Final Examination Monday, December 15 10:30 – 12:30 NOTE: The exam will be in LC 7 – not LC 1. Extra office hours (BA 111A): Thursday, December11 2:30 - 4:30 Sunday, December 142:30 - 4:30 Chapters covered on exam: 1-8, 10-11, 13-15, and 18 (60 to 65 percent of the exam will be drawn from chapters 13, 14 and 15 and to a much lesser extent chapter 18.)

Factor Markets and the Distribution of Income Chapter 18 Pages of chapter 20

The Circular-Flow Diagram Firms Households Market for Factors of Production Market for Goods and Services SpendingRevenue Wages, rent, and profit Income Goods & Services sold Goods & Services bought Labor, land, and capital Inputs for production

Market for a Factor of Production L W S D L0L0 W0W0 earnings

Price-taking firm’s decision regarding the quantity of an input to employ. The value of the marginal product of an input, VMP, is the marginal product of the input times the price of the output; VMP = MPP. Example: Suppose that the MP L is 1.5 shirts per hour and the price of shirts is $6 per shirt. A worker working one hour will yield the firm $9.00 in additional revenues.

Suppose that the market price of the output produced by a firm is $0.50 per unit and the market price of labor is $8.00 per hour.

A firm’s demand for an input is based upon the input’s VMP, which depends upon the input’s marginal productivity and the output’s value (price) in the market; VMP = MP P.

Markets for Factors of Production L W SLSL DLDL L0L0 W0W0 labor market K r SKSK DKDK K0K0 r0r0 market for another input labor earnings input’s earnings

Marginal Productivity Theory of Income Determination: In a market economy the distribution of income depends upon the distribution of resource (input) ownership and the prices of those factors of production. The prices of inputs are determined by supply and demand in the markets for those inputs. The importance of the marginal productivity of inputs in determining the distribution of income follows from the fact that the demands for inputs directly depends upon the values of their marginal products.

LHLH WHWHL WLWL SHSH DHDH SLSL DLDL LH1LH1 WH1WH1 WL1WL1 LL1LL1 market for high skilled workersmarket for lower skilled workers The Market Determination of Wages

The Distribution of Income in the United States: 1998

Average Annual earnings by Educational Attainment

Why has the gap in earnings between skilled and unskilled workers risen in recent years? uInternational trade has altered the relative demand for skilled and unskilled labor. uChanges in technology have altered the relative demand for skilled and unskilled labor.

DHDH SHSH LH1LH1 WH1WH1 LHLH WHWH market for high skilled workers DLDL SLSL WL1WL1 LL1LL1L WLWL market for lower skilled workers The Market Determination of Wages D H’ WH2WH2 LH2LH2

Principles of Economics Markets are usually a good way to organize economic activity. Governments can sometimes improve economic outcomes.