Download Factor Markets: Land, Labor, and Capital

Factor Markets:
Land, Labor, and Capital
AP Economics
Mr. Bordelon
Demand in the
Markets for Land and Capital
• Remember, we’re making the assumption that
markets for g/s are perfectly competitive. If
that’s true, then the derived demand in the
labor market applies to land and capital.
• Rental rate. For land and capital, rental rate is
the cost, explicit or implicit, of using a unit of
that asset for a given period of time.
Demand in the
Markets for Land and Capital
• VMPLand. In maximizing profits, landowner will
rent more land until VMPLand = rental rate.
• VMPCapital. In maximizing profits, business
owner will rent more equipment until
VMPCapital = rental rate.
• In other words, additional cost vs. additional
output.
Demand in the
Markets for Land and Capital
• What if the business already owns the land or
capital?
– Doesn’t matter. There is the implicit/opportunity
cost of using it for a specific purpose rather than for
something else.
• Key point: Profit-maximizing firms employ
additional units of land and capital until cost of
last unit employed, explicit or implicit, equals
the VMP of that unit.
Demand in the
Markets for Land and Capital
• You could probably guess that the slope for
this curve will be negative not just due to law
of demand, but also diminishing returns.
Supply in the
Markets for Land and
Capital
Take a look at this beautiful
supply and demand graph.
Notice that Sland is relatively
inelastic. Why? Because it’s a
good bet you’re not going to
be finding any new land any
time soon, short of planting a
flag on another planet. But
even more realistic,
converting land from one use
to another becomes more
and more expensive to do so.
(Who remember this
concept? Tell me in class, and
you will get another of
Chantal’s cookies.)
Supply in the
Markets for Land and
Capital
Now look at it from the
capital end.
Scapital is relatively elastic.
Why?
Because the supply of capital
is responsive to price. Capital
is paid for with investment
spending, planned or
unplanned, or even
investment savings. The
amount of savings investors
make available is relatively
responsive to the rental rate
for capital.
Supply in the
Markets for Land and Capital
• Supply curve for a factor of production will
shift as the factor becomes more or less
available. Duh.
• With diminishing returns, when supply of land
or capital changes, MP will also have to
change.
– When supply of land or capital decreases, MP and
rental rate increase.
– When supply of land or capital increases, MP and
rental rate decrease.
Equilibrium in
Land and Capital Markets
• Equilibrium rental rate and quantity in land
and capital markets are where supply and
demand meet. Duh.
Marginal Productivity Theory
• Marginal Productivity Theory of Income
Distribution. Every factor of production is
paid the equilibrium value of its marginal
product.
– In an economy-wide factor market, the price paid
for each factor is equal to the increase in the value
of output generated by the last unit of that factor
employed in the market.
– If a unit of labor is paid more than a unit of
capital, it is because at the equilibrium quantity of
each factor, value of MPL > MPK.
Marginal Productivity Theory
• Marginal Productivity Theory of Income
Distribution. Every factor of production is
paid the equilibrium value of its marginal
product.
– In a labor market for computer programmers is at
equilibrium, wage rate earned by all computer
programmers equals the market’s equilibrium
VMP—the value of the MP of the last computer
programmer hired.
Labor Market
• The conflict in labor supply is one of work vs.
leisure.
• Assumption: Individual laborer chooses to
work as many or as few hours as he likes.
• With that assumption, can we safely assume
that the laborer would choose to work as
many hours as possible?
Labor Market
• The short answer is no. Reality is that no one wants
to work forever, and would actually like to have a life
beyond work.
– Time allocation. Choice on how many hours spent on
varying activities.
• Trade off: Worker can work as much as they can to
earn more money and buy more goods. Increased
purchasing power comes at the expense of leisure,
however.
– Leisure. Time available for purposes other than earning
money to buy market goods.
Labor Market
• Assuming a rational self-interested worker, the
worker would analyze how much work to do
versus how much leisure to consume through
marginal analysis!
– How does an individual worker use a marginal
hour?
– The marginal utility received from one hour of
leisure should equal the marginal utility received
from the goods that the worker can purchase.
Wages and Labor Supply
• Assume for a second that Tyler’s wages double
from $10 to $20 per hour. How much would
he choose to work?
• Arguably, and probably initially, Tyler would
choose to work more hours because he can
earn twice as much.
• On the other hand, he could choose not to do
so since he’s actually making more money,
and can earn a similar amount by working
less.
Wages and Labor Supply
• We can predict Tyler’s reaction based on the
substitution and income effects.
• As Tyler’s income rises, this affects his demand
for leisure.
– The opportunity cost of leisure will increase, and
is measured by the amount of money he gives up
by taking an hour off work.
– Substitution effect works as an incentive to
consume less leisure and work more hours.
Wages and Labor Supply
• As Tyler’s income increases, this affects his
demand for leisure.
– The opportunity cost of leisure will decrease, and
is measured by the amount of money he gives up
by taking an hour off work.
– Income effect makes him want to consume more
leisure and supply less labor because leisure acts
as a normal good.
Wages and Labor Supply
• If the substitution effect dominates the
income effect, an increase in wages will lead
laborers to supply more hours of labor.
• If the income effect dominates the
substitution effect, an increase in wages will
lead laborers to supply less hours of labor.
