Class 3

 Factor Markets refers to the markets where services of the factors of production are bought and sold  Labor Markets  Capital Markets  The markets for raw materials  The market for management and entrepreneurial resources.  The demand for and supply of factors  Rent  Wages  Interest  Economic profit

 The demand for a factor is derived (Indirect)  There is demand for land because there is demand for rice.  The supply of factors of production  Depends on the system of property rights  The toil trouble involved in the work  (Depends on the leisure preference)

 In the free market (no government intervention and trade union pressure) the price of the factors of production are dependent on supply and demand.  Output determination  commodity pricing  Income distribution  factor pricing  Two types of income distribution  Functional distribution of income (Micro)  Personal distribution of income (Macro)

 Each factor is paid on the basis of the function performed by it.  Land owners – Rent  Workers – Wage  Suppliers of financial capital – interest  Entrepreneurs – profit.  Two main theories of factor price determination  Supply Demand Theory  The marginal productivity theory of factor demand

 When wages increase  Labor increases

 This suggests that an individual firm pays a factor on the basis of its Marginal product  MR = MC  However, there are other factors. A rupee spent on labor cannot be spent on capital  Therefore firms have to choose their best option.  This it the law of EQUI-MARGINAL RETURN

 Commercial Rent – Payment for the use of property  Economic Rent – Is the reward for the uses of the services of the land.  The Supply of the land is perfectly inelastic because the quantity available is fixed and determined by nature.  Supply has no influence in the determining of rent.  Demand is the only determinant of rent  Perfectly inelastic – so as demand increases/decreases rent will increase/decrease.  Economic Rent offers no incentive system.  Since Land is a gift of nature, any payment received by the owner is called PURE or ECONOMIC RENT

 Labor Unions try to increase wages in 3 ways  They try to increase the demand for labor by increasing productivity  By advertising union made products  By lobbying for the restriction of imports  Increase wage by restricting the supply of labor  High initiation fees  Long apprenticeships  Require that firms higher only union workers.  Increase wages by bargaining with employees  Threats of strikes  Go slow campaigns.

 The wage rate refers to the earning per hour of labor.  The wage rate divide by the price index gives the “Real Wage Rate”  The level of real wages depends on the productivity of labor  Real wages are higher  The greater the amount of capital available (hedge fund managers)  The more technology available (scientists)  The availability of natural resources (oil)

 By adding each firms demand for labor we get the Market demand for labor  The market supply for labor depends on the  Size of the population  The proportion of the population in the labor force  The state of the economy  The level of real wages  Competitive equilibrium real wage rate is determined by the intersection of the market demand and supply curves.  Then the firm hires labor until the MR = the wage rate

 You give me Rs 2000 today and in a year I will give you Rs 500 as interest and the original Rs.2000  (500/2000)*100 = 25%  Bank interest is 8%  So my economic profit is (25-8) = 17%  Banks sets Savings rates and Borrowing rates – and the bank keeps the difference as revenue. Rate of Interest = Interest *100 Principal

 Profit is a return on entrepreneurial ability or a reward for risk taking.  Economic role of profits  Profits as a signal to a resource owner  Profits are economics signals letting people know to enter markets or in cases of losses to leave markets.  Profits are motive for efficiency  Gives incentive to firms to reduce cost  Profits as reward  The prospect of earning rewards are the driving force behind development  Innovation  Profit is the prime mover of capitalistic economies.