Factor Markets 💰

Key Concepts

• Factors of Production: land, labor, and physical capital

• Payments for Factors:

  • Rent: payment for land

  • Wages: payment for labor

  • Interest: payment for physical capital

Production Function

• Shows the relationship between the quantity of labor a business hires and the amount of output those workers can produce

• Three phases of the law of diminishing marginal returns:

  1. Increasing marginal product

  2. Decreasing marginal product (diminishing marginal returns)

  3. Negative marginal product

Marginal Revenue Product (MRP)

• MRP = Marginal Revenue × Marginal Product

• Used to determine how many workers a business would like to hire

• Formula: MRP = P × MP, where P is the price and MP is the marginal product

Firm's Demand for Labor

• Definition: The quantity of labor a firm is willing and able to hire at a given wage rate

• Characteristics:

  • Downward sloping demand curve

  • Inverse relationship between the wage and the number of workers hired

  • When the wage falls, the number of workers hired increases

Market Demand for Labor

• Definition: The sum of each firm's marginal revenue product

• Characteristics:

  • Downward sloping demand curve

  • Inverse relationship between the wage and the number of workers hired

  • When the wage falls, the number of workers hired increases

Market Supply of Labor

• Definition: The quantity of labor households are willing and able to supply at a given wage rate

• Characteristics:

  • Upward sloping supply curve

  • Direct relationship between the wage and the quantity supplied

  • When the wage rises, the quantity supplied increases

Equilibrium Wage and Quantity

• Definition: The point where the supply and demand curves intersect

• Characteristics:

  • Determined by the interaction between supply and demand

  • Equilibrium wage: the wage at which the quantity supplied equals the quantity demanded

  • Equilibrium quantity: the quantity of labor hired at the equilibrium wage

Changes in the Factor Markets

• Changes in Demand:

  • Increase in demand: shifts the demand curve rightward

  • Decrease in demand: shifts the demand curve leftward

• Changes in Supply:

  • Increase in supply: shifts the supply curve rightward

  • Decrease in supply: shifts the supply curve leftward

Firms in Perfectly Competitive Factor Markets

• Characteristics:

  • Many buyers of labor

  • Each individual firm is a wage-taker

  • The market sets the wage

• Marginal Resource Cost (MRC):

  • The amount of money a business has to pay to hire one more worker

  • Equal to the market wage

Firm's Demand Curve

• Definition: The marginal revenue product curve

• Characteristics:

  • Upward sloping portion (increasing marginal returns)

  • Downward sloping portion (decreasing marginal returns)

  • Profit-maximizing quantity: where the marginal revenue product equals the marginal resource cost

Monopsony

• Definition: A market structure in which there is only one buyer of a resource (labor)

• Characteristics:

  • The firm's supply curve is the labor supply curve

  • The firm must increase wages to hire more workers

  • The relationship between the wage and the marginal resource cost is different from that in a perfectly competitive market## Monopsony in Labor Markets 📊

Marginal Resource Cost and Supply of Labor

• The marginal resource cost is the change in the total resource cost.

• In a monopsony, the marginal resource cost is greater than the wage.

• The supply of labor is upward sloping, represented by the market supply curve.

Graphical Representation

• The marginal resource cost curve is above the supply curve.

• The firm's demand curve is the marginal revenue product.

• The profit-maximizing quantity of labor is where the marginal revenue product equals the marginal resource cost.

Comparison to Perfectly Competitive Markets

• In a perfectly competitive market, the equilibrium wage is where the supply and demand curves intersect.

• The equilibrium quantity of labor is where the supply and demand curves intersect.

• A monopsony pays lower wages and hires fewer workers than a perfectly competitive market.

Allocative Efficiency and Deadweight Loss

• Monopsonies are not allocatively efficient.

• There is deadweight loss in a monopsony.

Least Cost Combinations of Resources 💡

Finding the Least Cost Combination

• Take the marginal product of each resource and divide it by the price of the resource.

• The profit-maximizing combination is found where the marginal product of labor divided by the price of labor equals the marginal product of capital divided by the price of capital.

Example

• In this example, the firm should employ more capital and less labor.