Markets for Factors of
Production
Factors of Production
-Land
-Labour
-Physical Capital
-Human Capital
-Other
These factors are bought and sold in a factor
market with supply and demand curves
similar to the goods market
1
Markets for Factors of
Production
These markets are important because:
• money incomes are primarily determined
by the prices set in these markets.
–distribution of income
• production costs determine which factors
are used and in what quantities
–resource allocation
2
CIRCULAR FLOW
$ Spending
Households
Resource
Owners
Product
Market
Products &
Services
$ Revenue
Products &
Services
Government
$ Taxes
$ Income
$ Taxes
Resource
Market
Business
Firms
$ Costs
LAND
LABOR
CAPITAL
3
for Apples
(b) The Market
Supply
P

Wage of Apple Pickers
(a) The Market
for Apple Pickers
Supply
W

Demand
0
Q
Quantity of
Apples
Demand
0
The Versatility of Supply & Demand
L
Quantity of
Apple Pickers
4
Shifters of Labor Demand
• Factors other than Wage that affect
Labour Demand
– 1) Changes in demand for the product
– 2) Changes in labour productivity (technology,
etc)
– 3) Change in the price of other factors (land,
human capital, etc.)
5
Shifters of Labour Supply
• Examples of Factors
•
4)
Expectations
other than Wage
–Future wages
which affect Labour
Supply:
–Income
• 1) Income,
–Job availability
wealth
• 5) Population
• 2) Lifestyle
(workforce)
• 3) The wage of
competing jobs
Essentially, all factors affecting
demand have a parallel affecting
labour supply
6
Labour Market:
Perfect Competition
• 1. many firms competing with one another
in hiring a specific type of labour.
• 2. numerous qualified workers with
identical skills independently supplying this
type of labour service.
• 3. neither firms nor workers can exert
control over the market wage rate.
• price takers.
7
Labour Market: Perfect
Competition
Industry Labour
Market
The Firm: on the
demand side is a
price taker
Wage
Wage
S
w1
w1
SL
D
L1
Labour Input (workers per week)
8
Labour Input (workers per week)
Labour Market: Perfect Competition
• There are many households selling to many
firms, and no one household or firm has any
power to influence the price.
Demand for Labour
• Assume that the firm on the demand side of the
market is
– buying (hiring) apple pickers in a perfectly
competitive labour market, and
– selling apples in a perfectly competitive
goods market.
9
Labour Market: Perfect
Competition:
Demand for Labour.
• The firm, on the Demand side of the
market, is a “price taker”.
• It has to decide:
– how many apple pickers to hire
• given the price of apples ( goods
market)
• given the wage rate for apple pickers
(factor market)
– in order to maximize profit
10
Marginal Review
Marginal Product of Labour
• Additional production of last worker hired
• MPL=Q /L
Marginal Revenue Product
• Additional revenue of last worker hired
• MRP=P x MPL
• MRP= TR /  L
11
The Competitive Firm Decides How Much
Labour to Hire: Price of Apples=$10/bu.
Wage Rate=$500/week
MRP
Output
marginal
(Bushels/
revenue
Marginal
product
Labor (# of Week)
workers)
Product of
(Q)
of Labour
(L)
Labour
0
0
(MPL=Q /L) (MRP=PxMPL)
MRP
marginal
revenue
product
TR
Total
revenue
of Labour
(TR /  L)
1
100
100
$1000
$1000
$1000
2
180
80
800
1800
800
3
240
60
600
2400
600
4
280
40
400
2800
400
5
300
20
200
3000
200
12
The Demand for Labour:
The Profit Max Hiring Decision
• In order to find the MR of the Profit Maximizing
decision: The firm must consider :
– 1. the production function - how the size of the work force
affects the amount produced by each worker, MPL
– 2. the contribution to revenue, MRPL, and to the profit
equation that each worker makes
– MRP = TR /  # of workers.
– MRP = Product Price x MPL.
» When MP   MRP  .
13
Profit Maximizing Hiring Decision
• In order to find the MC of the profit maximizing
decision; the firm must find
– 3 The Marginal Factor Cost (MFC)
= wage rate in perfect competition
= additional cost of hiring one more unit of labour in all types of
markets
• hire workers up to the point where:
MRP
(MR)
 Wage (MFC)
(MC)
14
Demand for Labour:
• The quantity of labour a firm will hire at any given
wage, cet. par.
