Factor Markets Chapter 25 Unit 3

Characteristics Market for resources Resources have a derived demand Demand for resources depends on the demand for the good it makes

If demand for a good is high, then demand for the resource that makes the good is high as well Also the price of the good will be high AND the price of the resources will be high

P S S P D2 D2 D D Q Q Demand for Resources P1 P1 Q1 Q2 Q1 Q2 P2 P2 Demand for good P Demand for resources S S P P2 P2 P1 P1 D2 D2 D D Q Q1 Q2 Q1 Q2 Q

Example Vanessa has a muffin shop. She needs Natural resources (flour, sugar, toppings, milk) Labor resources (muffin chef, employees) Capital resources (ovens, mixers, muffin pans, muffin cups) Vanessa’s muffins are really popular in her Buckhead store. As a result her demand for those resources will increase.

Causes of Demand for Resources Product Demand Good resource makes Productivity of resources Technology (capital equipment) Quality of resource Quantity of other available resources

Prices of other resources Price of Substitute resources Substitute resource becomes cheaper, firms will switch and demand for original resource will fall Called the substitution effect Output effect Lower resource price for one item (ex. Technology) means it is cheaper to produce so can afford to produce more goods which creates higher demand for OTHER resources (complements)

Complementary Resources If complementary resources are cheaper, demand for all resources increases

Market Structures for Resources Section 2 Market Structures for Resources

Market Structure for Resources Perfect Competition Monopolistic Competition Oligopoly Monopsony

Role of Firms Firms are now BUYERS instead of sellers Operating in the FACTOR Market Firms will BUY resources from households (sellers)

B HH Circular Flow Payments Payments Goods & Services Goods & Services Product Market (Market for Goods and Services) Payments Payments Goods & Services Goods & Services HH B Resources Resources Resources Resources Income Factor Market (Market for Resources) Income Income

Whatever type of market structure a firm was in the PRODUCT market will be the same type they are in the FACTOR market Ex. A perfectly competitive producer will be perfectly competitive in the resource market A firm that is a producer in the product market will be a buyer in the factor market

Price Setting – Perfect Competition Firms that were price TAKERS (perfect competition) in the product market will be WAGE TAKERS in the factor market Wage is the price of a resource Firms can hire as much as they want at the going market price Supply of labor is horizontal as a result

Supply Curve of Labor for a Perfectly Competitive Market D Labor Q1

Factor Market Vocabulary Marginal Revenue Product (MRP) Change in total revenue that results from employing one more unit of a resource MRP = ∆TR/∆L

Factor Market Terms Marginal Resource Cost (MRC) Change in total cost that results from employing one more unit of a resource MRC = ∆TC/∆L

Factor Market Terms Marginal Physical Product (MPP) Change in quantity of output that results from employing one more unit of a resource MPP = ∆Q/∆L

Perfect Competition Firms have to pay whatever labor wage the market gives them (wage takers) – there are too many firms out there for anyone to try any other wage Paying lower wages will just lose you workers- they can go to another firm who pays more

Perfect Competition If a firm hires another resource (say labor), their costs will go up by the same amount they pay for that resources In other words, the MRC of the labor is EXACTLY equal to the wage paid to the worker The firm will hire another worker only if the MRP (additional revenue that worker brings in) is equal to or greater than the wage they have to pay that worker

Imperfectly Competitive Markets: MC, Oligopoly, Monopoly MRP (Marginal revenue product) will decline (get smaller as you produce more) for two reasons: Law of Diminishing marginal returns – as you produce more, workers get crowded so they slow down and the amount a new worker can produce begins to fall

Imperfectly Competitive Markets: MC, Oligopoly, Monopoly The price of the product that the resource makes has to be lowered if these firms want to sell more goods/services This means that if firms want to sell more stuff, they will have to lower their prices in order to convince consumers to buy it. So the additional revenue the new sales bring in will be smaller than older sales at higher prices.

Difference between MPP and MRP MPP tells you how many more muffins Vanessa can make if she hires another worker MRP tells how much more revenue Vanessa will earn from those extra muffins produced by the additional worker

Demand Curve for Resources Demand curves for resources are downward sloping ALWAYS – this means that as the price of the resource falls, firms are willing and able to buy more of it Elasticity of demand in the resource market depends upon the elasticity of demand for the good The more sensitive demand for the good, the more sensitive demand for the resources

Rule for employing resources Just like in the product market there is a profit maximizing amount of resources Rule for employing resources MRC=MRP Hire more resources as long as additional revenue earned from that resource exceeds the additional cost Example: if one more worker costs Vanessa $12 per hour she should hire them ONLY if the product they make earns her more than $12 in revenue

Least Cost Rule Optimal combination of resources Least cost combination of resources - when the last dollar spent on each resource has the same marginal product – if a firm spends $29 on labor and $50 on capital, the labor bought with the 29th dollar should produce the same marginal product as the capital that was bought with the 50th dollar Cost is minimized when this equal point is reached Found when: Marginal Product of Labor (MPL)/Price of labor = Marginal Product of Capital (MPC) / Price of Capital

Daniel sells croissants in a perfectly competitive market for $2 each Labor Output quantity 10 70 20 130 30 180 40 220 50 250 60 270 280

Daniel sells croissants in a perfectly competitive market for $2 each Labor Output quantity MPP (change in TP/change in L) 10 70 7 20 130 6 30 180 5 40 220 4 50 250 3 60 270 2 280 1 Every time Daniel hires another worker, MPP shows us how much additional they can produce

Daniel sells croissants in a perfectly competitive market for $2 each Labor Output quantity MPP (change in TP/change in L) TR 10 70 7 140 20 130 6 260 30 180 5 360 40 220 4 440 50 250 3 500 60 270 2 640 280 1 560 If each croissant sells for $2 each this is Daniel’s total revenue chart

Daniel sells croissants in a perfectly competitive market for $2 each Labor Output quantity MPP (change in TP/change in L) TR MR 10 70 7 140 2 20 130 6 260 30 180 5 360 40 220 4 440 50 250 3 500 60 270 540 280 1 560 This is the additional revenue earned by Daniel from each new worker from each new croissant that is made

Daniel sells croissants in a perfectly competitive market for $2 each Labor Output quantity MPP (change in TP/change in L) TR MR MRP 10 70 7 140 20 130 6 260 120 30 180 5 360 100 40 220 4 440 80 50 250 3 500 60 270 2 540 280 1 560 This is the additional revenue earned by Daniel from each new worker

What are you worth to your employer? Labor (workers per hour) Total Product Marginal Product Marginal Revenue Marginal Revenue Product (MRP = MP*MR) Marginal Resource Cost 1 25 2 45 3 60 4 70 5 75 6 7 Vanessa’s Muffins Price per muffin is $3 Cost per worker is $8

What are you worth to your employer? Labor (workers per hour) Total Product Marginal Product Marginal Revenue Marginal Revenue Product Marginal Resource Cost 3 8 1 25 75 2 45 20 60 15 4 70 10 30 5 6 -5 -15 7 -10 -30 Vanessa’s Muffins Price per muffin is $3 Cost per worker is $8