Unit IV: Factor Markets

Factor Markets• When firms need to purchase a factor of

production, they buy them from the factor market.

Derived Demand

• A firm’s demand for a factor of production is derived from its decision to supply a good in another market.

• If Q increases in the product market at every price, demand in the factor market will increase

• If Q decreases in the product market at every price, demand in the factor market will decrease

Changes in demand in the factor market• If people really demand more horses in

parades…• Then the city will buy more horses in the

factor markets

The Labor Market

What is the lowest wage you would be willing to do this job…

The Labor Market

• Made up of firms and workers• Demand– Employers willingness to hire a worker at each

given wage

• Supply– Workers willingness to work at each given wage

Scenarios• Market = gym shoes– The majority of the public now prefers to wear

sandals. What happens to the wage and quantity of sweatshop gym shoe workers?

• The baby boomers become of working age. What happens to the wage and quantity of the general labor market.

• Market = basketballs– Nike is gaining more and more of the market

power. What will happen to the wage and quantity of Spalding workers.

Derived Demand Activity• On a separate sheet of blank paper, please do

the following:– Write a specific product market and affiliated

factor market (Adidas shoes and Rubber)– Write a scenario that will affect the product

market (Adidas spends 50 million dollars on a new advertisement campaign).

– MAKE IT UNIQUE BUT NOT CONFUSING!– Pass the paper behind you (group at the end…

walk to the front)

Partner Activity

• Read your market and the scenario.• Determine how this will impact the markets.• Then, graph and provide a written description

of the market change.– What happens to price/wage?– What happens to quantity?

Bringing it Back

• Each group will read their market and scenario they received. – Every student must write the market and scenario

they hear in their notes

• Each group will then explain the affect the scenario had on their labor market.– Every student must write the effect in their notes.

Hiring Decision

First, we need to learn some important terms

What is marginal product?

When an additional input is used, how

does that impact the total product?

So what is the marginal product of_____________?

Land

TimeSeeds

Labor

The Marginal Product of Labor (MPL)

• Change in the amount of output from an additional unit of labor.

The Production Function

Productionfunction

Quantity ofApple Pickers

0

Quantityof Apples

300280

240

180

100

1 2 3 4 5

What is the MPL of the 2nd worker?

Answer = 80 Apples

The Production Function

Productionfunction

Quantity ofApple Pickers

0

Quantityof Apples

300280

240

180

100

1 2 3 4 5

Notice that the MPL decreases as the quantity of workers is increased

The Marginal Resource Cost (MRC)• How much an additional input costs

The Value of the Marginal Product

• This is also called marginal revenue product or MRP. (Most people use this term)

• How much additional revenue is earned when one more input is added.

• Marginal Product X Price• It also eventually diminishes as the number of

inputs increase

Market for Apples

Total Revenue

Quantity ofApple Pickers

0

Quantity

300280

240

180

100

1 2 3 4 5

What is the MRP of the 3rd worker??

Answer = $60

Market for Apples

Total Revnue

Quantity ofApple Pickers

0

Quantity

300280

240

180

100

1 2 3 4 5

Notice, the MRP of labor decreases as more workers are added

How would you determine how

many farmers to hire?

Profit Maximizing Firm in Labor Market

• Hire workers where MRP = MRC• Never hire a worker if their MRP is less than

their MRC (wage)!• The MRP of labor (MRPL) curve is the labor

demand curve for a profit-maximizing firm.

MRP Curve

0 Quantity ofApple Pickers

0

Wage

Marginal revenue product(demand curve for labor)

Marketwage

Profit-maximizing quantity

Competitive Firm

Worksheet Practice…

Economic Rent

How much would you have to be paid per hour to work this job?

Economic Rent• An excess payment made for a factor of production

above the amount expected by its owner.• On a graph, the “price” for any physical capital is

“rent” or “R”

I would gladly rent out this building for

$50,000 a year.

But, a firm is willing to give me $150,000

a year!

The economic rent for this building to

the firm is $100,000

Least Cost Combination

Alternative Input CombinationsHow do firms decide how many different

combinations of inputs to use?

If you were the grocery store owner, which combination would you choose?

• 20 self-checkout stations

• 4 cashiers

• 10 self-checkout stations

• 10 cashiers

Costs to the firm1 self-checkout station = $2,000

1 cashier = $1,600

Option A Option B

Cost-Minimization Rule• The firm would add and subtract each input

until the marginal product of the first input per dollar spent is the same as the marginal product of the second input per dollar spent

• Because of diminishing marginal returns:– If the number is too high, the firm would increase

that input– If the number is too low, the firm would decrease

that input

MP(input 1) / MRC(input 1) = MP(input 2) / MRC(input 2)

Lets do two practice scenarios

Scenario 1

• Lets do an example of when the marginal product of labor per dollar is more than the marginal product of capital per dollar– Marginal product of labor = 20 units– Marginal product of capital = 100 units– Wage = $10– Rental rate for capital = $100

MP(input 1) / MRC(input 1) = MP(input 2) / MRC(input 2)MPL / Wage = MPK / Rent

Scenario 1

• The firm would hire more workers and use less capital

• This would lower the MP of labor per dollar and increase the MP of capital per dollar

MPL / Wage = MPK / Rent

2 units of output per dollar spent on labor > 1 unit of output per dollar spent on capital

Scenario 2

• Lets do an example of when the marginal product of labor per dollar is less than the marginal product of capital per dollar– Marginal product of labor = 20 units– Marginal product of capital = 100 units– Wage = $10– Rental rate for capital = $25

MPL / Wage = MPK / Rent

Scenario 2

• This hire would use less workers and rent more capital– This would increase the MPL/Wage– This would decrease the MPK/Rental rateMPL / Wage = MPK / Rent

2 units of output per dollar spent on labor < 4 unit of output per dollar spent on capital