1 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 The Demand for Factors of Production SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE

2 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 In this chapter you will learn 13.1 How factor prices are determined 13.2 What determines the demand for a factor 13.3 What determines the elasticity of factor demand 13.4 How to arrive at the optimal combination of factors to use in the production process

3 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Chapter 13 Topics 13.1 Factor Pricing & Demand 13.2 Determinants of Factor Demand 13.3 Elasticity of Factor Demand 13.4 Optimal Combination of Factors

4 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Factor Pricing & Demand Reasons to study how factor prices are determined: n Money-income determination n Resource allocation n Cost minimization n Policy issues

5 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Marginal Productivity Theory of Factor Demand n Factor demand is a derived demand n Depends on: –productivity of factor –price of the good it helps to produce

6 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Marginal Productivity Theory of Factor Demand n Marginal Revenue Product (MRP) –productivity Marginal Product (MP) eventually diminishesMarginal Product (MP) eventually diminishes n Factor demand is a derived demand

7 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP The Demand for Labour ] ] ] ] ] ] diminishing returns sets in with the second worker hired Table 13-1

8 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Marginal Productivity Theory of Factor Demand n Marginal Revenue Product (MRP) –productivity Marginal Product (MP) eventually diminishesMarginal Product (MP) eventually diminishes n Factor demand is a derived demand –product price Marginal Revenue Product (MRP)Marginal Revenue Product (MRP)

9 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP Productprice The Demand for Labour ] ] ] ] ] ] $ Table 13-1

10 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue The Demand for Labour ] ] ] ] ] ] $ $ Table 13-1

11 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] $ $ $ 14 Table 13-1

12 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] $ $ $ Table 13-1

13 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] $ $ $ Table 13-1

14 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Marginal Productivity Theory of Factor Demand n rule for employing factors –MRP=MRC n MRP is a factor demand schedule –consider the case of pure competition (product price is constant)

Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] $ $ $ factor price (wage rate) Quantity of factor demanded Figure Table 13-1

Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] $ $ $ factor price (wage rate) Quantity of factor demanded Figure 13-1 The purely competitive seller’s demand for a factor The purely competitive seller’s demand for a factor 16 Table 13-1

Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] $ $ $ factor price (wage rate) Quantity of factor demanded Figure 13-1 What about imperfect product market competition? 17 Table 13-1

Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP The Demand for Labour ] ] ] ] ] ] factor price (wage rate) Quantity of factor demanded Figure 13-2 $ Table 13-2

Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP The Demand for Labour ] ] ] ] ] ] factor price (wage rate) Quantity of factor demanded Figure 13-2 ] ] ] ] ] ] $ $ $ Table 13-2

Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP The Demand for Labour ] ] ] ] ] ] factor price (wage rate) Quantity of factor demanded Figure 13-2 ] ] ] ] ] ] $ $ $ Table 13-2 The imperfectly competitive seller’s demand for a factor The imperfectly competitive seller’s demand for a factor

21 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 n Market Demand for a Factor –sum the individual demand (MRP) curves for all firms hiring that factor Marginal Productivity Theory of Factor Demand

22 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Chapter 13 Topics 13.1 Factor Pricing & Demand 13.2 Determinants of Factor Demand 13.3 Elasticity of Factor Demand 13.4 Optimal Combination of Factors 

23 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Determinants of Factor Demand n Changes in Product Demand n Changes in Productivity –quantities of other factors –technological progress –quality of the variable factor

24 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Determinants of Factor Demand n Changes in the Prices of Other Factors –Substitute Factors of Production substitution effectsubstitution effect output effectoutput effect net effectnet effect –Complementary Factors of Production n Occupational Employment Trends –fastest growing occupations

25 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Chapter 13 Topics 13.1 Factor Pricing & Demand 13.2 Determinants of Factor Demand 13.3 Elasticity of Factor Demand 13.4 Optimal Combination of Factors  

26 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Elasticity of Factor Demand n what determines the elasticity of factor demand?

27 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Determinants of E rd n Ease of Factor Substitutability n Elasticity of Product Demand n Factor Cost as a Proportion of Total Cost

28 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Chapter 13 Topics 13.1 Factor Pricing & Demand 13.2 Determinants of Factor Demand 13.3 Elasticity of Factor Demand 13.4 Optimal Combination of Factors   

29 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Optimal Combination of Factors n The Least-cost Rule

30 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Optimal Combination of Factors n The Least-cost Rule n The Profit-maximizing Rule

31 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 QTP MP TR MRP ] ] ] ] ] ] ] ] ] ] ] ] $ $ QTPMPTR MRP ] ] ] ] ] ] ] ] ] ] ] ] $ $ Labour (price = $8) Capital (price = $12) Table 13-5 what is the least-cost combination of labour & capital to use in producing 50 units of output?

32 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 QTP MP TR MRP ] ] ] ] ] ] ] ] ] ] ] ] $ $ QTPMPTR MRP ] ] ] ] ] ] ] ] ] ] ] ] $ $ Labour (price = $8) Capital (price = $12) Table 13-5 will 50 units of output maximize the firm’s profit?

33 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 QTP MP TR MRP ] ] ] ] ] ] ] ] ] ] ] ] $ $ QTPMPTR MRP ] ] ] ] ] ] ] ] ] ] ] ] $ $ Labour (price = $8) Capital (price = $12) Table 13-5 No: MRP L = $12 P L = $8 firm should hire more labour No: MRP L = $12 P L = $8 firm should hire more labour

34 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 QTP MP TR MRP ] ] ] ] ] ] ] ] ] ] ] ] $ $ QTPMPTR MRP ] ] ] ] ] ] ] ] ] ] ] ] $ $ Labour (price = $8) Capital (price = $12) Table 13-5 profit-maximizing conditions are satisfied when firm employs 5 units of labour & 3 units of capital

35 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Marginal Productivity Theory of Income Distribution n income gets distributed according to contribution to output n criticisms: –inequality –market imperfections

36 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Chapter 13 Topics 13.1 Factor Pricing & Demand 13.2 Determinants of Factor Demand 13.3 Elasticity of Factor Demand 13.4 Optimal Combination of Factors    