1. The Markets for the Factors of Production © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Premium PowerPoint Slides by Ron Cronovich 2012 UPDATE N. Gregory Mankiw M icroeconomics Principles of Sixth Edition 18

2. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 11 In this chapter, look for the answers to these questions: What determines a competitive firm’s demand for labor? How does labor supply depend on the wage? What other factors affect labor supply? How do various events affect the equilibrium wage and employment of labor? How are the equilibrium prices and quantities of other inputs determined?

3. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 22 Factors of Production and Factor Markets  Factors of production: the inputs used to produce goods and services.  Labor  Land  Capital: the equipment and structures used to produce goods and services. Often called physical capital. Human capital is the improvement in labor from education.  Prices and quantities of these inputs are determined by supply & demand in factor markets.

4. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 33 Factor Distribution of Income  The division of income among land, labor, capital, and entrepreneurship in a country.  In the United States, the distribution in 2009:  71% compensation of employees  11% interest  6.3% corporate profits  2.5% rent  9.2% proprietors income

5. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 44 Derived Demand  Markets for the factors of production are like markets for goods & services, except:  Demand for a factor of production is a derived demand—derived from a firm’s decision to supply a good in another market.  The demand for labor is derived from the demand for a particular good.  For example, the demand for teachers is derived from the demand for educational services.

6. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 55 Two Assumptions 1. All markets are competitive. The typical firm is a price taker  in the market for the product it produces  in the labor market 2. Firms care only about maximizing profits.  Each firm’s supply of output and demand for inputs are derived from this goal.

7. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 66 Our Example: Farmer Jack  Farmer Jack sells wheat in a perfectly competitive market.  He hires workers in a perfectly competitive labor market.  When deciding how many workers to hire, Farmer Jack maximizes profits by thinking at the margin:  If the benefit from hiring another worker exceeds the cost, Jack will hire that worker.

8. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 77 Our Example: Farmer Jack  Cost of hiring another worker: the wage – the price of labor  Benefit of hiring another worker: Jack can produce more wheat to sell, increasing his revenue.  The size of this benefit depends on Jack’s production function: the relationship between the quantity of inputs used to make a good and the quantity of output of that good.

9. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 88 0 500 1,000 1,500 2,000 2,500 3,000 012345 No. of workers Quantity of output Farmer Jack’s Production Function 30005 28004 24003 18002 10001 00 Q (bushels of wheat per week) L (no. of workers)

10. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 99 Marginal Product of Labor (MPL)  Marginal product of labor: the increase in the amount of output from an additional unit of labor where ∆Q = change in output ∆L = change in labor  Diminishing Marginal Product: with each additional unit of input (labor), the marginal product of labor declines (output increases at a decreasing rate). ∆Q∆Q ∆L∆L MPL =

11. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 10 The Value of the Marginal Product  Problem:  Cost of hiring another worker (wage) is measured in dollars  Benefit of hiring another worker (MPL) is measured in units of output  Solution: convert MPL to dollars  Value of the marginal product: the marginal product of an input times the price of the output VMPL = value of the marginal product of labor = P x MPL

12. ACTIVE LEARNING Computing MPL and VMPL ACTIVE LEARNING 1 Computing MPL and VMPL © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. P = $5/bushel. Find MPL and VMPL, fill them in the blank spaces of the table. Then graph a curve with VMPL on the vertical axis, L on horiz axis. 30005 28004 24003 18002 10001 00 VMPLMPL Q (bushels of wheat) L (no. of workers)

13. ACTIVE LEARNING Answers ACTIVE LEARNING 1 Answers © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Farmer Jack’s production function exhibits diminishing marginal product: MPL falls as L increases. This property is very common. 30005 28004 24003 18002 10001 00 VMPL = P x MPL MPL = ∆Q/∆L Q (bushels of wheat) L (no. of workers) 1000200 2000400 3000600 4000800 $50001000

14. ACTIVE LEARNING Answers ACTIVE LEARNING 1 Answers © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Farmer Jack’s VMPL curve is downward sloping due to diminishing marginal product. L (number of workers) The VMPL curve 0 1,000 2,000 3,000 4,000 5,000 $6,000 012345

15. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 14 At any larger L, can increase profit by hiring one fewer worker. Farmer Jack’s Labor Demand Suppose wage (labor cost) is $2500/week. How many workers should Jack hire? Answer: L = 3 L (number of workers) The VMPL curve 0 1,000 2,000 3,000 4,000 5,000 $6,000 012345 $2,500 At any smaller L, can increase profit by hiring another worker.

16. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 15 VMPL and Labor Demand For any competitive, profit-maximizing firm:  To maximize profits, hire workers up to the point where VMPL = W.  The VMPL curve is the labor demand curve. W L VMPL W1W1 L1L1

17. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 16 Shifts in Labor Demand Labor demand curve = VMPL curve. VMPL = P x MPL Anything that increases P or MPL at each L will increase VMPL and shift labor demand curve upward. W L D1D1 D2D2

18. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 17 Causes of Shifts in Labor Demand  Change in price of output  VMPL = P x MPL  If P increases, VMPL will also increase  Change in technology  If technology enables each worker to produce more output, the MPL will increase.  Changes in supply of other factors  If the supply of other resources increases, each worker can produce more output and MPL will increase.  For example, if each worker has more land to cultivate, output will increase.

19. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 18 The Connection Between Input Demand & Output Supply  Recall: Marginal Cost (MC) = cost of producing an additional unit of output = ∆TC/∆Q, where TC = total cost  Suppose W = $2500, MPL = 500 bushels  If Farmer Jack hires another worker, ∆TC = $2500, ∆Q = 500 bushels MC = $2500/500 = $5 per bushel  In general: MC = W/MPL

20. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 19 The Connection Between Input Demand & Output Supply  In general: MC = W/MPL  Notice:  To produce additional output, hire more labor.  As L rises, MPL falls…  causing W/MPL to rise…  causing MC to rise.  Hence, diminishing marginal product and increasing marginal cost are two sides of the same coin.

21. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 20 The Connection Between Input Demand & Output Supply  The competitive firm’s rule for demanding labor: P x MPL = W  Divide both sides by MPL: P = W/MPL  Substitute MC = W/MPL from previous slide: P = MC  This is the competitive firm’s rule for supplying output.  Hence, input demand and output supply are two sides of the same coin.

22. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 21 Labor Supply  Trade-off between work and leisure: The more time you spend working, the less time you have for leisure.  The opportunity cost of leisure is the wage. If a worker makes $10 per hour, the opportunity cost of one hour of leisure is $10.  A worker must compare the utility received from $10 worth of goods/services with the utility received from one hour of leisure. The choice with the greater utility will be chosen.

23. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 22 The Labor Supply Curve for Individuals An increase in W is an increase in the opp. cost of leisure. People respond by taking less leisure and by working more. W L S1S1 W1W1 L1L1 W2W2 L2L2

24. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 23 Income & Substitution Effects  Substitution effect is when the change in price of a good changes the opportunity cost of a good. For example, if the price of pizza goes up, the opportunity cost of hamburgers decreases.  At low wage levels, workers will substitute work hours for leisure hours.  Income effect is when a change in the price of a good makes an individual richer or poorer in terms of buying power.  At high wage levels, workers supply less labor hours because the higher wage enables them to earn more money in fewer hours.

25. Labor Supply Curve for Individuals Substitution effect Income effect Hours of work (week ) IE>SE, downward sloping SE>IE, upward sloping Labor supply Hourly wage So as the wage rises, the substitution effect says “work more” while the income effect says “work less”. If the individual’s labor supply curve is upward sloping, it must be the case that the substitution effect is stronger than the income effect. If the income effect is stronger, particularly at very high wages, the labor supply curve is downward sloping, or “backward bending”.

26. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 25 Things that Shift the Labor Supply Curve  Changes in tastes or attitudes regarding the labor–leisure trade-off.  Example – increased number of women in labor force after WWII  Changes in population size, including immigration  Opportunities for workers in other labor markets  Example – greater opportunities for women and minority workers  Changes in wealth – when a class of workers wealth increases, the demand for normal goods increases, including leisure time. Curve shifts down.

27. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 26 Equilibrium in the Labor Market The wage adjusts to balance supply and demand for labor. The wage always equals VMPL. W L D S W1W1 L1L1

28. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 27 Impact of Minimum Wage above Market Wage W L W1W1 L1L1 S D W2W2 LDLD LSLS Labor supply will exceed labor demand, causing a surplus of labor or unemployment.

29. ACTIVE LEARNING Changes in labor-market equilibrium ACTIVE LEARNING 2 Changes in labor-market equilibrium In each of the following scenarios, use a diagram of the market for (domestic) auto workers to find the effects on their wage and employment. A. Baby boomers who worked in the auto industry retire. B. Car buyers’ preferences shift toward imported autos. C. Technological progress boosts productivity in the auto manufacturing industry. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

30. The retirement of baby boomer auto workers shifts supply leftward. W rises, L falls. W L D1D1 S1S1 W1W1 L1L1 S2S2 W2W2 L2L2 The market for autoworkers ACTIVE LEARNING Answers to A ACTIVE LEARNING 2 Answers to A © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

31. A fall in the demand for U.S. autos reduces P. At each L, VMPL falls. Labor demand curve shifts down. W and L both fall. W L D1D1 S1S1 W1W1 L1L1 D2D2 W2W2 L2L2 The market for autoworkers ACTIVE LEARNING Answers to B ACTIVE LEARNING 2 Answers to B © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

32. At each L, MPL rises due to tech. progress. VMPL rises and labor demand curve shifts upward. W and L increase. W L D1D1 S1S1 W1W1 L1L1 D2D2 W2W2 L2L2 The market for autoworkers ACTIVE LEARNING Answers to C ACTIVE LEARNING 2 Answers to C © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

33. 32 Productivity and Wage Growth in the U.S. Recall one of the Ten Principles: A country’s standard of living depends on its ability to produce g&s. Our theory implies wages tied to labor productivity (W = VMPL). We see this in the data. 2.22.71995–2010 1.21.41973–1995 2.8 1959–1973 1.9%2.1%1959–2010 growth rate of real wages growth rate of produc- tivity time period

34. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 33 The Other Factors of Production  With land and capital, must distinguish between:  purchase price – the price a person pays to own that factor indefinitely  rental price – the explicit price a person pays to use that factor for a limited period of time  The wage is the rental price of labor.  The determination of the rental prices of capital and land is analogous to the determination of wages…

35. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 34 How the Rental Price of Capital Is Determined Firms decide how much capital to rent by comparing the price with the value of the marginal product (VMP) of capital. The rental price of capital adjusts to balance supply and demand for capital. Curve is elastic because supply of capital is responsive to price. P Q D = VMP S P Q The market for capital

36. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 35 How the Rental Price of Land Is Determined  Firms decide how much land to rent by comparing the price with the value of the marginal product (VMP) of land.  The rental price of land adjusts to balance supply and demand for land.  Curve is inelastic because new sources of land are difficult to find and expensive. P Q D = VMP S P Q The market for land

37. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 36 Rental and Purchase Prices  Buying a unit of capital or land yields a stream of rental income.  The rental income in any period equals the value of the marginal product (VMP).  Hence, the equilibrium purchase price of a factor depends on both the current VMP and the VMP expected to prevail in future periods.  The implicit cost of a unit of capital you already own is the rental rate.  Firms will continue to employ more land until the VMP of the land is equal to the rental rate (VMP = P)

38. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 37 Linkages Among the Factors of Production  In most cases, factors of production are used together in a way that makes each factor’s productivity dependent on the quantities of the other factors.  Example: an increase in the quantity of capital  The marginal product and rental price of capital fall.  Having more capital makes workers more productive, MPL and W rise.

39. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 38 Marginal Productivity Theory of Income Distribution  Each factor of production is paid the value of the output generated by the last unit of that factor employed in the factor market, which is the equilibrium value of the marginal product.  In other words, the quantity of the factor of production will increase until VMP = P.

40. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 39 Imperfect Competition in the Product Market  Recall that MR < P with imperfect competition. That means the value of the marginal product = MP x MR.  With imperfect competition the value of the marginal product (VMP) is called marginal revenue product (MRP). MRPL is VMPL in imperfect competition. MRPL = MPL x MR Quantity of Labor (workers) Wage W* Em MRPL VMPL Ec

41. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 40 Marginal Revenue Product of Labor

42. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 41

43. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 42 Marginal Factor Cost of Labor  Cost of hiring one additional unit of labor.  In perfect competition, MFCL = market wage. Not true in imperfect competition, it is above mkt wage.

44. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 43 Monopsony  A labor market in which there is only one firm hiring labor.  For example, if a small town has one factory that hires the majority of workers in the town, that firm is a monopsonist.  Example: Caterpillar Tractor Company is the largest industry in Peoria, Illinois and hires a large percentage of the workers.  If a monopsonist wants to hire more workers, higher wages must go to all workers, not just the last hired. This causes MFCL>market wage.

45. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 44 Perfect Competition Market Labor Supply Curve

46. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 45 Imperfect Competition Market Labor Supply Curve

47. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 46 Equilibrium in Imperfect Competition Labor Market  In perfect competition, firms hire labor until VMPL = Market Wage.  In imperfect competition, the MFCL is higher than the market wage.  In imperfect competition, hire workers until the MRPL = MFCL.  The wage, however, will be equivalent to the market labor supply curve wage, not the MFCL amount.

48. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 47 Imperfect Competition Equilibrium

49. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 48 Rule for Profit Maximization  A profit maximizing firm in an imperfectly competitive market employs each factor of production up to the point at which the marginal revenue product of the last unit of the factor employed is equal to that factor’s cost.  For Labor, profit maximization occurs when MRPL = MFCL

50. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 49 Cost Minimizing Input Combination  Input substitutes are factors that can replace one another. For example, ATM’s replace bank tellers.  Input complements are factors that improve productivity by being used together. For example, farmers are more productive when they use tractors.  Cost minimization occurs when the lowest cost combination of inputs is used.

51. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 50 Which combination of cashiers and checkout stations has the lowest cost? A = $26,400B = $26,000

52. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 51 Cost Minimization Rule  Adjust hiring of (labor) inputs until the marginal product per dollar is equal for all inputs.  When the inputs are labor (L) and capital (K), the minimum cost formula is:  MPL/Wage = MPK/Rental Rate

53. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 52 Cost Minimization Example  MPL = 20 unitsMPK = 100 units  Wage = $10Rent = $100  MPL/$ = 2MPK/$ = 1  The firm receives 2 units of output per dollar for labor, but only one unit of output per dollar for capital.  The firm should substitute labor for capital until the falling marginal product of labor per dollar is equal to the rising marginal product of capital per dollar.

54. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 53 CONCLUSION  The theory in this chapter is called the neoclassical theory of income distribution.  It states that  factor prices determined by supply and demand  each factor is paid the value of its marginal product  Most economists use this theory as a starting point for understanding the distribution of income.  The next two chapters further explore income distribution and related issues.

55. SUMMARY The economy’s income distribution is determined in the markets for the factors of production. The three most important factors of production are labor, land, and capital. A firm’s demand for a factor is derived from its supply of output. Competitive firms maximize profit by hiring each factor up to the point where the value of its marginal product equals its rental price. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

56. SUMMARY The supply of labor arises from the trade-off between work and leisure, and yields an upward- sloping labor supply curve. The price paid to each factor adjusts to balance supply and demand for that factor. In equilibrium, each factor is compensated according to its marginal contribution to production. Factors of production are used together. A change in the quantity of one factor affects the marginal products and equilibrium earnings of all factors. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.