AP Micro Unit 5 - Factor Markets

Factor Market

* Where the factors of production are sold by households to businesses
* Factors are:
* Land
* Labor
* Capital
* Entrepreneurship

Derived Demand

* Demand for resources is determined/derived by the products they help to produce
* If demand for one thing increases, it will consequently increase demand for something else

Law of Diminishing Marginal Returns

* As variable resources are added to fixed resources, the additional output produced from each new input will eventually fall

Marginal Resource Cost (MRC)

* The cost of buying one additional unit of a factor (usually hiring a worker)
* For hiring a worker, this would wage rate

Marginal Product (MP)

* The additional product produced by hiring one more worker

Marginal Revenue Product (MRP)

* The additional revenue generated by hiring one more worker
* Marginal Product x Price
* MP x P

Profit Maximization

* MRP = MRC

Firms should continue to hire workers until…

they’re no longer profit off of their worker (when MRP = MRC)

Factor Supply

* AKA Labor Supply
* Upward sloping curve
* Non-firm side of the factor market
* Curve represents the lowest willingness and ability to sell one’s labor to a firm
* As wage increases, quantity of labor available increases

Factor Demand

* Downward sloping curve
* At a high wage, firms are not willing or able to buy much labor
* At a low wage, firms are willing to buy more labor

Factor Market Equilibrium

* Market labor and wage rate is set at where quantity of labor equals quantity of labor demanded
* Where Factor Demand and Factor Supply intersect
* No shortages or surpluses of labor

Determinants of Factor Demand

* Price of Related Input
* Changes in Productivity
* Product Demand

First Determinant of Factor Demand

Price of Related Input

* Substitute resources and complementary resources that are used in the production of goods and services
* If the price of one resource becomes more expensive, the firm will increase their demand for the substitute resource

Second Determinant of Factor Demand

Changes in Productivity

* Say there’s a new technique that cuts production time in half, increasing productivity and now each worker can produce more in the same amount of time
* This will lead to each worker’s value increasing, leading to an increased demand in labor

Third Determinant of Factor Demand

Product Demand

* A change in the demand for the good or service
* If there’s an increased demand for a good, the resources required to make that good/service will increase
* Resource Demand can also by determined by a change in prices

Determinants of Factor Supply

* Number of Qualified Workers
* Can be influenced by migration, immigration, education, training, and abilities
* Government Regulations
* Example: Laws about certification requirements, etc.
* Personal Values
* Personal values about leisure time and societal roles
* Wealth Effect

Wealth Effect

* If long-term wealth increases, fewer people will supply labor at all wages, meaning supply shifts left, and vice-versa

Characteristics of Perfectly Competitive Labor (Factor) Markets

* Many, small firms hiring workers
* Firms are “wage takers”
* Skill level of workers is identical (workers are perfect substitutes)
* Firms can hire as many workers they want or need at the set wage in the market
* Firms will hire workers as long as MRP > MRC or until MRP = MRC
* Firms will profit maximize

Perfectly Competitive Labor (Factor) Market Graph

Firm Graph in a Perfectly Competitive Labor Market

* The supply of labor is perfectly elastic because firms are “wage takers”

Side-by-Side Graphs in a Perfectly Competitive Labor Market

Cost Minimizing Combination of Resources

Least-Cost Rule

* (MPx/Px) = (MPy/Py)
* MP - Marginal Product
* P - Price

Profit Maximizing Combination of Resources

* (MRPx/MRCx) = (MRPy/MRCy) = 1
* Firms is hiring where MRP = MRC for each resource

Monopsony

* An imperfectly competitive factor market where only one firm buys resources
* A market with one buyer and many sellers

Characteristics of a Monopsony

* One, large firm hires all laborers in a single labor market
* Imperfectly competitive market
* Firm is a wage maker
* MRC > Supply
* When you hire an additional worker, you must pay them a higher wage, but you cannot price discriminate so you take the cost of the additional worker and raising the wages of all previous workers
* Firm will hire Quantity of Labor at MRP = MRC
* Firm will pay workers a wage they are willing and able to work for below their MRP

Graph of a Monopsony

* D = MRP