How Resource Prices are Determined: Marginal Product Theory Marginal Productivity Theory is the heart of the factor market unit. You must master the details of marginal productivity and complex terminology such as marginal physical product (MPP), marginal revenue product (MRP), marginal resource cost (MRC), and the MRP = MRC rule before you can grasp the main concepts. Furthermore, you must understand that the demand for a resource is derived from the demand for the goods and the services produced by that resource. Finally, you must understand how a firm hires resources when more than one resource is involved. The material covered in activities 44-47 is the most emphasized factor market questions on the AP Exam.

The visual below describes how many workers a firm will hire if it is perfectly competitive in both the resource market and the factor market. What is marginal physical product? Answer: the resulting rate of change in a firms output as a result of employing one extra unit of a factor of production for example labor Why does marginal physical product decline as input increases? Answer: because of law of diminishing marginal returns What is marginal revenue product? Answer: the change in total revenue resulting from a unit change in a variable input, keeping all other inputs unchanged. How is marginal revenue product calculated? Answer: by dividing the change in total revenue by the change in the variable input. Why does marginal revenue product decline as input increases? Answer:

Profit Maximizing Rule for Employing Resources MRP = MRC Marginal Revenue Product = Marginal Resource Cost

The Visual below shows how a firm maximizes profits if it is a perfect competitor in the resource market but sells in an imperfectly competitive market. What is the evidence that this is an imperfectly competitive product market? Answer: Why does the MRP of the imperfectly competitive firm fall more rapidly than the MRP of the perfect competitor? What are the implications of this?

How many workers would be hired if the wage were: $13.95 one worker The Visual below shows how a firm maximizes profits if it is a perfect competitor in the resource market but sells in an imperfectly competitive market. How many workers would be hired if the wage were: $13.95 one worker Answer: $11.95 two workers $9.95 two workers $7.95 three workers Given the same costs, what can we conclude about workers hired in perfectly competitive markets compared with imperfectly competitive product markets? Answer: More workers will be hired under perfectly competitive product markets.

Activity 44

Activity 45

Why is MRP downward sloping? Answer: What are the factors that can shift the demand for a resource? A. Change in product price B. Change in productivity C. Changes in the price of substitute or complimentary resource depending on the substitution effect or output effect. What are the determinants of elasticity of resource demand? Answer: Rate of MRP decline, elasticity of product demand, ease of resource substitutability, the proportion of total costs that the resource represents.

Activity 46 Key Points: A monopoly firm will hire fewer workers than a perfectly competitive firm. These examples compare monopoly and perfectly competitive firms in the product markets even though the analysis is in the factor markets.

Activity 47