Markets for Factors of Production

Markets for Factors of Production: Land, Labor, Capital, Entrepreneurship

  • This lecture discusses the markets for factors of production, including land, labor, capital, and entrepreneurship.
  • Key questions to be addressed:
    • What determines the wages that people earn?
    • What determines the prices of natural resources used in production?
    • What determines interest rates?

Demand for Factors of Production

  • Demand for a factor of production is a derived demand, meaning it's derived from the demand for the goods that the factors are used to produce.

  • The quantities of factors of production demanded are determined by the firm's output decisions, specifically the quantities that maximize its profit.

  • Value of the Marginal Product (VMP) determines the value of an additional unit of labor.

    • VMP = the revenue the firm earns by hiring one more worker.
    • Wage rate = what an additional worker costs a firm.

  • Profit maximization occurs when VMP= Wage Rate.

    • If VMP > Wage Rate, the firm can increase profit by employing more workers.
    • If VMP < Wage Rate, the firm can increase profit by reducing workers.

  • Example: If the Value of the Marginal Product for the labor of the 3rd worker is $15 an hour, the firm hires 3 workers @ $15 an hour.

Q (labor)VMP
1$21
2$18
3$15
4$12
5$9
  • Examples of VMP impacting wages:
    • Starbucks pays Achalasia $15 per hour because she adds at least $15 an hour to the store’s revenue.
    • Metropolitan Hospital pays Dr. Jenkins $150,000 per year because she adds at least $150,000 a year to the hospital’s revenue.
    • The Los Angeles Dodgers pay Mookie Betts $27M per year because he adds at least $27M to the team's revenue in ticket sales, concessions, TV advertising, jersey sales, etc.

Socialist Calculation Debate:

  • Poses the question of how to value factors of production without markets and prices for the end products, and vice versa.
  • The answer provided being that you cannot value one without the other.

Factor Substitution

  • If the price of capital decreases relative to the price of labor, firms substitute capital for labor.
  • Usually, the demand for labor will decrease when the price of capital decreases.

Impact of Technology on Labor Demand

  • New technologies can cause a decrease in the demand for some labor and an increase in the demand for other labor.
    • A firm might install a new machine in its factory and reduce its workforce.
    • The factory will require skilled persons to operate the machine.
    • The firms that manufacture and service automated machines hire more people.

Individual's Supply of Labor

  • The higher the wage rate, the greater is the amount of labor supplied.
  • At some point, the labor supply curve is backward bending.
  • When a person makes “enough”, they may choose more leisure over more labor.

Market Supply of Labor

  • The market supply curve for labor shows the total quantity of labor supplied in the market.
  • The market supply curve is upward sloping.

Equilibrium in the Labor Market

  • Supply and Demand determine the wage rate and the number of people employed.

Labor Unions

  • A labor union is an organized group of workers that aims to increase wages and influence working conditions.
  • Influences on Labor Supply: A decrease in the supply of labor to raise wage rates.
  • Influences on Labor Demand: Encouraging people to buy goods produced by union workers increases the price of those goods and increases VMP of the workers.
  • Unions try to restrict the supply for union labor and raise the wage rate.
  • Evidence suggest that the union–nonunion wage difference is between 10-20% of the wage rate.
  • The higher wage rate decreases the quantity of labor demanded. So the union tries to increase the demand for union labor by encouraging consumers to buy union made products.

Labor Unions Statistics (2024 vs 1983)

  • 2024: 9.9% of US workforce in labor union
  • 1983: 20.1% of US Workforce in labor union
  • Public vs Private Sector:
    • 35.7% Public-sector workers in a union
    • 6.7% Private-sector workers in a union
  • Occupation:
    • Workers in education, training, library occupations and in protective service occupations had the highest unionization rates, at about 33%.
  • Location:
    • New York & California continued to have the highest union membership rate (21%), North Carolina (2.3%) and South Carolina had the lowest rate (2.1%).