Individual Labor Supply Curve
This curve illustrates how these effects influence individual labor supply, and they
show the relationship between wages and the number of hours of labor supplied by
individual workers. But notice that these effects working together indicate that the
individual labor supply curve will not always slope positively. If the income effect
dominates, higher wages will reduce quantity of labor supplied.
Backward Bending
Labor Supply Curve
The combination of substitution
and income effects on the labor
supply curve indicate that it is
possible to have one that bends
backwards.
At lower wage rates, substitution
dominates income effect.
At higher wage rates, income
effect dominates substitution
effect.
Shifts of the Labor Supply Curve
•
•
•
•
Changes in Preferences and Social Norms
Changes in Population
Changes in Opportunities
Changes in Wealth
– Careful with this one. Income effect caused by a
change in wealth shifts labor supply, but income
effect from wage rate increase is a movement
along labor supply.
Equilibrium in Labor
Market
Remember, VMPL = W. Labor is
paid its equilibrium value of the
marginal product, E. E ultimately
represents the value of the
marginal product of the last
worker hired in the market as a
whole.
But this is a perfectly competitive
market…what happens when
we’re in a market that is not
perfectly competitive?
Product Market
in Imperfect Competition
• Perfect competition: VMP = W at E.
• In monopoly, demand for monopolist product
slopes downward, meaning that to sell an
additional unit of output, monopolists lower
prices. Any additional revenue received from
selling that unit is less than the price by the
amount of what was lost in the price effect.
• Monopolists determine its demand for
workers by finding the marginal revenue
product of labor instead.
Product Market
in Imperfect Competition
• Marginal revenue product of labor. Equals the MPL
times MR received from additional output. MRPLand
and MRPCapital work the same way.
• MPRL = (MPL)(MR)
Product Market
in Imperfect Competition
Key point: Profit maximizing firms in
imperfectly competitive product
markets use each factor of production
up to the point at which MRP of last
unit of the factor employed equals the
factor’s cost.
Labor demand curve is MRPL curve.
MRPL curve differs from MPL curve
when there is imperfect competition in
product market.
With perfect competition, MRPL and
VMPL are the same because MR = P.
That’s not the case in imperfect
competition.
Labor Market
in Imperfect Competition
• Biggest difference between a perfectly and
imperfectly competitive labor market is the
marginal factor cost, the additional cost of
hiring one more unit of a factor of production.
• Marginal factor cost of labor. Additional cost
of hiring an additional worker. MFCLand and
MFCCapital are similar concepts.
Labor Market
in Imperfect Competition
This graph shows the labor market in
perfect competition. In a perfectly
competitive labor market, each firm is
so small that it can hire as much labor
as it wants at the market wage, and
the decision does not affect the
market. Their hiring decisions can’t
affect the market. With perfect
competition in the labor market, the
additional cost of hiring another
worker will always equal the market
wage.
Marginal factor cost of labor. The
additional cost of hiring another
worker is always equal to the market
wage. MFCL = W
Labor Market in
Imperfect Competition
• New Ugly Vocab!
• Monopsonist. Single buyer in a factor market.
• Monopsony. A market in which there is a
monopsonist.
• In imperfect competition, the labor market
slopes upward and the MFC is above the
market wage. Firms in imperfectly
competitive labor market are large enough to
affect market wage.
Labor Market in
Imperfect Competition
• Assume there’s a firm that is the largest supplier of
jobs in town. This would be an example of
monopsony. They’re going to use up the most
factors, in this case, labor.
• If it wants to hire more workers, it must offer higher
wages to attract them. The higher wages go to all
workers, not just those hired last.
• MFCL, the additional cost of hiring an additional
worker is higher than the wage—it is the wage plus
raises paid to all workers.
Labor Market
in Imperfect Competition
In imperfect competition, the labor
supply curve slopes upward and
marginal factor cost is above the
market wage. In imperfect
competition, however, this isn’t a
problem because firms in imperfect
markets are large enough to have
market power and can affect market
wage.
But the type of work offered is either
specialized, or alternatively, the
monopsonist is the only job in town. If
the business wants to hire more
workers, it has to pay higher wages to
attract them.
The additional cost of hiring an
additional worker (MFCL) is higher
than the wage.
Labor Market
in Imperfect Competition
Because firms in imperfect
competition must raise wages to hire
more workers means MFCL is above
the labor supply curve.
To sell one more, the monopsonist has
to lower price, so additional revenue is
price minus losses on the units that
would otherwise sell at higher price.
For workers, the monopsonist has to
raise wages. Marginal factor cost is
wage plus wage increase for those
workers who would otherwise be hired
at the lower wage.
Equilibrium in Imperfectly
Competitive Labor Market
In perfectly competitive labor markets,
firms hire labor until VMPL = W. In
imperfect competition, firms will hire
workers until MRPL = MFCL.
Key point: Every firm hires workers up
to the point at which MRPL = MFCL.
Hire workers until MRPL = MFCL
To the right is equilibrium in an
imperfectly competitive labor market.
Notice that the MFCL is above the
wage rate, and that wages are paid at
the market labor supply curve. But
demand intersects at MFCL…you
should be able to draw parallels
between how a monopolist/oligopolist
sets production vs. how they make
higher decisions. 
The wage in imperfectly competitive
labor markets is less than the MFCL.