Lecture Notes: Econ 203 Introductory Microeconomics Lecture/Chapter 18: Markets for Factors of Production M. Cary Leahey Manhattan College Fall 2012. Goals. We now look at the determinants of the demand and supply of various factors of production, most notably labor.
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Lecture Notes: Econ 203 Introductory MicroeconomicsLecture/Chapter 18: Markets for Factors of Production M. Cary LeaheyManhattan CollegeFall 2012
For any competitive, profit-maximizing firm:
To maximize profits, hire workers up to the point where VMPL = W.
The VMPL curve is the labor demand curve.
Labor demand curve = VMPL curve.
VMPL = P x MPL
Anything that increases P or MPL at each L will increase MPL and shift labor demand curve upward.
Changes in output price, P
Technological changes which affects the MPL
The supply of other factors that affects MPL, such as capital making workers more productive (increasing the capital-labor ratio), increasing MPL and VMPL
If MC is the cost of producing an additional unit of output, then
MC = V/MPL
So that:, an additional unit of output requires more labor
If L rises, MPL falls,
causing WMPL to rise
causing MC to rise.
So that diminishing marginal product and rising marginal costs are two signs of the same coin.
If the demand for labor is: P X MPL = W, then dividing by MPL
P = W/MPL and if MC = V/MPL, then P = MC,
which is the rule for a competitive firm supplying labor
So that input demand and output supply are two sides of the same coin.
Labor supply is the tradeoff between work and leisure. The more time spent working reduces time for leisure.
The opportunity cost of leisure is the wage
An increase in Wis an increase in the opportunity cost of leisure.
People respond by taking less leisure and by working more.
Changes in tastes or attitudes regarding the labor-leisure tradeoff.
Opportunities for workers in other labor markets.
The wage adjusts to balance supply and demand for labor.
The wage always equals VMPL.
Recall one of the Ten Principles:
A country’s standard of living depends on its ability to produce g&s.
Our theory implies wages tied to labor productivity(W = VMPL).
We see this in the data.
growth rate of produc-tivity
growth rate of real wages
With land and capital, one must distinguish between
pruchase price – price paid to use the factor indefinately
rental price – price paid to use the factor for a limited period of time
The wage is the rental price of labor, so that the determination of the rental prices of capital and land are similar.
Firms decide how much land to rent by comparing the price with the value of the marginal product (VMP) of land.
The rental price of land adjusts to balance supply and demand for land.
D = VMP
The market for land
Firms decide how much capital to rent by comparing the price with the value of the marginal product (VMP) of capital.
The rental price of capital adjusts to balance supply and demand for capital.
D = VMP
The market for capital
Buying a unit of land or capital yields a stream of rental income.
That rental income equals the value of marginal product, VMP.
So the equilibrium purchase price of a factor depends on both the future and expected VMP.
Factors of production are used in conjunction with the quantities of other factors.
For example, the increase in the quantity of capital depends on the marginal product and rental price of capital. More capital per worker makes workers more productive so that MPL and W rise
This is the neoclassical theory of income distribution, in which factor prices are determined by supply and demand and that each factor is paid his value of marginal product.
The three factors of production-labor, land and capital.
Factor demand is derived from the its supply of output.
Competitive firms maximize profits by hiring each factor up to the point where the value of its marginal product equals its rental price.
The supply of labor is determined by the work-leisure tradeoff, yielding an upwardly sloping supply curve.
The price paid to each factor balances the supply and demand for each factor. In equilibrium, each factor is paid the value of its marginal product.
Factors of production are used in conjunction with one another. A change in the quantity of one factor changes the marginal products and earnings of all other factors of production.