Factors of Production

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Factors of Production Land Labor Physical capital Human capital What is capital? The value of the assets that are used by a firm in producing its output

Types of Capital Physical Capital “capital” Manufactured resources – equipment, buildings, tools, and machines Human Capital Improvement in labor created by education and knowledge and embodied in the workforce Become more important with progress of technology

Allocation of Resources Mississippi and Louisiana after Hurricane Katrina States had an urgent and immediate need for workers in building trades What ensured that those needed workers came? The FACTOR MARKET! The market for a factor of production allocated that factor of production to where it was needed

Allocation of Resources Derived Demand – demand for the factor is derived from the firm’s output choice Factor markets are also where most of us get the largest shares of our income Income usually comes in the form of wages and salaries Prices of factors of production differ among different groups Higher wage rate, larger proportion of the total income in the economy goes to people who derive their income from labor Factor distribution of income

Value of Marginal Product Most factor markets in the modern American economy are perfectly competitive – buyers and sellers are price-takers

The Production Function for George and Martha’s Farm (a) Total Product (b) Marginal Product of Labor Quantity of wheat (bushels) Marginal product of labor (bushels per worker) As we know from earlier chapters, a price-taking firm’s profit is maximized by producing the quantity of output at which the marginal cost of the last unit produced is equal to the market price. Once we determine the optimal quantity of output, we can go back to the production function and find the optimal number of workers. 100 TP 19 17 80 15 13 60 11 9 40 7 5 20 MPL Figure Caption: Figure 20-2: The Production Function for George and Martha’s Farm Panel (a) shows how the quantity of output of wheat on George and Martha’s farm depends on the number of workers employed. Panel (b) shows how the marginal product of labor depends on the number of workers employed. 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Quantity of labor (workers) Quantity of labor (workers)

Value of Marginal Product The value of the marginal product of a factor is the extra value of output generated by employing one more unit of that factor. Value of the marginal product of labor = VMPL = P × MPL The general rule is that a profit-maximizing, price-taking producer employs each factor of production up to the point at which the value of the marginal product of the last unit of the factor employed is equal to that factor’s price.

Value of Marginal Product Should George and Martha hire an extra worker? Yes, if VMPL > W

Value of Marginal Product The decision to hire is a marginal decision Marginal benefit to the producer from hiring an additional worker (VMPL) should be compared with the marginal cost to the producer (W) What is the optimal choice? Marginal benefit = marginal cost

Value of Marginal Product VMPL = W Does not apply to labor, only factors of production General Rule: profit-maximizing price-taking producer employs each factor of production up to the point at which the value of the marginal product of the last unit of the factor employed is equal to that factor’s price

Marginal Product and Factor Demand Quantity of Labor L (workers) Marginal product of labor MPL (bushels per worker) Value of the Marginal Product of Labor VMPL = P X MPL 19 1 17 2 15 3 13 4 11 5 9 6 7 8 Price is $20

The Value of the Marginal Product Curve Wage rate, VMPL Optimal point $400 300 A Market wage rate 200 Value of the marginal product value curve Figure Caption: Figure 20-3: The Value of the Marginal Product Curve This curve shows how the value of the marginal product of labor depends on the number of workers employed. It slopes downward because of diminishing returns to labor in production. To maximize profit, George and Martha choose the level of employment at which the value of the marginal product of labor is equal to the market wage rate. For example, at a wage rate of $200 the profit-maximizing level of employment is 5 workers, shown by point A. The value of the marginal product curve of a factor is the producer’s individual demand curve for that factor. 100 VMPL 1 2 3 4 5 6 7 8 Quantity of labor (workers) Profit-maximizing number of workers

Marginal Product and Factor Demand The value of the marginal product curve of a factor shows how the value of the marginal product of that factor depends on the quantity of the factor employed.

Utilizing the Marginal Product Curve Problem: Martha and George currently employ 3 workers who get paid $200 Should Martha and George employ an additional worker? If they add one worker, increase the value of their production by $260 but increase their cost by $200 which means an increased profit of $60

Utilizing the Marginal Product Curve A producer can always increase profit by employing on e more unit of a factor of production as long as the value of the marginal product produced by that unit exceeds it factor price

The Value of the Marginal Product Curve Wage rate, VMPL The firm maximizes profit by choosing a level of employment at which the value of the marginal product of the last worker hired EQUALS the wage rate Optimal point $400 300 A Market wage rate 200 Value of the marginal product value curve Figure Caption: Figure 20-3: The Value of the Marginal Product Curve This curve shows how the value of the marginal product of labor depends on the number of workers employed. It slopes downward because of diminishing returns to labor in production. To maximize profit, George and Martha choose the level of employment at which the value of the marginal product of labor is equal to the market wage rate. For example, at a wage rate of $200 the profit-maximizing level of employment is 5 workers, shown by point A. The value of the marginal product curve of a factor is the producer’s individual demand curve for that factor. 100 VMPL 1 2 3 4 5 6 7 8 Quantity of labor (workers) Profit-maximizing number of workers

Utilizing the Marginal Product Curve Firms use the marginal product curve in order to determine the profit-maximizing level of employment The value of the marginal product of labor curve is the individual producer’s labor demand curve In general…..a producer’s value of the marginal product curve for any factor of production is that producer’s individual demand curve for that factor of production

Factors of Production

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Factors of Production _________ __________________ What is capital?

