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