Unit IV: Factor Markets (Chapter 18)

Factor Markets When firms need to purchase a factor of production, they buy them from the factor market.

Derived Demand A firm’s demand for a factor of production is derived from its decision to supply a good in another market. If Q increases in the product market at every price, demand in the factor market will increase If Q decreases in the product market at every price, demand in the factor market will decrease

Changes in demand in the factor market If people really demand more horses in parades… Then the city will buy more horses in the factor markets

The Labor Market

The Labor Market Made up of firms and workers Demand Supply Employers willingness to hire a worker at each given wage Supply Workers willingness to work at each given wage

What is the lowest wage you would be willing to do this job…

Scenarios Market = gym shoes The majority of the public now prefers to wear sandals. What happens to the wage and quantity of sweatshop gym shoe workers? The baby boomers become of working age. What happens to the wage and quantity of the general labor market. Market = basketballs Nike is gaining more and more of the market power. What will happen to the wage and quantity of Spalding workers.

Derived Demand Activity On a separate sheet of blank paper, please do the following: Write a specific product market and an affiliated factor market (Adidas shoes and Rubber) Write a scenario that will affect any one of the markets. (Adidas spends 50 million dollars on a new advertisement campaign). MAKE IT UNIQUE BUT NOT CONFUSING! Pass the paper to another group

Partner Activity Read your market and the scenario. Determine how this will impact the markets. Then, graph and provide a written description of the market change. What happens to price/wage? What happens to quantity?

Bringing it Back Each group will read their market and scenario they received. Each group will then explain the affect the scenario had on their labor market.

Hiring Decision

First, we need to review some important terms

What is marginal product? When an additional input is used, how does that impact the total product?

So what is the marginal product of_____________? Land Labor Seeds Time

The Marginal Product of Labor (MPL) Change in the amount of output from an additional unit of labor.

The Production Function Quantity of Apples Production function 300 280 What is the MPL of the 2nd worker? 240 180 Answer = 80 Apples 100 1 2 3 4 5 Quantity of Apple Pickers

The Production Function Quantity of Apples Production function 300 280 Notice that the MPL decreases as the quantity of workers is increased 240 180 100 1 2 3 4 5 Quantity of Apple Pickers

The Marginal Resource Cost (MRC) How much an additional input costs

The Value of the Marginal Product This is also called marginal revenue product or MRP. (Most people use this term) How much additional revenue is earned when one more input is added. Marginal Product X Price It also eventually diminishes as the number of inputs increase

Market for Apples Market Price = $2 Quantity Total Product 300 280 What is the MRP of the 3rd worker?? 240 180 Answer = $120 100 1 2 3 4 5 Quantity of Apple Pickers

Market for Apples Quantity Total Revenue 300 280 Notice, the MRP of labor decreases as more workers are added 240 180 100 1 2 3 4 5 Quantity of Apple Pickers

How would you determine how many farmers to hire?

Profit Maximizing Firm in Labor Market Hire workers where MRP = MRC Never hire a worker if their MRP is less than their MRC (wage)! The MRP of labor (MRPL) curve is the labor demand curve for a profit-maximizing firm.

MRP Curve Competitive Firm Wage Marginal revenue product (demand curve for labor) Market wage Profit-maximizing quantity Quantity of Apple Pickers

Worksheet Practice…

How much would you have to be paid per hour to work this job? Economic Rent How much would you have to be paid per hour to work this job?

Economic Rent An excess payment made for a factor of production above the amount expected by its owner. On a graph, the “price” for any physical capital is “rent” or “R” The economic rent for this building to the firm is $100,000 I would gladly rent out this building for $50,000 a year. But, a firm is willing to give me $150,000 a year!

Least Cost Combination

Cost-Minimization Rule The firm adds and subtracts each input until the marginal product of the first input per dollar spent is the same as the marginal product of the second input per dollar spent Because of diminishing marginal returns: If input 1 > input 2, then the firm would increase input 1 and decrease input 2 If input 1 < input 2, then the firm would decrease input 1 and increase input 2 In other words: if the number you get is too big, then use MORE of that input. If the number you get is too small, then use LESS of that input. MP(input 1) / MRC(input 1) = MP(input 2) / MRC(input 2)

Lets do two practice scenarios

MP(input 1) / MRC(input 1) = MP(input 2) / MRC(input 2) Scenario 1 Lets do an example of when the marginal product of labor per dollar is more than the marginal product of capital per dollar Marginal product of labor = 20 units Marginal product of capital = 100 units Wage = $10 Rental rate for capital = $100 MPL / Wage = MPK / Rent MP(input 1) / MRC(input 1) = MP(input 2) / MRC(input 2)

Scenario 1 The firm would hire more workers and use less capital 2 units of output per dollar spent on labor > 1 unit of output per dollar spent on capital The firm would hire more workers and use less capital This would lower the MP of labor per dollar and increase the MP of capital per dollar MPL / Wage = MPK / Rent

Scenario 2 Lets do an example of when the marginal product of labor per dollar is less than the marginal product of capital per dollar Marginal product of labor = 20 units Marginal product of capital = 100 units Wage = $10 Rental rate for capital = $25 MPL / Wage = MPK / Rent

Scenario 2 This firm would use less workers and rent more capital 2 units of output per dollar spent on labor < 4 unit of output per dollar spent on capital This firm would use less workers and rent more capital This would increase the MPL/Wage This would decrease the MPK/Rental rate MPL / Wage = MPK / Rent

Monopsony Think of it in terms of a monopoly (a market with one seller) A monopsony is a market with one buyer. It’s a firm that hires fewer workers than a competitive firm. Reducing the number of jobs to overall lower wages and raising profits.