Unit 5: Factor Markets

(5.1) Intro to Factor Markets

  • factor market graphs convey same info from units 1-4, just looks at products in a factor perspective

    • households own factors of production

    • h earn income by selling factors in resource market (EX: selling labor for wages)

      supply + demand curve for factor market

  • marginal revenue product (MRP): extra revenue that firm gains when firm hires 1 additional worker/resource

    • formula: P * MR (change in revenue) = MRP

      • true whether product market is perfectly/imperfectly competitive

  • marginal factor or resource cost (MFC or MRC): additional cost paid by firm when it hires additional worker/resource

    • EX: wage for labor

    • MRC = TFC (price) / additional Q (usually +1)

    • MRP = MRC → MR = MC (profit maximizing quantity)

  • total product: amount produced with given amount of workers

    • marginal product: change in total product that results in an additional worker/resource

  • table indicators:

    • increasing returns = increasing marginal product

    • diminishing returns = marginal product decreases (or diminishes)

    • negative returns = marginal product is a negative integer

  • in perfect competition:

    • P (price) = MR means perfectly competitive product market

      • MP * MR = MRP is the same as MP * P = VMP (value marginal product) in perfect competition

        perfect competition table

  • in imperfect competition:

    • downward sloping demand curve → firm needs to lower the price to sell additional units

    • TP (total product) is Q

    • P * Q = TR (total revenue)

      • change in TR with 1 additional worker is MRP

    • P > MR → MRP is focused on

      • MRP = (change in TR) divided by (change in quantity of labor)

        imperfect competition table

(5.2) Changes in Factor Demand/Supply

  • derived demand: demand of resource from product demand

    • effects: productivity (MPP) and output price (MRP)

      • MPP (marginal physical product) = change in total product / change in quantity (usually +1)

        • MRP (marginal revenue product) = MPP * MR

      • diminishing returns = output increases at a decreasing rate (MPP decreases) with additional input

        MPP curve (decreasing area = diminishing returns)

  • demand determinants → MR

    • change in number of consumers

    • price of related good

      • increase if more expensive, decrease if not

    • government regulations

      • decreases productivity of workers → decreases demands

    • improvements in education

      • increase productivity of workers → increases demand

increase/decrease of demand in labor

  • 5 supply determinants

    • leisure (choosing not to work)

      • opportunity cost for work

      • increase in leisure → less in supply

    • number of alternative options

      • decrease in supply of one industry → increase in supply of another

    • age distribution

      • more retiring workers → less new workers entering

    • education

      • more years spent at universities → decrease in supply of labor

      • changes in skill levels

    • immigration

      • increase in immigration → increase in workers (vice versa)

supply curve (increase/decrease)

(5.3) Profit-Maximizing Behavior in Perfectly Competitive Factor Markets

  • wage takers: workers that are selling labor at set price

  • perfectly competitive supply curve

    • TFC (total factor cost) = Q of workers * wage rate

      • MFC or MRC = change in TFC / change in Q

    • wage rate (W) = supply curve (S) = MRC

      • perfectly elastic (horizontally straight)

  • imperfectly competitive firm

    • MRP < perfectly competitive MRP

  • least-cost rule: rule that minimizes costs/maximizes profits

    • minimizing costs formula: (MP of capital / P of capital) = (MP of labor / P of labor)

      • if ratios aren’t equal, remember diminishing marginal returns and figure out which to increase/decrease

    • similar to utility maximization

      • diminishing marginal returns is the diminishing marginal utility here (less is more)

    • inputs considered in least-cost rule can be complements and substitutes

  • type of worker + type of produce is perfectly competitive → MRP = VMP (value of the marginal product)

    • VMP is hence MP of labor * P

      • MR → P (from equation MP * MR = MRP)

(5.4) Monopolistic Markets

  • monopsony: market where there’s a single buyer (aka monopsonist)

    • one firm is hiring labor → control over wage rate (wage maker)

    • MFC > supply (S) = wage rate (W)

      • MFC = wage rate of ALL workers (wages of previous workers get raised to match the additional one)

  • profit maximizing monopsony (optimal quantity of workers): MRC = MRP

    • MRP = demand

    • wage: intersection of supply and profit maximizing line (Q of workers)

  • vs a perfectly competitive market

    • monopsony graph is just pc market + MFC curve

    • pays lower wages + hires fewer workers

      • is not allocatively efficient and produces DWL