Micro Unit IV
Chapters 25, 26, and 27
The economic concepts are similar to those for product markets.
2. The demand for a factor of production is derived from the demand
for the good or service produced from this resource.
3. A firm tries to hire additional units of a resource up to the point
where the resource’s marginal revenue product (MRP) is equal to
its marginal resource cost (MRC).
4. In hiring labor, a perfectly competitive firm will do best if it hires
up to the point where MRP = the wage rate.Wages are the marginal
resource cost of labor.
1.
5. If you want a high wage:
A. Make something people will pay a lot for.
B. Work for a highly productive firm.
C. Be in relatively short supply.
D. Invest in your human capital.
6. Real wages depend on productivity.
7. Productivity depends on real or physical capital, human capital,
labor quality and technology.
 Labor markets, like other markets in the economy, are governed by the
forces of supply and demand.
 Demand depends on
 Productivity of the resource in helping to create a good or service
 The market value or price of the good or service it helps produce
(a) The Market for Apples
(b) The Market for Apple Pickers
Price of
Apples
Wage of
Apple
Pickers
Supply
P
Supply
W
Demand
Demand
0
Q
Quantity of
Apples
0
L
Quantity of
Apple Pickers
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 Most labor services, rather than being final goods ready to be enjoyed by
consumers, are inputs into the production of other goods.
 The production function illustrates the relationship between the quantity
of inputs used and the quantity of output of a good.
Copyright©2004 South-Western
Quantity
of Apples
Production
function
300
280
240
180
100
0
1
2
3
4
5
Quantity of
Apple Pickers
Copyright©2003 Southwestern/Thomson Learning
 The marginal product of labor is the increase in the amount of output
from an additional unit of labor.
 MP = Q/L
 MP = (Q2 – Q1)/(L2 – L1)
 Diminishing Marginal Product of Labor
 As the number of workers increases, the marginal product of labor declines.
 As more and more workers are hired, each additional worker contributes less
to production than the prior one.
 The production function becomes flatter as the number of workers rises.
 This property is called diminishing marginal product.
 Diminishing marginal product refers to the property whereby the
marginal product of an input declines as the quantity of the input
increases.
Quantity
of Apples
Production
function
300
280
240
180
100
0
1
2
3
4
5
Quantity of
Apple Pickers
Copyright©2003 Southwestern/Thomson Learning
 The value of the marginal product of labor
(Marginal Revenue Product) is the marginal product
of the input multiplied by the market price of the output
in a perfectly competitive product market.
MRP = MP  P
 In an imperfectly competitive product market, it is the
change in TR divided by change in resource quantity.
∆𝑇𝑅
𝑀𝑅𝑃 =
∆𝑄𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒
 The value of the marginal product (also known as marginal revenue
product) is measured in dollars.
 It is the marginal benefit of hiring one more worker.
 It diminishes as the number of workers rises because the market price of
the good is constant.
 The marginal-revenue-product curve is the labor demand curve for a
competitive, profit-maximizing firm.
 Marginal Resource Cost (MRC) or Marginal Factor Cost (MFC) is the extra
cost for one additional unit of resource (labor, capital, etc.)
∆𝑡𝑜𝑡𝑎𝑙 𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒 𝑐𝑜𝑠𝑡
𝑀𝑅𝐶 =
∆𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
 The profit maximizing rule of life
 MC=MB
 To maximize profit, the competitive, profit-
maximizing firm hires workers up to the point where
the marginal revenue product (MB) of labor equals the
marginal resource cost (MC)
MRP = MRC
 When MRP=MRC, the firm produces an output where MC=MR
MRP
Market
Wage
(MRC)
MRP
(demand curve for labor)
0
Profit-maximizing quantity
Quantity of
Apple Pickers
Copyright©2003 Southwestern/Thomson Learning
 Combining Capital and Labor
 Profit Max
MRPL/PL = MRPC/PC = 1
 Least Cost
MPL/PL = MPC/PC
 Output Price
 Technological Change
 Productivity of the resource
 Supply of Other factors
 STOP HERE!
 The labor supply curve reflects how workers’ decisions about the labor-
leisure tradeoff respond to changes in opportunity cost.
 An upward-sloping labor supply curve means that an increase in the
wages induces workers to increase the quantity of labor they supply.
Wage
(MRC)
Supply
0
Quantity of
Labor
Copyright©2003 Southwestern/Thomson Learning
 Changes in Tastes
 Changes in Alternative Opportunities
 Immigration
 The wage adjusts to balance the supply and demand for labor.
 The wage equals the value of the marginal product of labor.
Wage
(price of
labor)
Supply
Equilibrium
wage, W
Demand
0
Equilibrium
employment, L
Quantity of
Labor
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 Labor supply and labor demand determine the equilibrium wage.
 Shifts in the supply or demand curve for labor cause the equilibrium wage
to change.
Wage
(price of
labor)
1. An increase in
labor supply . . .
Supply, S
S
W
W
2. . . . reduces
the wage . . .
Demand
0
L
Quantity of
Labor
3. . . . and raises employment.
L
Copyright©2003 Southwestern/Thomson Learning
 An increase in the supply of labor :
 Results in a surplus of labor.
 Puts downward pressure on wages.
 Makes it profitable for firms to hire more workers.
