Final Examination
Monday, December 15
10:30 – 12:30
NOTE: The exam will be in LC 7 – not LC 1.
Extra office hours (BA 111A):
Thursday, December11 2:30 - 4:30
Sunday, December 14 2:30 - 4:30
Chapters covered on exam: 1-8, 10-11, 13-15, and 18
(60 to 65 percent of the exam will be drawn from chapters
13, 14 and 15 and to a much lesser extent chapter 18.)
Factor Markets and
the Distribution of Income
Chapter 18
Pages 437-446 of chapter 20
The Circular-Flow Diagram
Revenue
Goods &
Services sold
Market for
Goods
and Services
Firms
Inputs for
production
Wages, rent,
and profit
Spending
Goods &
Services
bought
Households
Market for
Factors
of Production
Labor, land,
and capital
Income
Market for a Factor of Production
W
S
W0
D
earnings
L0
L
Price-taking firm’s decision regarding
the quantity of an input to employ.
  TR  TC
The value of the marginal product of an input,
VMP, is the marginal product of the input times
the price of the output; VMP = MP•P.
Example: Suppose that the MPL is 1.5 shirts per hour and
the price of shirts is $6 per shirt. A worker working one
hour will yield the firm $9.00 in additional revenues.
shirts
dollars
dollars
VMPL  MPL  P  1.5
 6
 9
hour
shirt
hour
Suppose that the market price of the output produced by a
firm is $0.50 per unit and the market price of labor is $8.00
per hour.
value of
variable total marginal marginal
input product product product
(hours) (pounds) (lbs/hr) ($/hour)
100
200
300
400
500
600
700
800
900
1000
2000
4400
7200
9800
12000
13800
15400
16600
17500
18000
--24.00
28.00
26.00
22.00
18.00
16.00
12.00
9.00
5.00
--12.00
14.00
13.00
11.00
9.00
8.00
6.00
4.50
2.50
total variable
output
costs
(pounds)
($)
2000
4400
7200
9800
12000
13800
15400
16600
17500
18000
800
1600
2400
3200
4000
4800
5600
6400
7200
8000
total
costs
($)
marginal
cost
($/pound)
2800
3600
4400
5200
6000
6800
7600
8400
9200
10000
--0.33
0.29
0.31
0.36
0.44
0.50
0.67
0.89
1.60
Value of the Marginal Product of Labor
14
$ per hour
12
10
8
VMP = MP P
6
4
2
0
0
100 200 300 400 500 600 700 800 900 100 110
0
0
hours of labor services
A firm’s demand for an input is based upon the input’s VMP,
which depends upon the input’s marginal productivity and the
output’s value (price) in the market; VMP = MP • P.
Markets for Factors of Production
labor market
market for another input
W
SL
r
W0
DL
r0
SK
DK
input’s
earnings
labor earnings
L0
L
K0
K
Marginal Productivity Theory of
Income Determination:
In a market economy the distribution of income depends
upon the distribution of resource (input) ownership and
the prices of those factors of production.
The prices of inputs are determined by supply and
demand in the markets for those inputs.
The importance of the marginal productivity of inputs
in determining the distribution of income follows from
the fact that the demands for inputs directly depends
upon the values of their marginal products.
The Market Determination of Wages
market for high skilled workers
WH
SH
market for lower skilled workers
WL
SL
WH1
DH
WL1
DL
LH1 LH
LL1
LL
The Distribution of Income in the United
States: 1998
Annual Family Income
Under $15,000
Percent of Families
11.7%
$15,000-$24,999
12.3
$25,000-$34,999
12.7
$35,000-$49,999
16.8
$50,000-$74,999
21.5
$75,000-$99,999
11.7
$100,000 and over
13.3
Average Annual earnings by Educational
Attainment
1978
1998
High school, no college
$31,847
$28,742
College graduates
$52,761
$62,588
+66 percent
+118 percent
High school, no college
$14,953
$17,898
College graduates
$23,170
$35,431
+55 percent
+98 percent
Men
Percent extra for college grads
Women
Percent extra for college grads
Why has the gap in earnings between skilled and
unskilled workers risen in recent years?
International trade has altered the relative
demand for skilled and unskilled labor.
Changes in technology have altered the
relative demand for skilled and unskilled
labor.
The Market Determination of Wages
market for high skilled workers
WH
WH2
WH1
market for lower skilled workers
SH
WL
SL
DH’
DH
WL1
DL
LH1 LH2LH
LL1
LL
Income Inequality in the United States, 1998
Fourth Fifth
23%
Middle Fifth
16%
Second Fifth
10%
Bottom Fifth
4%
Top Fifth
47%
Principles of Economics
Markets are usually a good way to
organize economic activity.
Governments can sometimes improve
economic outcomes.