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Unit 4

Unit 4. Section 13 Factor Markets. Factors of Production. Labor Land Capital Entrepreneurship. Factor Prices. The demand for a factor of production is a derived demand The demand for the product drives the demand for labor. Marginal Productivity and Factor Demand.

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Unit 4

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  1. Unit 4 Section 13 Factor Markets

  2. Factors of Production • Labor • Land • Capital • Entrepreneurship

  3. Factor Prices • The demand for a factor of production is a derived demand • The demand for the product drives the demand for labor

  4. Marginal Productivity and Factor Demand • Marginal product (MP) is the additional output produced as a result of hiring an additional unit of a factor of production. For example, MPL = additional output from hiring an additional worker.(some authors call this MPP) • The value of the marginal product (VMP) is the value of the additional output produced as a result of hiring an additional unit of a factor. (some authors call this MRP) • For example, VMPL = MPL x P (MRP = MPP x P) • The VMP curve is the demand curve for a factor (with a perfectly competitive labor market).

  5. Lemonade Stand - $2 per cup Wage for labor = Marginal Resource Cost (MRC) Hire a worker if: VMPL >= W. (or MRP>=MRC) Never hire a worker if: VMPL < W. Stop hiring workers up to the point where: VMPL = W (MRP=MRC) So, which of the labor resources above will be the last we hire? Suppose the wage rate goes up to $12?

  6. The VMPL curve is the demand curve!

  7. What Causes the Factor Demand Curve to Shift? W and VMPL VMP = D • Changes in the prices of goods • Changes in the supply of other factors • Changes in technology Units of Labor

  8. Lemonade $4/cup • Units of Labor

  9. Demand in the Markets for Capital and Land • The price (marginal cost) of capital or land is the rental rate (R) • Firms hire capital or land up to the point where VMP = R

  10. Supply in the Markets for Capital and Land • The supply curve for capital and land is upward sloping. • The supply of land is inelastic (very steep)

  11. Equilibrium in the Markets for Capital and Land • Supply and demand in factor markets work very much like supply and demand in product markets.

  12. Marginal Productivity Theory The Marginal Productivity Theory of Income Distribution • Each factor of production is paid the equilibrium value of its marginal value. • Think of office space in Manhattan. The rent is equivalent to the value the use of the space creates for the owner of the business. • Your wage (benefits included) is equal to the value of the product you produce. • Labor receives about 70% of total factor income. • VMPL > VMPcapitalor land

  13. Farm land example 1. Suppose that farm land in the U.S. is exchanged in a competitive market. • Use a correctly labeled graph of this market to show the equilibrium rental rate and quantity of farm land. • Suppose that a growing global population increases the demand for agricultural products grown in the U.S. In the graph, show how this impacts the market for farm land in the U.S. • Now suppose that much of the farm land in the U.S. has been converted into residential sub-divisions. In the graph from part (a), show how this trend affects the market for farm land in the U.S.

  14. Hourly wage Labor supply IE>SE, downward sloping SE>IE, upward sloping Hours of work (week) The Supply of labor • Substitution effect • Income effect

  15. Shifts of the Labor Supply Curve • Changes in preferences and social norms • Changes in population • Changes in opportunities • Changes in wealth

  16. Wage Market Labor Supply Equilibrium in the Labor Market W* Market Labor Demand • Up to this point we have assumed that both the product and labor markets are perfectly competitive • There are differences when either the product market or labor market is not perfectly competitive Quantity of Labor (workers) E*

  17. Imperfect Competition in the Product Market W* VMPL MRPL • Recall that MR < P with imperfect competition. That means the value of the marginal product = MP x MR. • With imperfect competition the value of the marginal product is called marginal revenue product (MRP). MRP = MP x MR Wage Em Ec Quantity of Labor (workers)

  18. Imperfect Competition in the Labor Market MFCL Labor Supply $12 $10 • A monoposony is a single buyer of a factor of production. • With imperfect competition in a factor market, MFC > W Wage 3 Quantity of Labor (workers)

  19. Equilibrium with Imperfect Competition MFCL Labor Supply W* • Monopsony power allows firms to pay a wage below MRP MRPL Wage MRP E* Quantity of Labor (workers)

  20. Determining the Optimal Input Mix • Least-cost combination of inputs • Cost-minimization rule MPL/w = MPK/r

  21. Marginal Productivity and Wage Inequality • Compensating differentials • Differences in talent • Human capital

  22. Other Sources of Wage inequality • Market Power • Efficiency Wages • Discrimination

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