UNIT 5:
FACTOR MARKETS
Why does a coach get paid $6 million?
In this section we will examine:
1. Define derived demand
2. Define & graph Demand for Labor (DL) &
Supply for Labor (SL)
3. Define & graph Marginal Revenue Product
(MRP) and Marginal Resource Cost (MRC)
4. Effects of shifts in the market supply or
demand for resources
5. Define & graph a perfectly competitive
labor markets
6. Review & graph imperfectly competitive
labor markets
Basic View of Resource Market
Use supply and demand analysis to explain why
surgeons earn an average salary of $137,050 and
gardeners earn $13,560.
Supply and Demand For Surgeons
Supply and Demand For Gardeners
SL
Wage Rate
Wage Rate
Quantity of Workers
SL
DL
DL
Quantity of Workers
Basic Graphing in
Factor Markets
Factor Market Overview
Basic view of the market for resource is a
mirrored image of the product market.
SProduct
$10
SLabor
$10
5000
Industry
DP
QProduct
DLabor
5000
Industry
QResource/Labor
Vocab: Derived Demand
The demand for a factor of production is a
derived demand.
 It is derived from the demand for the goods
and services the factor of production is used
to produce.
 In other words, if the demand for a good such as wheat
increases, then the productivity increases, which leads
to an increase in labor.
Vocab: Derived Demand
The demand for a factor of production is a
derived demand.
SProduct
$10
SLabor
$10
DP
5000
Industry
DP
QProduct
DLabor
5000
Industry
QResource/Labor
Vocab: Derived Demand
The demand for a factor of production is a
derived demand.
SProduct SProduct
$10
SLabor
$10
5000
Industry
DP
QProduct
DLabor
5000
Industry
QResource/Labor
Shifters of Resource Demand
1.) Changes in the Demand for the Product
• Price increase of the product increases along
the MRP.
2.) Changes in Productivity
• Technological advances increase
Marginal Product and therefore
MRP.
3.) Changes in Price of Other Resources
• Substitute Resources
Ex: What happens to the demand for assembly
line workers if price of robots falls?
• Complementary Resources
Ex: What happens to the demand for nails if
the price of lumber increases significantly?
Introduction to
MRP & MRC
How many resources do we use?
How many resources to use?
Step 1: figure out how much more output an added unit of input
will generate (MPP)
Marginal Physical Product (MPP): the additional output that an additional
unit of input (usually labor) produces.
Step 2: figure out how much the additional output is actually
worth to the firm (MRP)
Marginal Revenue Product (MRP): is the value the additional output
generated by the last unit of input.
Step 3: figure out how much the additional input will cost the firm
Marginal Factor Cost (MFC): is the cost the additional input generated for
the firm.
Step 4: determine how many units of input to hire
Marginal Physical Product (MPP)
The additional unit produced when one more
factor of production is used.
 It is a measure of effieciency in finshed
products, per unit of resource used.
MPP
=
Marginal
Product
x
Marginal
Resource
What happens in the
short-run, given that
one input is fixed?
MPP
Value of Marginal Product (VMP)
Value of Marginal Product (VMP) is the value of
goods produced by hiring one more unit of labor.
 The value of marginal product is simply:
Value of
Marginal
Product
=
Marginal
Product
x
Price of
those
additional
units
Marginal Revenue Product (MRP)
Marginal Revenue Product (MRP) is the change in
revenue that results from the addition of one extra
unit when all other resources are kept equal.
 The MRP is often used to calculate the affect of
adding employees, as companies want to add
employees up to the point at which additional
labor won't bring in enough revenue to cover
costs.
Marginal Revenue Product (MRP)
Marginal Revenue Product (MRP):
 The additional revenue generated by an additional worker
(resource).
 Another way to calculate MRP is:
Change in
Total Revenue
Marginal
Revenue
Product
=
Marginal
Revenue
Product
=
Change in
Inputs
Marginal Revenue
x
How much are those
unit of labor worth in
term of additional
revenue?
