Module
Econ: 69
Factor Markets:
Introduction and Factor Demand
•KRUGMAN'S
•MICROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• How factors of production—resources like
land, labor, and capital—are traded in factor
markets.
• How factor markets determine the factor
distribution of income.
• How the demand for a factor of production
is determined.
I. Factors of Production
A.
B.
C.
D.
Labor
Land
Capital
Entrepreneurship
• Also known as inputs
or resources
II. Factor Prices
A. Factor prices allocate
resources among producers
B. The demand for a factor of
production is a derived
demand
Ex. the demand for nurses is derived
from the demand for the services
that nurses provide. As the US
population ages, the demand for
medical care, which certainly
includes nursing services, rises
and thus the demand for nurses
rises.
C. Most people get the largest
share of their income from
factor markets
III. Marginal Productivity and
Factor Demand
A. 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.
B. 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. For example, VMPL = MPL x P.
C. The VMP curve is the demand curve for a factor (with a
perfectly competitive labor market).
D. If W is a constant wage.
1.
Hire a worker if: VMPL >= W.
2.
Never hire a worker if: VMPL < W.
3.
Stop hiring workers up to the point where: VMPL = W.
4.
This is the profit-maximizing hiring decision for ANY factor of
production. The last unit of any factor is hired when the value of its
marginal product is exactly equal to the marginal cost of hiring it.
5.
The Law of Demand also applies in factor markets. As the price of a
factor increases, firms hire less of that factor (and as the price of a
factor falls, firms hire less of that factor).
6.
The VMPL curve serves as the demand for labor. For any factor, the
VMP curve serves as the demand curve for that factor of production.
IV. What Causes the Factor
Demand Curve to Shift?
A. Changes in the prices of
goods
B. Changes in the supply
of other factors
C. Changes in technology
W and
VMPL
VMP = D
Units
of
Labor
Module
Econ: 70
The Markets
for Land and Capital
•KRUGMAN'S
•MICROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• How to determine demand and supply in
the markets for land and capital.
• How to find equilibrium in the capital and
land markets.
• How the demand for factors leads to the
marginal productivity theory of income
distribution.
I. Demand in the Markets for
Capital and Land
A. The price (marginal
cost) of capital or land
is the rental rate (R)
B. Firms hire capital or
land up to the point
where VMP = R
II. Supply in the Markets for
Capital and Land
A. The supply curve for capital and land is upward
sloping.
B. The supply of land is inelastic (very steep)– only so
many square miles of land available.
III. Equilibrium in the Markets for
Capital and Land
• Supply and demand in factor markets work very much
like supply and demand in product markets.
IV. Marginal Productivity Theory
A. If all factor markets are in equilibrium, the last
unit employed is paid a wage (or rental rate)
equal to the value of the marginal product.
These equilibrium factor prices determine the
distribution of factor income shown in Module
69.
B. Because labor’s share of factor income is about
70%, it must be the case that labor’s value of the
marginal product is greater than the other factors
land and capital.
– VMPL > VMPcapital or land
Module
Econ: 71
The Market for Labor
•KRUGMAN'S
•MICROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• The way in which a worker’s decision about
time preference gives rise to labor supply.
• How to find equilibrium in the perfectly
competitive labor market.
• How equilibrium in the labor market is
determined if either the product, or the
factor, market is not perfectly competitive.
I. The Supply of labor
A. Work versus leisure
1. Benefit of one hour of work: a wage
that can be used to consume goods
and services that provide utility.
2. Cost of one hour of work: the utility
that could be gained from leisure.
The price of leisure is the wage a
person gives up.
B. Wages and labor supply
1. If wages rise, more people supply labor
resulting in an upward labor supply
curve
The Supply of labor Cont.
C. Substitution effect
1. People will work more
because wages are
higher
Hourly wage
Labor supply
IE>SE, downward sloping
Backward bending
D. Income effect
1. People will consume
more hours of leisure
because they are
making enough
money regardless
SE>IE, upward sloping
Hours of work (week)
II. Shifts of the Labor Supply Curve
A. Changes in preferences and social norms
(women after WWII)
B. Changes in population (baby boomers,
immigration)
C. Changes in opportunities (health
services)
D. Changes in wealth (value of assets—
home, stocks, mutual funds)
III. Equilibrium in the Labor
Market
A. Up to this point we have
assumed that both the
product and labor
markets are perfectly
competitive
B. There are differences
when either the product
market or labor market is
not perfectly competitive
Wage
Market Labor Supply
W*
Market Labor Demand
E*
Quantity of Labor (workers)
IV. Imperfect Competition in the
Product Market
W*
A. Recall that MR < P with
imperfect competition.
That means the value of
the marginal product = MP
x MR.
B. With imperfect
competition the value of
the marginal product is
called marginal revenue
product (MRP).
MRP = MP x MR
Wage
VMPL
MRPL
Em
Ec
Quantity of Labor (workers)
V. Imperfect Competition in the
Labor Market
A. A monoposony is a
single buyer of a
factor of production.
B. With imperfect
competition in a factor
market, MFC > W
MFCL
Wage
Labor Supply
$12
$10
3
Quantity of Labor (workers)
VI. Equilibrium with Imperfect
Competition
A. Monopsony power
allows firms to pay a
wage below MRP
MFCL
Wage
Labor Supply
MRP
W*
MRPL
E*
Quantity of Labor (workers)
Module
Econ: 73
Theories of
Income Distribution
•KRUGMAN'S
•MICROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• Labor market applications of the marginal
productivity theory of income distribution.
• Sources of wage disparities, including the
role of discrimination.
I. The Marginal productivity
Theory of Income Distribution
A. According to MP
theory, the division of
income among factors
of production is
determined by MP
• Can we use MP theory
to explain why some
workers are paid more
than others?
II. Marginal Productivity and Wage
Inequality
A. Compensating differentials
–
Chicago police officer makes
more than a DP police officer
B. Differences in talent
–
More money for a more
talented chef, baseball player
C. Human capital
–
More education
III. Other Sources of Wage
inequality
A. Market Power
–
Large groups like Unions can raise wages
B. Efficiency Wages
–
People are paid too much for the work they do. Employers cannot
prove exactly what an employee is worth. Employees do not want
to quit. Acts like a Price Floor and creates a surplus of workers
who wish to have this job.
C. Discrimination
–
Some laws try to prevent this