Factors of Production Labor Land Capital Entrepreneurship
Factor Prices The demand for a factor of production is a derived demand The demand for the product drives the demand for labor
Marginal Productivity and Factor Demand Marginal product (MP) is the additional output produced as a result of hiring an additional unit of a factor of production. For example, MP L = additional output from hiring an additional worker. (some authors call this MPP) The value of the marginal product (VMP) is the value of the additional output produced as a result of hiring an additional unit of a factor. (some authors call this MRP) For example, VMP L = MP L x P (MRP = MPP x P) The VMP curve is the demand curve for a factor (with a perfectly competitive labor market).
Lemonade Stand - $2 per cup Units of LaborTotal Product (cups per hour) Marginal product of Labor – MP L (MPP) Value of the Marginal Product of Labor – VMP L (MRP) 00-- 18816 2181020 326816 432612 53648 63824 Wage for labor = Marginal Resource Cost (MRC) Hire a worker if: VMPL >= W. (or MRP>=MRC) Never hire a worker if: VMPL < W. Stop hiring workers up to the point where: VMPL = W (MRP=MRC) 1.So, which of the labor resources above will be the last we hire? 2.Suppose the wage rate goes up to $12?
What Causes the Factor Demand Curve to Shift? Changes in the prices of goods Changes in the supply of other factors Changes in technology Units of Labor VMP = D W and VMPL
Lemonade $4/cup Units of Labor Total Product (cups per hour) Marginal product of Labor – MP L (MPP) Value of the Marginal Product of Labor – VMP L (MRP) 00-- 18832 2181040 326832 4 624 536416 63828
Demand in the Markets for Capital and Land The price (marginal cost) of capital or land is the rental rate (R) Firms hire capital or land up to the point where VMP = R
Supply in the Markets for Capital and Land The supply curve for capital and land is upward sloping. The supply of land is inelastic (very steep)
Equilibrium in the Markets for Capital and Land Supply and demand in factor markets work very much like supply and demand in product markets.
Marginal Productivity Theory The Marginal Productivity Theory of Income Distribution Each factor of production is paid the equilibrium value of its marginal value. Think of office space in Manhattan. The rent is equivalent to the value the use of the space creates for the owner of the business. Your wage (benefits included) is equal to the value of the product you produce. Labor receives about 70% of total factor income. VMP L > VMP capital or land
Farm land example 1. Suppose that farm land in the U.S. is exchanged in a competitive market. a.Use a correctly labeled graph of this market to show the equilibrium rental rate and quantity of farm land. b.Suppose that a growing global population increases the demand for agricultural products grown in the U.S. In the graph, show how this impacts the market for farm land in the U.S. c.Now suppose that much of the farm land in the U.S. has been converted into residential sub-divisions. In the graph from part (a), show how this trend affects the market for farm land in the U.S.
The Supply of labor Substitution effect Income effect Hours of work (week) IE>SE, downward sloping SE>IE, upward sloping Labor supply Hourly wage
Shifts of the Labor Supply Curve Changes in preferences and social norms Changes in population Changes in opportunities Changes in wealth
Equilibrium in the Labor Market Up to this point we have assumed that both the product and labor markets are perfectly competitive There are differences when either the product market or labor market is not perfectly competitive Quantity of Labor (workers) Market Labor Demand Market Labor Supply Wage W* E*
Imperfect Competition in the Product Market Recall that MR < P with imperfect competition. That means the value of the marginal product = MP x MR. With imperfect competition the value of the marginal product is called marginal revenue product (MRP). MRP = MP x MR Quantity of Labor (workers) Wage W* Em MRPL VMPL Ec
Imperfect Competition in the Labor Market A monoposony is a single buyer of a factor of production. With imperfect competition in a factor market, MFC > W Quantity of Labor (workers) Wage 3 MFCL Labor Supply $12 $10
Equilibrium with Imperfect Competition Monopsony power allows firms to pay a wage below MRP Quantity of Labor (workers) Wage E* MFCL Labor Supply W* MRPL MRP
Determining the Optimal Input Mix Least-cost combination of inputs Cost-minimization rule MP L /w = MP K /r
Marginal Productivity and Wage Inequality Compensating differentials Differences in talent Human capital
Other Sources of Wage inequality Market Power Efficiency Wages Discrimination