Markets for Land and Capital

1. Land and Capital ▫Demand in the markets for land and capital  If you maintain the assumption that the markets for goods and services are perfectly competitive, the result that we derived for demand in the labor market also applies to other factors of production.  Land- you would rent land up until the value of the marginal product of an acre of land is equal to the rental rate per acre.  Capital- you would compare the additional cost of the equipment with the value of the additional output it generates.  The explicit cost of renting a unit of land or capital for a set period of time is known as the rental rate.

 What if you already own the land and equipment?  Even if you own the land and equipment there is still an implicit cost, or opportunity cost, because it could be used for something else.  So a profit maximizing firm employs additional units of land and capital until the cost of the last unit employed, explicit or implicit, is equal to the value of the marginal product of that unit.

▫Supply in the markets for land and capital  Supply curve for land  It is relatively steep and therefore relatively inelastic.  This reflects that finding new supplies of land for production is typically difficult and expensive

 Supply curve for capital  It is relatively flat and therefore relatively elastic  Supply curve for capital is relatively responsive to price: capital is typically paid for with the savings of investors, and the amount of savings that investors make available is relatively responsive to the rental rate for capital.  Supply curve for a factor will shift as the factor becomes more or less available.

▫Equilibrium in Land and Capital Markets  Equilibrium rental rate and quantity in the land and capital markets are found at the intersection of supply and demand curves.

2. Marginal Productivity Theory ▫Definition:  Every factor of production is paid the equilibrium value of its marginal product. ▫This is used to sum up payments to factors when goods markets and factor markets are perfectly competitive.

▫According to the theory:  Each factor is paid the value of the output generated by the last unit of that factor employed in the factor market as a whole (its equilibrium value of the marginal product.)  Division of income among economy’s factors of production isn’t arbitrary.  In the economy-wide factor market, the price paid for each factor is equal to the increase in the value of output generated by the last unit of that factor employed in the market.  Also remember that factors differ considerably with respect to productivity