Principles of Microeconomics: Ch. 18 Second Canadian Edition Chapter 18 The Markets for the Factors of Production © 2002 by Nelson, a division of Thomson Canada Limited

Principles of Microeconomics: Ch. 18 Second Canadian Edition Overview  The Market for the Factors of Production  Labour Market Equilibrium  Other Factors of Production - Land and Capital

Principles of Microeconomics: Ch. 18 Second Canadian Edition The Market for the Factors of Production  Factors of Production are the inputs used to produce goods and services. – What are the major factors of production? – What determines how much each factor of production is paid? – What determines how much of each factor of production will be purchased?

Principles of Microeconomics: Ch. 18 Second Canadian Edition The Market for the Factors of Production  The demand for a factor of production is a Derived Demand.  A firm’s demand for a factor of production is derived from its decision to supply a good in another market.

Principles of Microeconomics: Ch. 18 Second Canadian Edition A Firm’s Demand For Labour  Labour markets, like other markets in the economy, are governed by the forces of supply and demand.  Most labour services, rather than being final goods ready to be enjoyed by consumers, are inputs into the production of other goods.

Principles of Microeconomics: Ch. 18 Second Canadian Edition A Firm’s Demand For Labour: The Competitive Profit-Maximizing Firm  A Competitive Firm – is a price taker, for both the product it sells (e.g. apples) and the input it buys (e.g. apple pickers) – has the goal to maximize profits  The firm’s supply of apples and its demand for workers are derived from its primary goal of maximizing profits.

Principles of Microeconomics: Ch. 18 Second Canadian Edition The Production Function and The Marginal Product of Labour Illustrates and describes the relationship between the quantity of inputs used and the quantity of output from production. Output Input

Principles of Microeconomics: Ch. 18 Second Canadian Edition The Marginal Product of Labour  Marginal Product of Labour: The increase is the amount of output from an additional unit of labour. MPL = (Q 2 - Q 1 ) ÷ (L 2 - L 1 )  Example: MPL = ( ) ÷ (2 - 1) = 80 – The second unit of labour adds 80 additional bushels of apples picked

Principles of Microeconomics: Ch. 18 Second Canadian Edition The Diminishing Marginal Product of Labour  As the number of workers increases, the marginal product of labour declines.  As more and more workers are hired, each additional worker contributes less to the production. – The production function gets flatter as the number of workers rises.

Principles of Microeconomics: Ch. 18 Second Canadian Edition The Marginal Product of Labour: How many workers to hire? To maximize profits, the firm considers how much profit each worker would bring in... Value of the Marginal Product

Principles of Microeconomics: Ch. 18 Second Canadian Edition Value of the Marginal Product... … is the marginal product of the input (MPL) multiplied by the market price of the output: VMPL = (MPL) x (P Q ) – VMPL is measured in dollars and diminishes as the number of workers rises because the market price of the good (P Q ) is constant.

Principles of Microeconomics: Ch. 18 Second Canadian Edition Value of the Marginal Product Value of Marginal Product Curve VMPL Quantity of labour

Principles of Microeconomics: Ch. 18 Second Canadian Edition “How Many Workers Do I Hire?” Value of Marginal Product Curve VMPL Quantity of labour ?

Principles of Microeconomics: Ch. 18 Second Canadian Edition How many workers to hire?  To maximize profit, the firm hires workers up to the point where the VMPL is equal to the cost of the labour, i.e. market wage. VMPL = WAGE  The value-of-marginal-product curve is the labour demand curve for a competitive, profit-maximizing firm.

Principles of Microeconomics: Ch. 18 Second Canadian Edition “How Many Workers Do I Hire?” VMPL & WAGE Quantity of labour Market Wage VMPL Curve

Principles of Microeconomics: Ch. 18 Second Canadian Edition “How Many Workers Do I Hire?” VMPL & WAGE Quantity of labour Market Wage VMPL Curve

Principles of Microeconomics: Ch. 18 Second Canadian Edition “How Many Workers Do I Hire?” VMPL & WAGE Quantity of labour Market Wage Profit-Max Quantity VMPL Curve

Principles of Microeconomics: Ch. 18 Second Canadian Edition Quick Quiz!  Define “marginal product of labour” and the “value of the marginal product of labour.”  Describe how a competitive, profit- maximizing firm decides how many workers to hire.

Principles of Microeconomics: Ch. 18 Second Canadian Edition Overview The Market for the Factors of Production  Labour Market Equilibrium  Other Factors of Production - Land and Capital

Principles of Microeconomics: Ch. 18 Second Canadian Edition Labour-Market Equilibrium  Labour supply and labour demand together determine the equilibrium wage, and shifts in the supply or demand curve for labour cause the equilibrium wage to change.  Profit maximization by competitive firms demanding labour, ensures that the equilibrium wage always equals the value of the marginal product.

