Principles of MicroeconomicsModule 6

Market for Inputs in Production

Factors of Production• Factorsofproduction:theinputsusedtoproducegoodsandservices.

• ProductionFunction:Relationshipbetweenquantityofinputs(orfactorsofproduction)andtotaloutput

Q=f(Land,Labor,Capital)

Determining Production

Example:Q=100K+25L

Ifthefirmincreasescapital(K)itwillincreaseproduction(Q)Ifthefirmincreaseslabor(L)itwillincreaseproduction(Q)

• Demandforfactorsofproductioncomesfromthefirm• Supplyoffactorsofproductioncomesfromthehousehold

Demand for Factors of Production• Firmsdemandinputstoproducegoodsandservices• Buttheirdemandisbasedonthedemandofotherpeopleforthegoodtheyareproducing• Ifmanypeoplewanttobuytheirgood– needlotsofinputstoproducealargequantitytomeetthedemand• Ifdemandislow– theydon’tneedtoproduceasmuch

àDerivedDemandforfactorsofproduction• Firm’sdemandforinputsisderived fromconsumers’demandfortheirproduct

Demand for Labor

• MarginalPhysicalProductofLabor(MPL)explainswhysomepeopleearnmorethanothers• Someworkersaremoreproductive:• Experience• Education/Training• Accesstolatestproductiontechnology

Demand for Labor

Marginal Product of Labor

Labor Output MPL ValueofMPL(MPL*Price)

Wageperworker(daily)

MarginalProfit

0 0

1 50

2 90

3 120

4 140

5 150

7 150

Supposewehaveasmallcompanymakingtoasters.Thepriceofeachtoasteris$10.Assumeeachworkerispaid$100perday

Marginal Product of Labor

Labor Output MPL ValueofMPL(MPL*Price)

Wageperworker(daily)

MarginalProfit

0 0

1 50 50

2 90 40

3 120 30

4 140 20

5 150 10

6 150 0

Supposewehaveasmallcompanymakingtoasters.Thepriceofeachtoasteris$10.Assumeeachworkerispaid$100perday

Marginal Product of Labor

Labor Output MPL ValueofMPL(MPL*Price)

Wageperworker(daily)

MarginalProfit

0 0

1 50 50 $500

2 90 40 $400

3 120 30 $300

4 140 20 $200

5 150 10 $100

6 150 0 $0

Supposewehaveasmallcompanymakingtoasters. Thepriceofeachtoaster is$10.Assumeeachworker ispaid$100perday

Marginal Product of Labor

Labor Output MPL ValueofMPL(MPL*Price)

Wageperworker(daily)

MarginalProfit

0 0

1 50 50 $500 $100

2 90 40 $400 $100

3 120 30 $300 $100

4 140 20 $200 $100

5 150 10 $100 $100

6 150 0 $0 $100

Supposewehaveasmallcompanymakingtoasters. Thepriceofeachtoaster is$10.Assumeeachworker ispaid$100perday

MarginalProductofLabor

Labor Output MPL ValueofMPL(MPL*Price)

Wageperworker(daily)

MarginalProfit

0 0

1 50 50 $500 $100 $400

2 90 40 $400 $100 $300

3 120 30 $300 $100 $200

4 140 20 $200 $100 $100

5 150 10 $100 $100 $0

6 150 0 $0 $100 -$100

Supposewehaveasmallcompanymakingtoasters. Thepriceofeachtoaster is$10.Assumeeachworker ispaid$100perday

Value of Marginal Product of Labor• ValueofMPLà thevalueofthelastunitproducedbytheadditionalworker• Alsoknownas:MarginalRevenueProduct(MRP)orMarginalValueProduct• IncompetitivemarketsMRP=P*MPL becausefirmsarepricetakersandthepricealsoreflectsmarginalrevenue

Demand for LaborValueofMPL

QuantityofLabor

DemandbyFirms

$500

$400

$300

$200

$100

$0 MarketWageRate$100

1 23 45

Wageofeachworker=ValueofoutputtheyeachproduceWage=ValueofMPL

ValueofMPL:Firm’swillingnesstopayforlabor

Diminishing Marginal Returns to LaborOutputisincreasingatadecreasingrateiffirmincreasesonlyoneinputEachworkeraddstoproduction,butlessandless

Labor Output MPL0 01 50 502 90 403 120 304 140 205 150 106 150 0 01234567

150

140

130

120

90

50

0

Shifts in Demand for Labor1. Changeinoutputprice

• Priceofgoodincreasesà• Firmwillproducemoreà• Demandmorelabor

• ValueofMPLgoesup!

ValueofMPL

QuantityofLabor

D.1

$500

$400

$300

$200

$100

$0

1 23 45

D.2

Shifts in Demand for Labor

2.TechnologicalChange• Techprogressà workersmoreproductiveà firmneedslesslabor

3.Supply/Costofotherfactors• Ifotherfactorsbecomescarceà firmcanproducelessoverallà lessdemandforlabor

Supply of Labor•

Marginal Factor Costs• Recallthatthewagerate=$100perworker

Labor Output Wageperworker(daily)

LaborCostfortheFirm

0 0 $0

1 50 $100 $100

2 90 $100 $200

3 120 $100 $300

4 140 $100 $400

5 150 $100 $500

6 150 $100 $600

Marginal Factor Costs• Recallthatthewagerate=$100perworker• WhenthewagedoesnotchangewiththenumberofworkersemployedMFC=Wage

Labor Output Wage(daily)

LaborCostfortheFirm MFC

0 0 $0

1 50 $100 $100 $100

2 90 $100 $200 $100

3 120 $100 $300 $100

4 140 $100 $400 $100

5 150 $100 $500 $100

6 150 $100 $600 $100

Supply of LaborWage

QuantityofLabor

SupplybyHouseholds$150

$125

$100

$75

$50

$25

$0

1 23 45

MarginalFactorCost=

MarketWageRate

Shifts in Supply of Labor• Changeinnumberofworkers/population• Moreworkersinterestedinajobà morelaboravailable• Influxofworkersà shiftssupplycurve

• ChangeinPreferencesorIncome:• Moreincome:peopleprefertotaketimeoffandgoonvacation– Slabordecreases• Prefertobuymoregoods:needtoworkmoreformoreincome

• ChangeinPriceofRelatedServices(andgoods):• Servicesthataffectthe“cost”ofworking:childcarecosts• Childcaremoreexpensive:maychoosetonotwork

• ChangeinExpectations:• Retirementage/pension• Lifeexpectancy• Health

EquilibriumforLaborWage

QuantityofLaborDemandbyFirms

SupplybyHouseholds$150

$125

$100

$75

$50

$25

$0

1 23 456 78 910

Equilibrium:ValueMPL=MFC

EquilibriumintheFactorsMarketoccurswhentheValueofoutputproducedbythelastworkerisequaltothecostofemployingthatworker(OR)whereValueMPL=MFC

Linkages among the Factors of Production

• Factorsofproductionareusedtogether• Productivityofeachfactordependsonthequantitiesoftheotherfactorsavailable

• Changeinthesupplyofanyonefactorcanchangetheearningsofallofthefactors.• Changeintheearningsofanyfactorcanbefoundbymeasuringtheimpactoftheeventmarginalproductofthatfactor.