Factors of production are the inputs used to produce goods and services.
The demand for a factor of production is a derived demand, as a result of decision to supply a good in
another market. Rather than being final goods ready to be enjoyed by consumers
Labor markets are different from most other markets because labor demand is a derived demand.
In study of labor demand by the firm, we set 2 assumptions:
1) Firm is competitive both in selling products and buying labor - price taker in both roles.
2) Firm is profit maximizing. - care only profit as decision making criteria.
Production function is the relationship between the quantity of the inputs used in production and the
quantity of output from production.
Marginal product of labor is the increase in the amount of output from an additional unit of labor.
Diminishing marginal product is the property whereby the marginal product of an input declines as the
quantity of the input increases.
Production function curve
To find the worker's contribution to revenue, we must convert the marginal product of labor (which is
measured in bushels of apples) into the value of the marginal product (which is measured in dollars).
Value of the marginal product is the marginal product of that input multiplied by the market price of the
output.
Marginal revenue product is the extra revenue the firm gets from hiring an additional unit of a factor of
production.
A competitive, profit-maximizing firm hires workers up to the point where the value of the marginal
product of labor equals the wage.
The value-of-marginal-product curve is the labor-demand curve for a competitive, profit-maximizing
firm.
Labor-demand curve
Labor demand curve shift due to
1) Output price change - apple price increase will hire more workers
2) Technological change - machine replace workers,
3) Supply of other factors (compliment input factors - supply of ladder for apple pickers)
The price of the firm's output is equal to the marginal cost of producing a unit of output.
When a competitive firm hires labor up to the point at which the value of the marginal product equals the
wage, it also produces up to the point at which the price equals marginal cost.
A profit-maximizing firm chooses the quantity of labor so that the value of the marginal product equals
the wage.
P × MPL = W
P = W/MPL
P = MC
Luddite refers to anyone who opposes technological progress
The labor-supply curve reflects how workers' decisions about the labor-leisure trade-off respond to a
change in that opportunity cost.
An upward-sloping labor supply curve means that an increase in the wage induces workers to increase the
quantity of labor they supply.
Labor-supply curve need not be upward sloping because at the higher wage, one might choose to work
fewer hours.
Causes that shift Labor-Supply curve
1) Changes in Taste - women work more than in the past.
2) Changes in Alternative Opportunities - pear picker's wage vs. apple pickers.
3) Immigration
Any event that changes the supply or demand for labor must change the equilibrium wage and the value
of the marginal product by the same amount because these must always be equal.
Shift in Labor Supply
Shift in Labor Demand
Highly productive workers are highly paid, and less productive workers are less highly paid because
wages equal productivity (measured by the value of the marginal product of labor.)
A monopsony is a market with one buyer. It hires fewer workers than would a competitive firm; by
reducing the number of jobs available, the monopsony firm moves along the labor supply curve, reducing
the wage it pays and raising its profits.
Capital refers to the stock of equipment and structures used for production. The accumulation of goods
produced in the past that are being used in the present to produce new goods and services. E.g. Ladder,
truck, building
Purchase price of land or capital is the price a person pays to own that factor of production indefinitely.
Rental price is the price a person pays to use that factor for a limited period of time.
Wage is the rental price of labor; same concept applies to the rental prices of land and capital. Like wage,
the firm increases the quantity hired of land and capital until the value of the factor's marginal product
equals the factor's price. Thus, the demand curve for each factor reflects the marginal productivity of that
factor.
The price paid to any factor of production—labor, land, or capital—equals the value of the marginal
product of that factor.
Capital income is the rent that households receive for the use of their capital.
Different forms of capital income are interest income to households lent money to firms through banks.
A stockholder is a person who has bought a share in the ownership of the firm and, therefore, is entitled to
share in the firm's profits.
Dividends are payments by a firm to the firm's stockholders.
A firm retain some earnings within the firm and use these earnings to buy additional capital.
Capital is paid according to the value of its marginal product, regardless of whether this income is
transmitted to households in the form of interest or dividends or whether it is kept within firms as retained
earnings.
Product of any factor depends on the quantity available of that factor.
Because of diminishing marginal product, a factor in abundant supply has a low marginal product and
thus a low price, and a factor in scarce supply has a high marginal product and a high price.
The supply of a factor falls, its equilibrium factor price rises.
Physical capital - manufactured productive resources such as equipment, buildings, tools, and machines
Human capital - the improvement in labor created by education and knowledge that is embodied in the
workforce
Factor distribution of income - the division of total income among labor, land, and capital
Value of the marginal product - the extra value of output that is generated by employing one more unit of
labor
VMPL = P * MPL
MPL is marginal product of labor
P is price per unit of output
Value of the marginal product curve - shows how the value of the marginal product of that factor depends
on the quantity of the factor employed
Equilibrium value of the marginal product - the additional value produced by the last unit of a factor
employed in the factor market as a whole
Rental rate - the cost, explicit or implicit, of using a unit of that asset for a given period of time
Marginal productivity theory of income distribution - every factor of production is paid its equilibrium
value of the marginal product
Compensating differentials - wage differences across jobs that reflect the fact that some jobs are less
pleasant than others
Unions - organizations of workers that try to raise wages and improve working conditions for their
members by bargaining collectively
Efficiency-wage model - some employers pay an above-equilibrium wage as an incentive for better
performance
Time allocation - how many hours to spend on different activities
Leisure - time available for purposes other than earning money to buy marketed goods
Individual labor supply curve - shows how the quantity of labor supplied by an individual depends on that
individual's wage rate