To maximize profit the firm hires the
quantity of labour where the
MRP = MFC (W in P.C.)
MRP schedule is the
Demand for Labour,
for a competitive profit
maximizing firm
15
Profit Max: MRP=W(MFC):
The MRP is the Demand for Labour
W1
Wage
MFC
W2
MFC
W3
MFC
•MRP = P x MPL
(the value of the worker’s output)
•MFC = W
(the cost of hiring a worker)
•Optimal number of employees
occurs where MFC = MRP
•Labour Demand is down sloping
D=MRP
0
Q1
Q2
Q3
Labour Input (workers per week)
Market demand for
labour in perfect
competition
16
“Shifters of Labour Demand”
• labour does not satisfy wants directly:
demand for resources is a
“Derived” Demand
and therefore depends on
1. How productive (MP) labour is
Non labour inputs, technological progress,
labour quality, prices of other resources
2.Price of the product
3.Price of other inputs
17
Market Supply of Labour
• To attract workers, the wage rate paid must
cover
– the opportunity costs of alternative uses of time
spent,
• in other labour markets,
• in house-hold activities
• in leisure.
• Higher wages attract people whose opportunity
costs are not covered at lower wages:
therefore the Supply of labour to any labour
market is upward sloping.
18
Supply Shifters
• The supply of labour changes
and the supply curve shifts if
– The adult population changes
– Technology and capital in the home
change
– Preferences change
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Wage Rate per Worker per Week ($)
Equilibrium Wage Rate:
Perfectly Competitive Labour Market
S
Surplus
498
The
wage adjusts so
Qn.D=Qn.S
Shifts of demand or
supply will change the
equilibrium wage and the
MRPL by the same amount
since they are always
equal
Shortage
D
0
Q1
Quantity of Labour
20
Labour Market: Perfect
Competition
Industry Labour
Market
The Firm: on the
demand side is a
price taker
Wage
Wage
S
w1
w1
SL
D
L1
Labour Input (workers per week)
21
Labour Input (workers per week)
Monopsony
A monopsony is a market in which there
is a single buyer.
• A monopsonist faces the Market Supply of
Labour
 To hire more labour, a higher wage must be
paid: marginal cost of labour (MFC) curve is
upward sloping.
To maximize profit the monopsonist hires
until the marginal cost of labour , that is ,
the marginal factor cost , is equal to the
marginal revenue product.
22
Supply of labour: monopsony in the hire of
labour
(1)
(2)
(3)
(4)
Units of Wage Total labor cost
Marginal
labor
rate
(wage bill)
factor(labour) cost
0
$5
$0
TFactorC/QL
$6
1
6
6
8
2
7
14
10
3
8
24
12
4
9
36
•the cost of an
extra worker :
MFC  the
wage rate by
the amount
needed to
bring the wage
rate of all
workers
currently
employed up to
the new wage.
14
5
10
50
16
6
11
66
23
MFC and MRP per Worker-Week ($)
Marginal Factor Cost :
Monopsonist: Profit Max Employment
MFC
MRP > W
S
E
We
Wm
MRP
Qm
Qe
Labour Input (worker-weeks)
•Monopsony
decreases the
level of
employment
and the wage
rate, compared
to perfect
competition
Hire Qm where
MFC = MRP and
pay Wm
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Monopsony Results
A monopsony reduces employment and
wages when compared to PC
• Provides rationale for regulation of
monopsony’s
Monopsonistic exploitation – workers are
paid a wage rate less than the
monopsonist’s revenues
• Programs such as work camps, free housing,
and after-education work contracts can benefit
the producers more than the workers
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Minimum Wage in Monopsony
• MFC follows suit
• To maximize profit, MFC =MRP
monopsony hires 75 hours at
$7.50 an hour.
• The minimum wage has
increased the wage rate by
$2.50 an hour and the amount
of labour employed by 25
hours a day.
Wage rate (dollars per hour)
• The supply now becomes
perfectly elastic at the minimum
wage
MFCL
S
10.00
7.50
Minimum wage
5.00
Increase in
employment
0
MRP = D
50
75
26
Labour (hours per day)
Imperfect Competition
2) Unions: Monopoly on the
Supply Side of the Labour Market
• In some markets, workers collectively “sell”
their labour through unions.
