Chapter 18: Labour, Capital & Land: Focus on the Demand Side

18 Driven Demand for Labor, Capital and Land as Factors of Production

In this abbreviated treatment of chapter 18 you will:  Understand the demand for factor inputs as a derived demand based on the value of the marginal product of the factor input (labour, capital, land/natural resources.  Understand the difference between user cost (or rental prices) and purchase prices for capital, resources, and labour(slavery)  Explore how capital and land rental rates and natural resource prices are determined  Understand the Hotelling Principle as it applies to extracting or not extracting natural resources. Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

The Anatomy of Factor Markets Our four factors of production are:  Labour: wage rates  Capital: rental price of capital  Land (natural resources): rental price of land/resources  Entrepreneurship: As we explored in earlier chapters, entrepreneurs earn Normal Profit. (Nothing more dealt with regarding entrepreneurs in this chapter) Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

Market for Labour Services Most labour markets have many buyers and many sellers and are competitive. In these labour markets, the wage rate, cost per time period, is determined by supply and demand. One cannot, of course, buy the labourer, as one can buy capital, land or resources. To buy the labourer would be slavery. The Anatomy of Factor Markets Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

Market for Capital Services Capital the tools, machines, buildings produced in the past, and now used to produce goods and services. The price per time period (hour, week, month, year) of the services of capital is called the user cost or rental cost of capital Capital goods are also bought and sold but those prices are not their input user price per time The Anatomy of Factor Markets Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

Markets for Land Services and Natural Resources Land and natural resources: The market for land as a factor of production is the market for the services of land, i.e. the use of land. This price is a rental rate. Nonrenewable natural resources: inputs that can be used only once, such as oil, natural gas, and coal, Their prices are determined in (global) commodity markets. The price of land, or of a coal mine or natural gas well, is different from rental rate of the commodity as an input. The Anatomy of Factor Markets Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

The demand for a factor is derived from the its contribution to the output it is used to produce. The value from hiring one more unit of a factor is called the value of marginal product (VMP) VMP = MP x Price in competitive output market VMP = MP x MR in a monopoly output market MP depends on the skills and talent of the worker, and on the technology and other inputs used in production. If these change the VMP changes as well.. The Derived Demand for a Factor of Production Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

The firm maximizes profit by hiring labour to the point where VMP = the wage rate. If VMP > wage rate: hire one more worker If VMP < wage rate, fire one worker. If VMP = wage rate, firm is at profit maximizing labour input. Labour demand is thus a derived demand based on VMP, and is downward sloping because of diminishing marginal product. The Demand for a Factor of Production Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

Changes in a Firm’s Demand for Labour (shifts demand curve) The firm’s demand for labour depends on  The price of the firm’s output: changes value of MP  The prices of other factors of production: changes input mix through substitution, and changes MP  Technology: changes MP The Demand for a Factor of Production Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

Technology New technologies may decrease or increase the demand for different types of labour. Example: New automated bread-making machine New automated bread-making machine decreases the demand for bakery workers. Firms that make and service automated bread-making machines hire more labour. The Demand for a Factor of Production Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

Competitive Labour Market Equilibrium Labour market equilibrium determines the wage rate and the number of worker employed. Labour Markets Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

A Labour Market with a Union A labour union is an organized group of workers that aims to increase wages and influence other job conditions. Influences on Labour Supply One way to raise the wage rate is to decrease the supply of labour. Influences on Labour Demand Another way to raise the wage rate is to encourage people to buy goods produced by union workers, which raises the price of those goods and increases VMP of the workers. Labour Markets Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

Capital and Natural Resource Markets Capital Rental Markets The demand for capital is derived from the value of marginal product of capital. Profit-maximizing firms hire the quantity of capital services that makes the value of marginal product of capital equal to the rental rate of capital. Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

Capital Rent-Versus-Buy Decision The capital that a firm owns and operates itself has an implicit rental rate that arises from depreciation, interest costs, and other opportunity costs. The decision to rent capital services or buy capital involves comparing explicit rent with implicit rent and a choice to minimize cost. Capital and Natural Resource Markets Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

The Hotelling Principle: The idea that traders value the the price of a nonrenewable natural resource in the ground, against the rate of interest. Opportunity cost of leaving it in the ground: the interest forgone on the revenue received from sale. Opportunity cost of taking it out of the ground: the price appreciation forgone from leaving it in the ground. If the price of oil is expected to rise at a rate that exceeds the interest rate, it is profitable to leave it in the ground. If the expected rate of interest exceeds the expected rise in the price of oil, it is profitable to take it out of the ground. Capital and Natural Resource Markets Copyright © 2013 Pearson Canada Inc., Toronto, Ontario