Marginal Product
Are MRP & VMP the same?
MRP = VMP: but not always
Notice that VMP = MRP: this
is ONLY true for perfect
competitors
Assumes $3 per wash.
Marginal
Revenue
Product = VMP
Are MRP & VMP the same?
MRP versus VMP
Notice that VMP > MRP:
this is true for monopolies
Assumes different prices
per wash.
P
VMP
MRP
$40
$8
$40
$40
$63
$7
$28
$23
$72
$6
$18
$9
$56
$4
$8
-$16
$15
$1
$1
-$41
TR
MRP Curve
Marginal Revenue Product:
The orange line
is the firm’s value
of the marginal
revenue product
of labor curve.
Also called the marginal
revenue product curve.
Assumes $3 per wash.
Thus the demand
for labor is the
marginal revenue
product curve.
Note: the VMP is the same as the
MRP ONLY in perfectly competitive
labor markets
DL=MRP
Marginal Resource Cost (MRC)
Marginal Resource Cost (MRC):
The additional cost of an additional resource.
Another way to calculate MRC is:
Marginal
Resource
Cost
=
Change in
Total Cost
Change in
Inputs
How much extra does
each resource cost
me?
Marginal Cost of Labor (MCL)
Marginal Cost Labor (MCL):
The additional cost of an additional worker.
Another way to calculate MCL is:
Marginal
Cost Labor
=
Change in
Total Cost
Change in
Labor
How much extra does
each laborer cost me?
MRP = MRC RULE
How do you know how many resources
(workers) to employ?
Continue to hire until…
MRP = MRC
How many resources to use?
Step 1: figure out how much more output an added unit of input
will generate (MPP)
Marginal Physical Product (MPP): the additional output that an additional
unit of input (usually labor) produces.
Step 2: figure out how much the additional output is actually
worth to the firm (MRP)
Marginal Revenue Product (MRP): is the value the additional output
generated by the last unit of input.
Step 3: figure out how much the additional input will cost the firm
Marginal Factor Cost (MFC): is the cost the additional input generated for
the firm.
Step 4: determine how many units of input to hire
In our example, let’s assume a perfectly
competitive resource market.
PERFECTLY COMPETITIVE
LABOR MARKET
We are stuck making
the same wage as
everyone else in this
labor market!
Types of Factor Markets
Perfect
Competition
Monopsony
Perfectly Competitive Labor Market
Characteristics:
 Many small firms are hiring workers
 No one firm is large enough to manipulate
the market.
 Many workers with identical skills
 Wage is constant: firms are wage takers
 Firms can hire as many workers as they
want at a wage set by the industry
Types of Factor Markets
Perfect
Competition
Monopsony
Perfectly Competitive Labor Market
Number of
Workers Wanted
1
2
3
4
Wage that Must Be Paid
To Attract an Extra Worker
$4.00
$4.00
$4.00
$4.00
Marginal Cost of Labor
(MCL)
+$4.00
+$4.00
+$4.00
+$4.00
MRC = Wage
same as
MCL = Wage
Perfectly Competitive Labor Market
Generally this condition is found in low skilled labor markets.
SL Wage
Wage
WE
SL=MRC
DL=MRP
DL
QE
Industry
Q
Qe
Firm
Q
Perfectly Competitive Labor Market
What happens to the wage and quantity in the market
and firm if new workers enter the industry?
SL Wage
SL1
Wage
WE
SL=MRC
W1
SL1=MRC1
DL=MRP
DL
QE Q1
Industry
Q
Qe Q1
Firm
Q
Perfectly Competitive Labor Market
Suxs to be
a Wage
Taker
United
Auto
Workers
I am stuck
making the
same wage as
everyone else!
In perfectly competitive labor markets there
is sometimes the pressure to unionize workers in
an effort to increase the wage above the market
equilibrium wage.
Practice: What should the firm do –
hire more, hire less, or stay put?