• Labour unions are worker/employee
organizations
• Engage in collective bargaining to establish a
contract which sets out
• Wages,fringe benefits, maximum work days, working
conditions
27
Unions: Goal, Increase Wages
• Suppose a union is formed in an otherwise
competitive market,
 the union is bargaining with a large
number of employers.
• Assume the major goal is to increase wages
• A variety of ways to achieve this
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Unions: Increase Wages
Wage increases and
more labour is hired
• 1) Increase
Demand for Labor.
• Often self-fulfilling, as
higher wages lead to
higher quality
– increase productivity
Wage Rate per Hour
– increase demand for
the product - union
label.
– Decrease demand for
alternatives
S
W1
We
E
D`
D
Qe
Q1
Quantity of Labour per Time Period
29
Unions: Increase Wages
S2
Labour Supply
• exclusive or craft
union:
– union that
comprises workers
of a given skill.
– occupational
licensing.
Wage Rate per Hour ($)
• 2) Restrict
E2
16
If union membership is
limited to Q1, wages
increase to $16 instead
of $15 when demand
increases
E3
15
E1
14
D2
S1
D1
Q1
Q2
Number of Workers per Time Period
30
Unions: Increase Wages
– union that seeks as
members all unskilled,
semi skilled & skilled
workers in a given
industry.
MRP=MFC
Wage Rate per Hour ($)
• 2) Restrict Labour
Supply.
• inclusive/ industrial
union:
Supply becomes
horizontal at the union
wage rate: MFC=Wu.
Su
Wu
SL
Wc
D=
MRP
Qu
Qc
31
Number of Workers per Time Period
Unions: Goal, Increase Wages
• Contracts for higher wages can be
negotiated via the THREAT of
reduced labour supply (ie: a strike)
• Control over the supply side of the
labour market is required here
32
Unions: Employ workers
want to employ
more workers
than at
equilibrium.
This requires,
however a
reduction in
wage from W1
to W2
Wage Rate per Hour ($)
• 2) A union may
E2
W1
This union goal is less
common due to the
decrease in wages for
employed workers
E3
W2
D2
S1
Q1
Q2
Number of Workers per Time Period
33
3.) Bilateral Monopoly
• In communities with a single major
employer, there is typically also a union.
A bilateral monopoly exists when a union
(monopoly seller) faces a monopsony buyer.
Wages are determined by bargaining.
34
3.) Bilateral Monopoly
MCL
• The monopsony
hires 50 hours and
pays $5/hour.
Wage rate (dollars per hour)
• The union may
agree to work 50
hours, but seeks the
highest wage rate
the employer can be
forced to pay —
$10/hour=MRPL
S
10.00
7.50
5.00
MRP
0
50
75
35
Labour (hours per day)
3.) Bilateral Monopoly
• The monopsony firm
and union bargain
over the wage rate
• It will settle between
$5 and $10/hour
(depending upon who
is stronger).
MCL
Wage rate (dollars per hour)
• It is unlikely the union
will get $10/hour or
that the firm can keep
wages at $5.00/hr.
S
10.00
7.50
5.00
MRP
0
50
75
Labour (hours per
36 day)
Wage Differentials
• If all labour was homogeneous and all jobs were
equally attractive, and all labour markets were
perfectly competitive, then all wages would be the
same……..
• Wages & earnings typically exhibit wide variations:
– 1) Labour Market Imperfections
– workers are not always mobile
– institutional restrictions – unions..
– discrimination – hiring practices model of labour market imperfection
another
37
Wage Differentials
– 2) Compensating Differences
–jobs vary in attractiveness
– 3) Non-competing Occupational Groups
–workers aren’t homogeneous, they
have different ability, different education
and training.
38
Union Benefits
– 1) Allows for increased productivity, skill and
efficiency
– 2) Reduce wage inequality
– 3) Reduce profits (transfer surplus to
workers)
– 4) Provide a voice for workers
– 5) Increase workforce stability (and job
security)
39
Union Drawbacks
– 1) Job security can lead to reduced productivity.
Free-riding = expecting others to work hard
Featherbedding = forcing employers to use more
workers than needed
– 2) Increase wage inequality between union and
non-union workers
– 3) Cause businesses with little economic profit to
fold, resulting in unemployment
– 4) Generally causes unemployment
– 5) Often prevents natural market mechanisms to
take place (ie: raises to hard workers, fire others)
40