Download Unit 6 _ ppt 1 _ Markets for Factors of Production

Happy Monday 
• Why is chicken cheaper than steak?
• Why are apples cheaper (per pound) than
grapes?
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…
• Why do airline pilots earn more than school bus
drivers?
• Why is land on the Boardwalk in Atlantic City
more expensive than land fifty miles southwest
of Atlantic City?
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18: The Markets for Factors of Production
LEQ: How do firms make decisions in the factor market?
The Markets for the Factors of
Production
• Factors of production are the inputs used to
produce goods and services.
• RECALL: What are the factors of production
you’d find in a market or mixed market economy?
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The Market for the Factors of
Production
• The demand for a factor of production is a
derived demand.
• A firm’s demand for a factor of production is
derived from its decision to supply a good in
another market.
• For example, a restaurant’s demand for cooks is
derived from its decision to supply food.
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THE DEMAND FOR LABOR
• Labor markets, like other markets in the
economy, are governed by the forces of supply
and demand.
• Households are the suppliers; firms are the
demanders
• Remember the Circular Flow Model?
• The wage earned by workers is determined by
supply and demand
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Figure 1 The Versatility of Supply and Demand
(a) The Market for Apples
(b) The Market for Apple Pickers
Price of
Apples
Wage of
Apple
Pickers
Supply
P
Supply
W
Demand
Demand
0
Q
Quantity of
Apples
0
L
Quantity of
Apple Pickers
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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.
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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.
• This should sound familiar!
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Table 1 How the Competitive Firm Decides How
Much Labor to Hire
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Figure 2 The Production Function
Quantity
of Apples
Production
function
300
280
240
180
100
0
1
2
3
4
5
Quantity of
Apple Pickers
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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.
• MPL = Q/L (rise over run)
• MPL = (Q2 – Q1)/(L2 – L1) (slope of the
production function)
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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.
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The Production Function and the Marginal
Product of Labor
• Fancy Schmancy Definition: Diminishing
marginal product refers to the property whereby
the marginal product of an input declines as the
quantity of the input increases.
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Figure 2 The Production Function
Quantity
of Apples
Production
function
300
280
240
180
100
0
1
2
3
4
5
Quantity of
Apple Pickers
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How many workers should a firm hire?
• A firm must consider how much profit each
worker would bring in.
• Recall, Profit = TR-TC
• Profit from an additional worker = worker’s
contribution to revenue minus the worker’s
wage
• How do we calculate that?
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The Value of the Marginal Product and the
Demand for Labor
• The value of the marginal product (VPML) is
the marginal product of the input multiplied by
the market price of the output.
VMPL = MPL  P
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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 diminishes as the number of workers rises
because the market price of the good is constant
(assuming perfectly competitive market)
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The Value of the Marginal Product and the
Demand for Labor
• To maximize profit, the competitive, profitmaximizing firm hires workers up to the point
where the value of the marginal product of
labor equals the wage.
VMPL = Wage
Verbiage on AP exam:
MRP (marginal revenue product of labor) = MRC (marginal resource cost)
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Are you picking up what I’m putting
down?
• Complete Lesson 2, Activity 44
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The Value of the Marginal Product and the
Demand for Labor
• The value-of-marginal-product (MRP) curve is the
labor demand curve for a competitive, profitmaximizing firm.
• The marginal revenue cost curve is the labor supply
curve for a competitive, profit-maximizing firm.
• With perfectly competitive output market and perfectly
competitive factor market, firms are both wage takers
and price takers, so:
• VMP = MRP = MRC
Add graphs to your notes / Complete Activity 45
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• With a monopolistic output market and
perfectly competitive factor market, firms are
wage takers BUT price makers, so:
• VMP > MRP
Add graphs to your notes / Complete Activity 46
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Figure 3 The Value of the Marginal Product of Labor
Value
of the
Marginal
Product
Market
wage
Value of marginal product
(demand curve for labor)
0
Profit-maximizing quantity
Quantity of
Apple Pickers
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FYI—Input Demand and
Output Supply
• When a competitive firm hires labor up to the
point at which the value of the marginal product
equals the wage, it also produces up to the point
at which the price equals the marginal cost.
• COPY INTO YOUR NOTES:
• If W is the wage and an extra unit of labor produces MPL units of
output, then the marginal cost of a unit of output is MC = W/MPL
• Profit-maximizing firm chooses the quantity of labor so that the value of
the marginal product (P x MPL) is equal to the wage (W)
• P x MPL = W
• Divide both sides by MPL to get: P = W/MPL
• Because W/MPL = MC, we have: P = MC
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What Causes the Labor Demand Curve to
Shift?
•
•
•
•
Output Price
Technological Change
Supply of Other factors
Add to your notes an example for each…
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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.
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Figure 4 Equilibrium in a Labor Market
Wage
(price of
labor)
0
Supply
Quantity of
Labor
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What Causes the Labor Supply Curve to
Shift?
•
•
•
•
Changes in Tastes
Changes in Alternative Opportunities
Immigration
Add to your notes an example for each…
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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.
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Figure 4 Equilibrium in a Labor Market
Wage
(price of
labor)
Supply
Equilibrium
wage, W
Demand
0
Equilibrium
employment, L
Quantity of
Labor
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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.
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Figure 5 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
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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.
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Figure 6 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
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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.
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Table 2 Productivity and Wage Growth
in the United States.
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OTHER FACTORS OF PRODUCTION:
LAND AND CAPITAL
• Capital refers to the equipment and structures
used to produce goods and services.
• The economy’s capital represents the accumulation
of goods produced in the past that are being used in
the present to produce new goods and services.
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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.
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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 factor’s marginal product equals the factor’s
price.
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Figure 7 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
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Equilibrium in the Markets for Land and
Capital
• Each factor’s rental price must equal the value
of its marginal product.
• They each earn the value of their marginal
contribution to the production process.
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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.
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Linkages among the Factors of Production
• A change in the supply of one factor alters the
earnings of all the factors.
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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.
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Summary
• The economy’s income is distributed in the
markets for the factors of production.
• The three most important factors of production
are labor, land, and capital.
• The demand for a factor, such as labor, is a
derived demand that comes from firms that use
the factors to produce goods and services.
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Summary
• Competitive, profit-maximizing firms hire each
factor up to the point at which the value of the
marginal product of the factor equals its price.
• The supply of labor arises from individuals’
tradeoff between work and leisure.
• An upward-sloping labor supply curve means
that people respond to an increase in the wage
by enjoying less leisure and working more
hours.
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Summary
• The price paid to each factor adjusts to balance
the supply and demand for that factor.
• Because factor demand reflects the value of the
marginal product of that factor, in equilibrium
each factor is compensated according to its
marginal contribution to the production of
goods and services.
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Summary
• Because factors of production are used together,
the marginal product of any one factor depends
on the quantities of all factors that are available.
• As a result, a change in the supply of one factor
alters the equilibrium earnings of all the factors.
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