1. MRPL = $15; PL = $6 2. MRPL = $10; PL = $10
MORE
STAY PUT
2. MRPL = $5; PL = $10 4. MRPL = $10; PL = $15
LESS
LESS
3. MRPL = $25; PL = $20 6. MRPL = $15; PL = $15
MORE
STAY PUT
4. MRPL = $12; PL = $12 8. MRPL = $50; PL = $40
STAY PUT
MORE
PRACTICE MRP = MRC RULE
How do you know how many resources
(workers) to employ?
This example
assumes a
perfectly
competitive
labor market.
More on this
later
Wage = $20
Quantity of
Workers
0
1
2
3
4
5
6
7
Total
Product
(Pizzas)
0
2
7
10
12
13
13
10
PIZZA
Price =
(only 1 Oven)
Marginal
Physical
Product
Marginal
Revenue
Product
-
-
This example
assumes a
perfectly
competitive product
$10
market
Marginal
Resource
Cost
PRACTICE MRP = MRC RULE
How do you know how many resources
(workers) to employ?
Wage = $20
Quantity of
Workers
The firm should
NOT hire more
than 4 workers.
(MRP = MRC)
Thus this logic
applies to all
inputs.
0
1
2
3
4
5
6
7
PIZZA
Price = $10
(only 1 Oven)
(Pizzas)
Marginal
Physical
Product
Marginal
Revenue
Product
0
2
7
10
12
13
13
10
2
5
3
2
1
0
-3
20
50
30
20
10
Total
Product
0
-30
Marginal
Resource
Cost
20
20
20
20
20
20
20
PRACTICE MRP = MRC RULE
Note: One would not stop hiring here
since there is additional marginal
revenue per unit of product to achieve.
The firm will stop hiring inputs at the 4th
worker since any more workers (given
current other fixed inputs) will result in
diminished returns on the marginal unit
produced.
Wage
LABOR MARKET
SL
$20
FIRM
Wage
SL=MRC
$20
DL
100
Quantity of
Labor
As long as MRP >
MRC the firm will
continue to hire inputs
DL=MRP
4
Quantity of
Labor
PRACTICE MRP = MRC RULE
Practice
1. If the price of labor is $25, how many units of labor should be
employed?
PRACTICE MRP = MRC RULE
IMPERFECT LABOR MARKET
Monopsony
Types of Factor Markets
Perfect
Competition
Monopsony
Monopsony Labor Market
Monopsonist (Greek: mono”single” - opsonia”purchase”)
Characteristics:
 Few large firms are hiring workers
 One firm is large enough to manipulate the labor
market.
 Wage is NOT constant: firms are wage makers

If the monopsonist wants to increase the number of
workers that it hires, it must increase the wage that it
pays to all of its workers, including those whom it
currently employs.
Imperfect Labor Market
Monopsonist (Greek: mono”single” - opsonia”purchase”)
An employer is said to be a monopsonist if the
employer must increase the wage offered to
workers in order to attract additional workers.
There are two types of monopsonists:
1. A non-discriminating monopsonist is an employer
who must increase the wage offered to workers in
order to attract more workers.
2. A discriminating monopsonist is one that pays the
higher wage only to the extra worker for whom the
employer raised the wage. Could be illegal!!
Imperfect Labor Market
Monopsonist
Non-discriminating monopsonist: true cost to the firm of adding an extra
worker (MRC) will be greater than the wage paid to that worker. [MRC > Wage]
Number of
Workers Wanted
1
2
3
4
Wage that Must Be Paid
To Attract an Extra Worker
$4.00
$4.10
$4.20
$4.30
MRC
Marginal Cost of Labor
MRC
(MCL)
+$4.00
+$4.20
+$4.40
+$4.60
Basic View of MRP & MRC
Most beneficial
amount of
inputs to
employ.
MRC
SLabor
This would be the
socially optimal
wage.
$10
MRP = DLabor
It is almost a
mirrored image of
the product market
graph.