Types of Capital Physical Capital Human Capital Become more important with progress of technology

Allocation of Resources Mississippi and Louisiana after Hurricane Katrina States had an urgent and immediate need for workers in building trades What ensured that those needed workers came? _____________________ The market for a factor of production allocated that factor of production to where it was needed

Allocation of Resources Derived Demand – Factor markets are also where most of us get the largest shares of our income Income usually comes in the form of _________ and _________ Prices of factors of production differ among different groups Factor distribution of income

Value of Marginal Product Most factor markets in the modern American economy are perfectly competitive – buyers and sellers are __________________

The Production Function for George and Martha’s Farm (a) Total Product (b) Marginal Product of Labor Quantity of wheat (bushels) Marginal product of labor (bushels per worker) 100 19 17 80 15 13 60 11 9 40 7 5 20 Figure Caption: Figure 20-2: The Production Function for George and Martha’s Farm Panel (a) shows how the quantity of output of wheat on George and Martha’s farm depends on the number of workers employed. Panel (b) shows how the marginal product of labor depends on the number of workers employed. 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Quantity of labor (workers) Quantity of labor (workers)

Value of Marginal Product The value of the marginal product of a factor is the extra value of output generated by employing ___________of that factor. Value of the marginal product of labor = _____________________ The general rule is that a profit-maximizing, price-taking producer employs each factor of production up to the point at which the value of the marginal product of the last unit of the factor employed is equal to that factor’s price.

Value of Marginal Product Should George and Martha hire an extra worker?

Value of Marginal Product The decision to hire is a marginal decision What is the optimal choice?

Value of Marginal Product VMPL = W General Rule: profit-maximizing price-taking producer employs each factor of production up to the point at which the value of the marginal product of the last unit of the factor employed is equal to that factor’s price

Marginal Product and Factor Demand Quantity of Labor L (workers) Marginal product of labor MPL (bushels per worker) Value of the Marginal Product of Labor VMPL = P X MPL 19 1 17 2 15 3 13 4 11 5 9 6 7 8 Price is $20

The Value of the Marginal Product Curve Wage rate, VMPL $400 300 A 200 Value of the marginal product value curve Figure Caption: Figure 20-3: The Value of the Marginal Product Curve This curve shows how the value of the marginal product of labor depends on the number of workers employed. It slopes downward because of diminishing returns to labor in production. To maximize profit, George and Martha choose the level of employment at which the value of the marginal product of labor is equal to the market wage rate. For example, at a wage rate of $200 the profit-maximizing level of employment is 5 workers, shown by point A. The value of the marginal product curve of a factor is the producer’s individual demand curve for that factor. 100 VMPL 1 2 3 4 5 6 7 8 Quantity of labor (workers)

Marginal Product and Factor Demand The value of the marginal product curve of a factor shows how the value of the marginal product of that factor depends on the quantity of the factor employed.

Utilizing the Marginal Product Curve Problem: Martha and George currently employ 3 workers who get paid $200 Should Martha and George employ an additional worker? If they add one worker, increase the value of their production by $260 but increase their cost by $200 which means an increased profit of $60

Utilizing the Marginal Product Curve A producer can always increase profit by employing on e more unit of a factor of production as long as the value of the marginal product produced by that unit exceeds it factor price

The Value of the Marginal Product Curve Wage rate, VMPL $400 300 A 200 Value of the marginal product value curve Figure Caption: Figure 20-3: The Value of the Marginal Product Curve This curve shows how the value of the marginal product of labor depends on the number of workers employed. It slopes downward because of diminishing returns to labor in production. To maximize profit, George and Martha choose the level of employment at which the value of the marginal product of labor is equal to the market wage rate. For example, at a wage rate of $200 the profit-maximizing level of employment is 5 workers, shown by point A. The value of the marginal product curve of a factor is the producer’s individual demand curve for that factor. 100 VMPL 1 2 3 4 5 6 7 8 Quantity of labor (workers)

Utilizing the Marginal Product Curve Firms use the marginal product curve in order to determine the profit-maximizing level of employment The value of the marginal product of labor curve is the individual producer’s labor demand curve In general…..