ECN 112 Chapter 18 Lecture Notes
18.1 The Anatomy of Factor Markets
Three factors of production—labor, capital and land—are traded in factor markets, which are
markets where the equilibrium quantity of the factor and the factor price are determined. A
fourth factor of production, entrepreneurship, creates firms and hires the other factors.
A. Labor Markets
The labor market is a collection of people and firms who are trading labor services.
Some labor is traded on a daily basis called casual labor but most is traded on a contract,
called a job.
1. Human capital is an individual’s skills obtained from education, on-the-job experience,
and work experience.
2. The price of labor is the wage rate.
B. Financial Markets
Financial capital is the funds that firms use to buy and operate physical capital. A
financial market is a collection of people and firms who are lending and borrowing to
finance the purchase of physical capital.
1. Stock Market
A stock market is a market in which shares in the stocks of companies are traded. A
stock is an entitlement to a share in the company’s profits.
2. Bond Market
A bond market is a market in which bonds issued by firms and governments are
traded. A bond is a promise to pay specified sums of money on specified dates.
C. Land Markets
Land consists of all the gifts of nature including metal ores, oil, and natural gas.
1. A commodity market is the market in which raw materials are traded.
D. Competitive Factor Markets
Most factor markets are competitive, that is, there are many buyers and sellers.
18.2 The Demand for a Factor of Production
The demand for a factor of production is a derived demand, which is derived from the
demand for the goods and services it is used to produce.
A. Value of Marginal Product
The value of marginal product is the value to a firm of hiring one more unit of a factor of
production. The value of marginal product equals the price of a unit of output multiplied
by the marginal product of the factor of production.
1. The Value of Marginal Product Curve
The value of marginal product curve is graphed with the number of workers on the xaxis and the value of marginal product on the y-axis. The curve is downward sloping
because the value of marginal product decreases as the quantity of labor employed
increases.
B. A Firm’s Demand for Labor
The value of marginal product and the wage rate determine the quantity of labor
demanded by a firm. The value of marginal product reflects the additional revenue
earned by the firm by hiring one more worker and the wage rate is the additional cost the
firm incurs by hiring the additional worker. To maximize profits, a firm hires up to the point
at which the value of marginal product equals the wage rate.
1. A Firm’s Demand for Labor Curve
a. A firm’s demand for labor curve is also its value of marginal product curve.
b. As the wage rate rises, a firm hires fewer workers and as the wage rate decreases,
a firm hires more workers. That is, as the wage rate changes there is a change in
the quantity demanded of labor or a movement along the demand curve.
C. Changes in the Demand for Labor.
The demand for labor depends on three factors. Changes in these factors will shift the
demand for labor curve.
1. The Price of the Firm’s Output.
As the price of the firm’s product increases, the firm demands more labor because an
increase in the product’s price increases the value of marginal product. The demand
curve for labor shifts rightward.
2. The Prices of Other Factors of Production.
a. If the price of capital decreases relative to the wage rate, a firm substitutes capital
for labor. The firm’s demand for labor curve shifts leftward.
b. If the decrease in the price of capital leads to a large enough increase in the scale
of production, a firm might buy additional capital and hire more labor, which
increases the demand for labor. This change occurs in the long run.
3. Technology.
Depending on the type of technology, the demand for labor might increase or
decrease. An increase in technology might decrease the demand for labor in that
industry but increase the demand for labor in the industry that produces and maintains
the technology.
18.3 Wages and Employment
A. The Supply of Labor
1. A person supplies labor to earn an income. While the wage rate is a key factor in the
amount of labor a person supplies, there are other factors.
2. An individual’s labor supply curve is upward sloping at lower wage rates, but
eventually bends backward at high wage rates.
3. Market Supply Curve
The market supply curve is the sum of all labor supplied at various wage rates. The
market labor supply curve in a given job slopes upward.
B. Influences on the Supply of Labor
The supply of labor depends on three key factors:
1. Adult Population
An increase in the adult population increases the supply of labor.
2. Preferences
As more women have chosen to work, the supply of labor has increased.
3. Time in School and Training
As more people remain in school for full-time education and training, the supply of
high-skilled labor increases and the supply of low-skilled labor decreases.
C. Labor Market Equilibrium
The labor market equilibrium determines the wage rate and employment.
1. If the wage rate exceeds the equilibrium wage rate, there is a surplus of labor and the
wage rate falls.
2. If the wage rate is less than the equilibrium wage rate, there is a shortage of labor and
the wage rate rises.
18.4 Financial Markets
A. The Demand for Financial Capital
1. A firm’s demand for financial capital depends on its demand for physical capital to
produce goods and services. The quantity of physical capital that a firm plans to use
depends on the interest rate.
2. The higher the interest rate, the smaller the quantity of capital demanded.
3. The demand for financial capital depends on two main factors:
a. Population growth. As the population grows, the demand for all goods and services
increases, so the demand for the physical capital that produces them increases.
b. Technological change. As technology advances, the demand for some types of
physical capital increases and the demand for other types decreases.
B. The Supply of Financial Capital
The quantity of financial capital supplied results from people’s saving decisions.
1. The higher the interest rate, the more people save and the greater the quantity of
financial capital supplied.
2. The supply of financial capital depends on three main factors:
a. Population. An increase in the population increases the supply of saving because it
increases the number of potential savers.
b. Average income. The higher a household’s income, the more it saves.
c. Expected future income. If a household’s expected future income is low, its saving
is high. If a household’s expected future income is high, its saving is low.
C. Financial Market Equilibrium and the Interest Rate
The intersection of the demand for financial capital curve and the supply of financial
capital curve determines the equilibrium interest rate and the quantity of capital.
1. Over time, both the demand for and supply of capital increase, which leads to an
increase in the quantity of capital but the interest rate does not persistently increase or
decrease.
18.5 Land and Natural Resource Markets
All natural resources, called land, fall into two categories: renewable and nonrenewable.
Renewable natural resources are natural resources that can be used repeatedly.
Nonrenewable natural resources are natural resources that can be used only once and
cannot be replaced once they have been used.
A. The Market for Land (Renewable Natural Resources)
1. The higher the rent, the lower the quantity of land demanded.
2. The quantity of land is fixed, so regardless of the rent, the supply of land does not
change. The supply of each particular block of land is perfectly inelastic.
B. Economic Rent and Opportunity Cost
1. Some human resources are so unique, for example Tiger Woods, that they also are in
fixed supply.
2. Economic rent is the income received by any factor of production over and above the
amount required to induce it’s a given quantity of the factor to be supplied.
3. Opportunity cost is the income required to induce the supply of a given quantity of a
factor of production.
C. The Supply of a Nonrenewable Natural Resource
1. Over time, the quantity of a nonrenewable resource decreases, but its known quantity
increases as technology enables ever less accessible sources of the resource to be
discovered.
2. Using a nonrenewable resource reduces its supply and increases its price, but as
technology reveals new supply, the resource’s price can fall. Recently, this the forces
that bring lower prices have outweighed those that bring higher prices and natural
resource prices have fallen.