5000
Firm
QLabor
Imperfect Labor Market
Monopsonist
Non-discriminating monopsonist: true cost to the firm of adding an extra
worker (MRC) will be greater than the wage paid to that worker. [MRC > Wage]
MRC doesn’t
equal wage
MRC = MRP
Imperfect Labor Market
Monopsonist
Deadweight Loss: only in imperfect resource market, does one find less than
socially optimal resource employment levels and costs.
DWL
LEAST COST RULE
Up to this point we have analyzed the use
of only one resource.
What about when a firm wants to
combine different resources?
MPx = MPy
Px
Py
Least Cost Rule
$10
How much additional output does each
resource generate per dollar spent?
MP
MP/PR
(Robots)
(PriceR =$10)
1
30
3
2
20
3
4
Robots
$5
MP
MP/PW
(Workers)
(PriceW =$5)
1
20
4
2
2
15
3
10
1
3
10
2
5
.50
4
5
1
Workers
If you only have $35, the best combination is
2 robots and 3 workers
Least Cost Rule
MPx = MPy
Px
Py
$10
MP
MP/PR
(Robots)
(PriceR =$10)
1
30
3
2
20
3
4
Robots
$5
MP
MP/PW
(Workers)
(PriceW =$5)
1
20
4
2
2
15
3
10
1
3
10
2
5
.50
4
5
1
Workers
If you only have $35, the best combination is
2 robots and 3 workers
Profit Maximizing Rule for a Combining
Resources
MRPx = MRPy
=
MRCx MRCy
1
This means that the firm is
employing resources where
MRP = MRC for each resource.
The Labor Market:
Minimum Wage Laws &
Unions
How can raising
minimum wage
cause higher
unemployment?
The Labor Market:
Perfectly Competitive Labor Market
Generally this condition is found in low skilled labor markets.
Wage
Surplus
of Labor
SL Wage
If viewed to be too low. The
government attempts to
adjust the wage.
$10
Minimum
Wage
Wminimum
WE
SL=MRC
DL=MRP
DL
QDL QE QSL Q
Industry
Qmin Qe
Q
Unionized Labor Market
1. A labor union restricts
the supply of labor and
the supply of labor
curve shifts leftward
to LS1.
2. The wage rate rises to
$15 an hour, but
employment
decreases to 200
workers.
3. Jobs are traded off for
a higher wage rate.
Unionized Labor Market
4. If union action increases
labor productivity, the
demand for union labor
increases and the
demand for labor curve
shifts rightward to LD1.
5. The wage rate rises to
$20 an hour and
employment increases
to 250 workers.
2010 Practice FRQ
51
Shifters of Resource Demand
S=MRC
P2
P1
D=MRP
D=MRP
Q1
Q2
QResource
Imperfect Labor Market
Monopsonist
Discriminating monopsonist: true cost to the firm of adding an extra worker
(MRC) will be equal to the wage paid to that worker. [MRC = Wage]
Number of
Workers Wanted
1
2
3
4
Wage that Must Be Paid
To Attract an Extra Worker
$4.00
$4.10
$4.20
$4.30
S=MRC
Marginal Cost of Labor
MRC
(MCL)
+$4.00
+$4.10
+$4.20
+$4.30
We could go
elsewhere, so
what are you
going to pay me?
You will need
to pay me
more than the
other guy.
Imperfect Labor Market
Monopsonist
Non-discriminating monopsonist: true cost to the firm of adding an extra
worker (MRC) will be greater than the wage paid to that worker. [MRC > Wage]
Acme Coal Mining Co.
Wage rate
(per hour)
Number of
Workers
Marginal
Resource Cost
$4.00
0
-
4.50
1
$4.50
5.00
2
5.50
5.50
3
6.50
6.00
4
7.50
7.00
5
11
8.00
6
13
9.00
7
15
10.00
8
17
MRC doesn’t
equal wage
MRC = MRP