Factor Markets

David MayerAP Microeconomics

Winston Churchill High SchoolSan Antonio, Texas

Factor Demand

• The factors of production are– Land– Labor– Capital– Entrepreneurship

• Producers demand the factors of production in order to supply goods and services in the product market

• In order to understand factor demand we will focus on the demand for labor.

• Marginal Revenue Product (MRP)

• MRP = ∆ Total Revenue / ∆ Input

• MRP = MR*MPL=P * MPL

• MRP = Demand for Labor

• Marginal Resource Cost (MRC)

• MRC = ∆ Total Resource Cost / ∆ Input

• MRC = Wage

• MRC = Supply of Labor to a competitive firm

The Perfectly Competitive Firm’s Market for Labor

The Perfectly Competitive Firm’s Market for Labor

Price of Labor

Quantity of Labor

MRC = Wage = Supply of Labor

MRPL= Demand for Labor

Q

w

Determinants of Resource Demand• Product Demand (creates Derived Demand)• Productivity of Labor– Access to physical capital– Increased technology– Improvements in human capital

• Price of other resources– Substitute Resource• Substitution effect• Output effect

– Complementary resources

Change in Resource Demand

Price of Labor

Quantity of Labor

MRC

MRPL

Q

w

Assume the price (P) of a competitive firm’s product increases. Because MRPL = P * MPL .: MRPL will increase… P↑ .: MRPL↑ .: Quantity of labor employed ↑

→

MRPL1

Q1

Least-Cost Hiring Rule

• Given a budget constraint, what is the least costly combination of labor and capital that will generate a maximum level of output ?

• MPL/PL = MPK/PK = MPL/MPK = PL/PK

• If MPL/PL > MPK/PK , then the firm will hire more labor and employ less capital until MPL/PL = MPK/PK

• If MPL/PL < MPK/PK , then the firm will employ more capital and employ less labor until MPL/PL = MPK/PK

Labor Market

Price of Labor

Quantity of Labor

Supply of Labor

Q

w

Demand for Labor

Imperfect Competition in the Product Market (Monopoly)

• For a monopolist in the product market MR<P, so in the factor market MRPM < MRPC

Price of Labor

Quantity of Labor

MRC

MRPC

QC

w

MRPM

QM

Imperfect Competition in the Factor Market (Monopsony)

• Unlike a monopoly, which is the sole producer of a good or service, a monopsonist is the sole consumer of a good or service. In the factor market this leads to a condition where the MRC > Wage.

Price of Labor

Quantity of Labor

Supply of Labor

Qc

wc

MRP

MRC

Qm

wm