Principles of Microeconomics: Ch. 18 Second Canadian Edition Labour-Market Equilibrium: Shifts in the Supply and Demand of Labour  The wage adjusts to balance the supply and demand for labour.  Shift in Supply of labour: may be caused by increased number of available labour.  Shift in Demand for labour: may be caused by an increased demand for the final product produced by labour.

Principles of Microeconomics: Ch. 18 Second Canadian Edition Shifts in the Supply and Demand of Labour  Shifts in Supply of Labour: Result in a surplus of labour, which puts downward pressure on wages, which makes it profitable for firms to hire more workers, which results in diminishing marginal product, which lowers the value of the marginal product. Gives a new equilibrium...

Principles of Microeconomics: Ch. 18 Second Canadian Edition “How Many Workers Do I Hire?” VMPL & WAGE Quantity of labour Market Wage Profit-Max Quantity VMPL Curve S0S0 S1S1

Principles of Microeconomics: Ch. 18 Second Canadian Edition “How Many Workers Do I Hire?” VMPL & WAGE Quantity of labour Market Wage Profit-Max Quantity VMPL Curve S0S0 S1S1

Principles of Microeconomics: Ch. 18 Second Canadian Edition “How Many Workers Do I Hire?” VMPL & WAGE Quantity of labour Market Wage Profit-Max Quantity VMPL Curve S0S0 S1S1

Principles of Microeconomics: Ch. 18 Second Canadian Edition What causes productivity and wages to vary so much over time?  Physical Capital: when workers work with a larger quantity of equipment and structures, they produce more.  Human Capital: when workers are more educated, they produce more.  Technological Knowledge: When workers have access to more sophisticated technologies, they produce more.

Principles of Microeconomics: Ch. 18 Second Canadian Edition Quick Quiz!  How does the immigration of workers affect labour supply, labour demand, the marginal product of labour, and the equilibrium wage?

Principles of Microeconomics: Ch. 18 Second Canadian Edition Overview The Market for the Factors of Production Labour Market Equilibrium  Other Factors of Production - Land and Capital

Principles of Microeconomics: Ch. 18 Second Canadian Edition Other Factors of Production: Land and Capital  Capital: refers to the stock of equipment and structures used for production. – 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.

Principles of Microeconomics: Ch. 18 Second Canadian Edition Two Prices for Land & Capital  Purchase Price: – the price a person pays to own that factor of production indefinitely.  Rental Price: – the price a person pays to use that factor for a limited period of time.

Principles of Microeconomics: Ch. 18 Second Canadian Edition Determining the Rental Price and Quantity of Land and Capital  Rental Price: – The rental price of land and the rental price of capital are determined by supply and demand.  Quantity Purchased: – The firm increases the quantity hired until the value of the factor’s marginal product equals the factor price.

Principles of Microeconomics: Ch. 18 Second Canadian Edition The Market for Land/Capital P Q Supply Demand Rental Price of Land/ Capital Quantity of Land/Capital

Principles of Microeconomics: Ch. 18 Second Canadian Edition Profit Maximizing Quantities for Land/Capital Market Price Profit-Max Quantity VMP Factor Price Quantity of Land/Capital

Principles of Microeconomics: Ch. 18 Second Canadian Edition Determining the Rental Price and Quantity of Land and Capital Labour, land, and capital each earn the value of their marginal contribution to the production process.

Principles of Microeconomics: Ch. 18 Second Canadian Edition Determining the Purchase Price and Quantity of Land and Capital  Equilibrium Purchase Price: – depends on both the current value of the marginal product and the value of the marginal product expected to prevail in the future. – Land and Capital are paid the value of their marginal product.

Principles of Microeconomics: Ch. 18 Second Canadian Edition Linkages Among the Factors of Production The factors of production not only depend on the demand and supply of the products they are used to produce, but they are also dependent upon each other. Economic Interdependence

Principles of Microeconomics: Ch. 18 Second Canadian Edition Economic Interdependence between Factors of Production  An event that changes the supply of any factor of production can alter the earnings of all the factors.  The 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.

Principles of Microeconomics: Ch. 18 Second Canadian Edition Quick Quiz!  What determines the income of the owners of land and capital?  How would an increase in the quantity of capital affect the incomes of those who already own capital? How would it affect the incomes of workers?

Principles of Microeconomics: Ch. 18 Second Canadian Edition Overview The Market for the Factors of Production Labour Market Equilibrium Other Factors of Production - Land and Capital