 Results in diminishing marginal product.
 Lowers the value of the marginal product.
 Gives a new equilibrium.
Wage
(price of
labor)
Supply
W
1. An increase in
labor demand . . .
W
2. . . . increases
the wage . . .
D
Demand, D
0
L
Quantity of
Labor
3. . . . and increases employment.
L
Copyright©2003 Southwestern/Thomson Learning
 An increase in the demand for labor :
 Makes it profitable for firms to hire more workers.
 Puts upward pressure on wages.
 Raises the value of the marginal product.
 Gives a new equilibrium.
Copyright©2004 South-Western
 Capital refers to the equipment and structures used to produce goods and
services.
 The economy’s capital represents the accumulation of goods produced in the
past that are being used in the present to produce new goods and services.
 Prices of Land and Capital
 The purchase price is what a person pays to own a factor of production
indefinitely.
 The rental price is what a person pays to use a factor of production for a
limited period of time.
 The rental price of land and the rental price of capital are determined by
supply and demand.
 The firm increases the quantity hired until the value of the factor’s marginal
product equals the factor’s price.
(a) The Market for Land
Rental
Price of
Land
(b) The Market for Capital
Rental
Price of
Capital
Supply
P
Supply
P
Demand
Demand
0
Q
Quantity of
Land
0
Q
Quantity of
Capital
Copyright©2003 Southwestern/Thomson Learning
 Each factor’s rental price must equal the value of its marginal product.
 They each earn the value of their marginal contribution to the production
process.
 Factors of production are used together.
 The marginal product of any one factor depends on the quantities of all
factors that are available.
 A change in the supply of one factor alters the earnings of all the factors.
 A change in earnings of any factor can be found by analyzing the impact
of the event on the value of the marginal product of that factor.
The Effects of Resource Market Structure on Wages and Employment
Unit 4 : Microeconomics
National Council on Economic Education
 Why is the market labor demand
curve downward sloping?
 Why is the market labor supply
curve upward sloping?
 Why is the labor supply to a firm
horizontal?
 The firm can hire all the labor it
wants at the market wage; it does
not have to raise the wage to
attract more labor.
 A monopsony is the sole buyer of labor and must offer a higher wage to
attract more workers.
 The basic hiring rule applies to any firm, regardless of whether it buys labor
in a perfectly competitive or a monopsonistic labor market: Hire where MRP
= MRC.
 Since the firm pays the market wage to all workers in a perfectly competitive
labor market, that firm can also use the hiring rule of MRP = wage.
 A monopsony must stick with the MRP = MRC rule because the wage is less
than the MRC for a monopsonist.
 The firm’s marginal resource cost from adding another unit of labor is
greater than the wage paid to that labor unit.
 The firm determines its profit-
maximizing quantity of labor
where MRP = MRC.
 Its optimal wage comes from the
labor supply curve at that quantity
of labor.
Unit 4 : Microeconomics
National Council on Economic Education
Unit 4 : Microeconomics
National Council on Economic Education
 Determination of rent, like wages, occurs within context of supply &
demand factors and institutional circumstances
 Economic rent: The price paid for the use of land and other natural
resources, the supply of which is fixed (perfectly inelastic)
 Rent usually accorded special treatment because of inelasticity of supply
of land and other natural resources
 This aspect of natural resources has attracted attention of economists
since days of the Physiocrats, has led to controversial issues in economic
theory and public policy
 Physiocrats believed wealth of nations came solely from agriculture and land
development, agricultural goods should be highly priced
 Other examples: Henry George’s single-tax movement, urban-renewal
programs, “obscene profits” of landlords and oil industry
 MAJOR THEORITCAL POINT TO UNDERSTAND: when the supply of
a factor is perfectly inelastic, price paid to that factor cannot provide
incentive to produce more
 Economists refer to such a factor as a surplus or as economic rent.
 Amount of economic rent received by owners of land and other factors
fixed in supply is determined by productivity of each factor
 Henry George and others argued that, since a tax on land or any other
factor with fixed supply doesn’t affect amount of that factor available to
society, all economic rent could be taxed away with no cost to society
 Critics of this theory point out that rent is a cost to individuals because
the supply of land for any one use is not perfectly inelastic.
 Users of land, just as with other factors of production, must bid the land
away from alternative uses
 Therefore, rent is merely a cost of production
 Scenario 1:
Agricultural land near a large city was selling for $3,000 an acre last
year. Now a subdivision is being developed on this land, and it is selling for
$50,000 an acre. Why did the price rise so dramatically? Do you think it is
fair that the owners of this land reaped such a large and sudden return for
no effort on their part?
 Scenario 2:
A professional basketball player earns $850,000 a year. The next-best
alternative for this player might be as a high school coach for $40,000 a year.
Should $810,000 of his current salary be considered wages or rent (an
economic surplus)? If a large part of the wages and salaries of many highly
paid athletes, entertainers and others is considered as economic-surplus
payments (not necessary to attract people into a particular line of work),
does this suggest that such incomes should be taxed heavily?
 The interest rate is the price paid for the use of money (loanable funds).
 Like other prices, the price of money (an interest rate) is determined by
the supply of and demand for loanable funds.
 A real interest rate is the nominal rate of interest minus inflation.
 Real interest rates influence investment decisions.