1. Ch. 18: Demand and Supply in Factor Markets
The firm’s choice of the quantities of labor and capital to employ.
People’s choices of the quantities of labor and capital to supply.
Explain how wages and interest rates are determined in competitive resource markets

2. Factor Prices and Incomes
Factors of production
resources used to produce goods and services.
4 factors of production
Labor
Capital
Land
Entrepreneurship

3. Factor Prices and Incomes
Factor prices determine incomes:
Labor earns wages.
Capital earns interest.
Land earns rent.
Entrepreneurship earns normal profit.
Economic profit/loss to owner of the firm.

4. Factor Prices and Incomes
Income earned by the owner of a factor of production equals the equilibrium price times equilibrium quantity.

5. Factor Prices and Incomes
Effect of increases in factor demand:
Factor price rises
Income rises
Increase in price/quantity depends on elasticity of supply
Effect of increases in factor supply:
Factor price falls
Income could rise or fall depending on demand elasticity

6. Labor Markets
Allocate labor and the price of labor is the real wage rate (the wage rate adjusted for the price level).
In 2002, labor earned 72 percent of total income in the United States.
Source: St. Louis Federal Reserve Bank

7. Wages by Occupation (May 2007)
Hourly wage
Annual Earnings
All
$18.84
$39,190
Management
$44.20
$91,930
Legal
$41.04
$85,360
Computer and mathematical
$33.29
$69,240
Architecture and engineering
$31.82
$66,190
Healthcare practitioners and technical
$29.82
$62,030
Education, training, and library
$21.79
$45,320
Construction and extraction
$18.89
$39,290
Installation, maintenance, and repair
$18.78
$39,060
Protective service
$17.81
$37,040
Sales and related
$16.52
$34,350
Office and administrative support
$14.60
$30,370
Transportation and material moving
$14.16
$29,460
Healthcare support
$11.83
$24,610
Personal care and service
$11.02
$22,920
Building, grounds cleaning, &maintenance
$10.86
$22,580
Food preparation and serving related
$8.86
$18,430
Source: Bureau of Labor Statistics

8. Source: Forbes Magazine, 2008. Most Lucrative College Majors

9. Source: Forbes Magazine, 2008. Most Lucrative College Majors

10. The Demand for Labor A firm’s demand for labor is a derived demand
derived from the demand for the goods or services produce by the factor.
The marginal revenue product of labor (MRPL)
change in total revenue that results from employing one more unit of labor.
MRPL = MPL  MR = MPL X P if perfect competition

11. Labor Demand Curve 1 5 2 9 3 12 4 14 15 L (no. of workers) TP MP
TR if P=MR=4
MRP if P=MR=4 1 5 2 9 3 12 4 14 15

12. Labor Demand Curve
MRP falls as L increases because of law of diminishing marginal returns.
Firm should hire more labor if MRPL > W and stop when MRPL =W
How many workers should firm hire if
Wage = $8
Wage = $12

13. Labor Demand Curve
The marginal revenue product curve for labor is the demand curve for labor.
“consumer’s surplus” in labor market = increase in profits from hiring labor.

14. Labor Demand Curve
The demand for labor (MRPL ) rises and the demand for labor curve shifts if:
The price of the firm’s output rises (MR rises)
Worker productivity rises (MP rises)
The prices of other factors of production change
Substitution effects
Scale effects
Technology changes (could increase or decrease demand for labor)

15. Labor Demand Curve Market Demand
The market demand for labor is obtained by summing the quantities of labor demanded by all firms at each wage rate.
Because each firm’s demand for labor curve slopes downward, so does the market demand curve.

16. Labor Demand Curve Elasticity of Demand for Labor
The labor intensity of the production process
The elasticity of demand for the product
The substitutability of capital for labor
Importance of elasticity of labor demand
Minimum wage effects
Power of unions
Effects of immigration on wages