fell. • The cost of capital for a substitute good significantly fell. • Wages of auto repair workers significantly fell. • Mild weather resulted in fewer car crashes this winter. • Workers at the auto repair shop became less productive.

  42. Question #9 When the wage increases 5 percent, the quantity of workers hired falls 1 percent. This indicates that the demand for labor is • Perfectly inelastic • Relatively inelastic • Unit elastic • Relatively elastic • Perfectly elastic

  43. Question #10 According to the profit-maximizing rule for hiring resources, the firm should hire labor and capital until the marginal revenue product for each equals the: • Market price of the product. • Quantity of labor and capital hired. • Price ceiling for the product. • Profit per unit for each. • Marginal Factor Cost

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