1. Chapter 18 notes
Part 1

2. The Markets for the Factors of Production
Factors of production are the inputs used to produce goods and services.
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.

3. THE DEMAND FOR LABOR
Labor markets, like other markets in the economy, are governed by the forces of supply and demand.
But, instead of looking at the final product we are looking at an input.

4. The Competitive Profit-Maximizing Firm
We assume that the firm is competitive in the product market (as a seller) and the factor market (as a buyer).
We assume that the firm is profit-maximizing and is only concerned with profit.

5. Figure 1 The Versatility of Supply and Demand
(a) The Market for Apples
(b) The Market for Apple Pickers
Price of
Wage of
Apples
Apple
Pickers
Supply
Demand
Supply
Demand P Q L W
Quantity of
Quantity of
Apples
Apple Pickers
The apple producer’s demand for apple pickers is derived from the market demand for apples.
Copyright©2003 Southwestern/Thomson Learning

6. Remember the production function?
It’s the relationship between the Q of inputs and the Q of output.
Marginal Product of Labor – the increase in the amount of output from an additional unit of labor.
MPL = Q/L
MPL = (Q2 – Q1)/(L2 – L1)
Diminishing Marginal Product – the marginal product of an input declines as Q of input increases.

7. Figure 2 The Production Function
Quantity
of Apples
Production
function
300
280
240
180
100 1 2 3 4 5
Quantity of
Apple Pickers

8. Table 1 How the Competitive Firm Decides How Much Labor to Hire

9. The Value of the Marginal Product and the Demand for Labor
The value of the marginal product is the marginal product of the input multiplied by the market price of the output.
VMPL = MPL  P
MRP = MPL x P
The value of the marginal product (also known as marginal revenue product) is measured in dollars.
It diminishes as the number of workers rises because the market price of the good is constant.

10. Cont’d
To maximize profit, the competitive, profit-maximizing firm hires workers up to the point where the value of the marginal product of labor equals the wage.
VMPL = Wage
MRP = Wage
The value-of-marginal-product curve is the labor demand curve for a competitive, profit-maximizing firm.

11. Figure 3 The Value of the Marginal Product of Labor
Value of marginal product
(demand curve for labor)
Market
wage
Profit-maximizing quantity
Quantity of
Apple Pickers

12. FYI—Input Demand and Output Supply: Two Sides of the Same Coin
When a competitive firm hires labor up to the point at which the value of the marginal product equals the wage, it also produces up to the point at which the price equals the marginal cost.
MC = W/MPL

13. What causes labor demand curves to shift?
The output price – if MRP = MPL x P, then if P changes, so does MRP (which is the labor demand curve) and the curve shifts. If P increases, then the MRP of each worker increases.
Technological change – technological advances typically raise the MPL, which in turn increases the D for labor and shifts the labor-demand curve to the right.
But, some technology is labor-saving and reduces the D for labor. Most is labor-augmenting, though.

14. Cont’d
The supply of other factors – Example: a decrease in S of ladders, for instance, will reduce the MP of apple pickers and the D for apple pickers (since MRP= MPL x P)

15. The Supply of Labor
Reflects how workers’ decisions about the labor-leisure trade-off respond to a change in that opportunity cost.
An upward-sloping labor supply curve means that an increase in the wage induces workers to increase the Q of labor they supply.
For now, assume that the labor supply curve is upward sloping.

16. What causes the labor supply curve to shift?
Occurs when people change the amount they want to work at a given wage.
Changes in Tastes – Example: more women work now than in 1950 – increases the S of labor.
Changes in Alternative Opportunities – if the wage in another market increases, some workers will want to change occupations.

17. Cont’d
Immigration – when immigrants come to the U.S., the S of labor in the U.S. increases and the S of labor in their home countries decreases.

18. Question:
Who has a greater opportunity cost of enjoying leisure – a janitor or a brain surgeon?
What might this explain?

19. Part 2

20. Equilibrium in the Labor Market
The wage adjusts to balance the supply and demand for labor.
The wage equals the value of the marginal product of labor.

21. Figure 4 Equilibrium in a Labor Market
Wage
(price of
labor)
Supply
Demand
Equilibrium
wage, W
employment, L
Quantity of
Labor

22. Shifts in Labor Supply
Example: in the 80’s, many Palestinians commuted to jobs in Israel. But, in 1988, political unrest caused the Israeli gov’t to impose curfews, check work permits, and ban overnight stays. The # of Palestinians with jobs in Israel fell by half, but those who continued to work in Israel got higher wages.

23. Labor supply and labor demand determine the equilibrium wage.
Shifts in the supply or demand curve for labor cause the equilibrium wage to change.

24. Figure 5 A Shift in Labor Supply
Wage
1. An increase in
labor supply . . .
(price of
Supply, S
labor)
Demand S W L
reduces
the wage . . . W L
Quantity of
and raises employment.
Labor

25. Shifts in Labor Supply An increase in the supply of labor:
Results in a surplus of labor.
Puts downward pressure on wages.
Makes it profitable for firms to hire more workers.
Results in diminishing marginal product.
Lowers the value of the marginal product.
Gives a new equilibrium.

26. Shifts in Labor Demand An increase in the demand for labor :
Makes it profitable for firms to hire more workers.
Puts upward pressure on wages.
Raises the value of the marginal product.
Gives a new equilibrium.

27. Figure 6 A Shift in Labor Demand
Wage
(price of
Supply
labor) D W L
Demand, D
1. An increase in
labor demand . . .
increases
the wage . . . W L
Quantity of
and increases employment.
Labor

28. Table 2 Productivity and Wage Growth in the United States

29. FYI: Monopsony When there is a single employer (buyer) of labor.
Monopsonies hire fewer workers than a competitive firm
By reducing # of jobs available, the monopsony firm reduces the wage to raise profits.
Distorts market outcome and causes deadweight losses.
Very rare.

30. The other factors
Capital – the equipment and structures used to produce goods and services.
Land – natural resources used in production.
Purchase price – price a person pays to own that factor of production indefinitely.
Rental price – price a person pays to use that factor for a limited period of time.

31. Cont’d
The rental price of land and capital are determined by supply and demand.
The demand for land and capital is determined just like the demand for labor – the firm increases the Q hired until the value of the factor’s marginal product equals the factors price.

32. Figure 7 The Markets for Land and Capital
(a) The Market for Land
(b) The Market for Capital
Rental
Rental
Price of
Price of
Supply
Land
Capital
Supply
Demand
Demand P Q Q P
Quantity of
Quantity of
Land
Capital

33. The purchase price of capital and land is related to the rental price.
The purchase price of a piece of land or capital depends on both the current value of the marginal product and the value of the marginal product expected in the future.

34. Linkages among the Factors of Production
Factors of production are used together.
The marginal product of any one factor depends on the quantities of all factors that are available. A change in the supply of one factor alters the earnings of all the factors.
A 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.

35. Black Death
Does it prove the theories about the factor markets we have discussed?
What happened in this historical example?