Ch 18: The Markets For the Factors of Production What are the “factors of production”? Remember the circular flow model?????

Factor Markets differ from “goods markets” ………..because the DEMAND for a factor is DERIVED ………meaning the demand is derived from the decision to supply a good Ex: the demand for “great econ teachers” is derived from the decision to “supply” the AP Econ curriculum

Labor (or any other factor of production) – governed by laws of Supply and Demand ………assumptions……… Perfect competition for BOTH the market for the good and the market for the labor Price and Wage “TAKERS” GOAL - Profit max.

Production Function p.401 Y– axis … ….output X – axis…. ….input or (factor of production) So what lesson did we learn from the production function??????? Diminishing Marginal Product

Value of the Marginal Product (Marginal Revenue Product) How many workers to hire????? Consider how much profit each worker would bring in. Profit = TR – TC …right? ….so the profit from an additional worker is the ….. “Workers Contribution” to revenue - Wage

Workers Contribution to revenue????? Convert the MPof Labor (MPL) into the Value of the MPL (VMPL) (also Marg Rev Prod.) Simply Price of the good x MPL = VMPL (or MRP) P x MPL = VMPL (or P x MPL = MRP) ……because market price is constant and we experience diminishing MPL,……then the VMPL (MRP) also diminishes

…….so how many workers do we hire ??? Wage (W) = VMPL or W = MRP …..so your Labor D curve is a reflection of the VMPL (MRP) (for a competitive profit max. firm)

Wage, Supply D (VMPL) (MRP) = D Supply Wage Q Labor Profit Max Rule: MR=MC Profit Max Rule: W = VMPL W = MRP Now evaluate when not at Qmax

…….REMEMBER……VMPL (MRP) = P x MPL... and the VMPL (MRP) is the D curve. ……so if the P increases or decreases, then VMPL (MRP) will ….? Increase or decrease ……and so the D curve will….? Shift left or right Or if he MP increases or decreases, then the VMPL (MRP) will …? Increase or decrease ………and so the D curve will…? Shift left or right

p. 403 FYI ……also REMEMBER….. A profit max COMPETITIVE firm will produce where P = MC and hire where W = VMPL(MRP) …if P x MPL = W…. …then P = W / MPL...and W / MPL = MC…. ….then P = MC

Shifting Labor Demand Curve Output Price (P x MPL) = VMPL (MRP) If P changes …then…? Technology (increases the MPL of each worker…(P x MPL) = VMPL(MRP)....so increases the VMPL (MRP) Opposite of technology increase? Supply of other factors ….will affect MPL of each worker

Supply of Labor ….reflects how Labor / Leisure tradeoff responds to change in opportunity cost. ….an increase in W will increase the Labor you will supply …..think of the “law of supply” ….but an increase in Labor supplied by you = a decrease in leisure time W increase = increase in opportunity cost of leisure

Shifting Labor Supply Curve ***whenever people change the amount of work they will provide at a given wage Change taste (lifestyle) – ex- women Change in alternative opportunities (better opportunities in other fields) …or change in landscape of the industry.. How would you like to be an investment banker now? Immigration

Productivity and Wages Principle: Productivity = Standard of Living Wages = Productivity as measured by VMPL(MRP) 3 Determinants of Productivity/Standard of Living: Physical capital Human capital Technological knowledge

Capital Income Simplified for our model- income households earn from the rent of their capital Reality- most firms own their own capital ……but the income earned from the use of this is eventually returned to households in forms of stock dividends, bond interest