Lecture 12 - Factor Markets (1)

Learning Outcomes

  • Describe the anatomy of factor markets.

  • Explain how the value of marginal product determines the demand for a factor of production.

  • Explain how wage rates and employment are determined and how labour unions influence labour markets.

  • Explain how capital and land rental rates and natural resource prices are determined.

Factor Markets Overview

  • Product Market: Focus on final goods and services.

    • Demand: Consumers

    • Supply: Firms

  • Factor Market: Involves goods and services used as inputs to production.

    • Demand: Firms

    • Supply: Households

  • Demand and supply of inputs determine prices and quantity exchanged.

Anatomy of Factor Markets

Factors of Production

  1. Labour

  2. Capital

  3. Land (Natural Resources)

  4. Entrepreneurship

Market for Labour Services

  • Definition: Labour: physical and mental work effort supplied to produce goods and services.

  • Labour Market: Collection of people and firms trading labour services.

    • Competitive nature with multiple buyers and sellers.

    • Interaction of demand and supply determines the wage rate.

Market for Capital Services

  • Definition: Capital includes tools, instruments, machines, and buildings.

  • Capital goods are traded in goods markets, while capital services are rented out.

  • Implicit Rental Rate of Capital: Reflects depreciation and interest costs.

  • Firms that use capital also implicitly rent the capital to themselves.

Markets for Land Services and Natural Resources

  • Definition: Land consists of natural endowments.

  • Market for land services: the use of land, with rental rates determining prices.

  • Nonrenewable Resources: e.g., oil, natural gas; priced in global markets.

  • Economic Rent: Income from ownership of limited resources.

Entrepreneurship

  • Definition: Entrepreneurs combine land, labour, and capital to earn profits.

  • Innovation stems from entrepreneurship; payment is profit but may lead to risks of loss.

Demand for Labour

Labour Demand Curve

  • Shows relationship between wages and the quantity of workers firms want to hire.

  • Firms act as wage takers in competitive markets; derived demand based on product demand.

  • Marginal Benefit (MB) and Marginal Cost (MC) of Hiring Labour: Firms decide to hire based on MB > MC.

Market Structures

  • Structures influence demand and supply of labour.

  • Product markets can be perfect competition, monopolistic competition, oligopoly, and monopoly; similar structures exist for labour markets.

Value of Marginal Product of Labour (VMPL)

  • Formula: VMPL = Price × Marginal Product of Labour (MPL).

  • Example: If price is $5 and MPL is 100, then VMPL is $500.

Marginal Cost of Labour

  • In competitive markets, MC equals the wage rate.

  • Decisions on hiring depend on comparing MB and MC.

Profit Maximization Condition

  • Firm maximizes profit by hiring where VMPL = W.

  • If VMPL > W, hire more; if VMPL < W, reduce workforce.

Shifts in Demand for Labour

  1. Product Price

  2. Marginal Product of Labour (MPL)

Labour Markets

Competitive Labour Market

  • Many firms demand labour and households supply it.

  • Market Demand for Labour: Total demand from all firms at each wage rate; downward-sloping curve.

Market Supply of Labour

  • Derived from individual supply decisions based on leisure vs. labour allocation.

  • Reservation Wage: Lowest wage an individual will accept for labour.

Supply Curve Dynamics

  • Jill's Labour Supply Curve Example: Shows changing supply based on wage rates.

  • Backward Bending Supply Curve: At higher wages, individuals may reduce supply due to increased preference for leisure.

Market Supply Curve

  • Upward sloping, representing the total supply of labour across households.

Labour Market Equilibrium

  • Balance between quantity of labour supplied and demanded determines wage rate.

  • At equilibrium, e.g., wage of $10 with 300 workers employed, wage adjustments occur based on surplus or shortages.

Next Class

  • Completion of current material.

  • Pages 496-513 in Chapter 16 can be skipped.