Monopsony in Labor Markets

  • A monopsony is a market with just one buyer (employer).
  • Because a monopsony controls the labor market, it has the market power to set the market wage rate.
  • Monopsony maximizes profit by hiring the quantity of labor at which MCL = VMP, but pays the lowest wage rate for that quantity
  • Compared to a competitive labor market, the monopsony employs fewer workers and pays a lower wage rate.
  • MCL stands for Marginal Cost of Labor

Bilateral Monopoly

  • Occurs when a monopsony encounters a monopoly.
  • Both the employer and the union must judge each other's market power and come to an agreement on the wage rate paid and the number of workers employed.
  • Depending on the relative costs that each party can inflict on the other, the outcome of this bargaining might favor either the union or the firm.

Labor Markets and Discrimination

  • Discrimination: When someone who is qualified to do a job is not hired for some reason not related to their ability to work, such as race, sex, religion or sexual orientation.
  • Labor discrimination is illegal.
  • The competitive market penalizes discrimination.
    • Firms that discriminate have higher costs, lower profits, and a weaker competitive position.
  • The market is mostly an anonymous mechanism.
    • We don’t know the personal characteristics of the people who make the products we buy or sell.
  • We see the lowest amount of discrimination in free market economies.

Labor Markets in the Long Run

  • Wage rates increase over time—trend upward—because the value of marginal product of labor trends upward.
  • New Technologies, and New Capital Investments, makes labor more productive.
  • With greater labor productivity, the demand for labor increases, and so does the average wage rate.

Fastest Growing & Declining Industries in America

  • Identified by the Bureau of Labor Statistics (BLS) for the period between 2021 and 2031.
  • Fastest Growing Industries (Percentage Change):
    • Event Promoters, Agents & Managers: +39%
    • Amusement Parks & Arcades: +38%
    • Individual & Family Services: +31%
    • Spectator Sports: +31%
    • Other Personal Services: +28%
    • Performing Arts Companies: +35%
    • Private Education Services: +22%
      • Computer Systems Design: +20%
      • Travel & Reservation Services: +23%
      • Museums & Historical Sites: +20%
      • Film, Video, & Audio Recording: +23%
      • Agriculture & Forestry Support: +23%
      • Artists, Writers & Performers: +23%
      • Mining Support Activities: +31%
  • Industries with Largest Job Gains:
    • Home Health Care Services: +22%
    • Individual & Family Services: +31% (requiring 850,000 more workers by 2031)
    • Health Practitioners: +20%
    • Leisure & Hospitality
    • Professional & Business Services
    • State & Local Government Passenger Transit
    • Accommodation
  • Declining Industries:
    • CDs, Tapes, Videogame Cartridge Makers: -51%
    • Tobacco: -53%
    • Coal Mining: -26%
    • Newspaper & Book Publishers: -24%
    • Other Furniture: -20%
    • Engine, Turbine, Power Transmission Equipment: -17%
    • Logging: -13%
      • Lighting Equipment:-13%
      • Office Equipment: -13%
      • Iron Ore & Steel Scrap Smelting: -13%
      • Textile Mills: -13%
      • Apparel & Leather: -36%
  • Manufacturing sector accounts for 14 of the top 20 declining industries.

Capital Markets

  • Interest, the return on capital, depends on the marginal productivity of capital.
  • Demand for capital is derived from the value of the marginal product of capital.
  • Profit-maximizing firms deploy the quantity of capital that makes the value of marginal product of capital equal to the marginal cost of capital.

Land Markets

  • Rent, the return for using land, depends on the marginal productivity of the land.
  • Demand for land is derived from the value of marginal product of land.
  • Profit-maximizing firms rent the quantity of land at which the value of marginal product of land is equal to the rental rate of land.

Summary

  • The demand for a factor of production is a derived demand, stemming from the demand for the goods it produces.
  • The value to the firm of using one more unit of a factor of production is called the value of marginal product.
  • Firms use resources until the VMP = factor rate (price).
  • The demand and the value of land, labor, capital and natural resources result from their marginal productivity.
  • New Technologies, and New Capital Investment makes labor more productive.
  • With greater labor productivity, the demand for labor, and the average wage rate increases.
  • The market penalizes labor discrimination with higher costs, lower profits and a weaker competition position.