1. Unit IV: Factor Markets (Chapter 18)

2. Factor Markets
When firms need to purchase a factor of production, they buy them from the factor market.

3. Derived Demand
A firm’s demand for a factor of production is derived from its decision to supply a good in another market.
If Q increases in the product market at every price, demand in the factor market will increase
If Q decreases in the product market at every price, demand in the factor market will decrease

4. Changes in demand in the factor market
If people really demand more horses in parades…
Then the city will buy more horses in the factor markets

5. The Labor Market

6. The Labor Market Made up of firms and workers Demand Supply
Employers willingness to hire a worker at each given wage
Supply
Workers willingness to work at each given wage

7. What is the lowest wage you would be willing to do this job…

9. Scenarios Market = gym shoes
The majority of the public now prefers to wear sandals. What happens to the wage and quantity of sweatshop gym shoe workers?
The baby boomers become of working age. What happens to the wage and quantity of the general labor market.
Market = basketballs
Nike is gaining more and more of the market power. What will happen to the wage and quantity of Spalding workers.

10. Derived Demand Activity
On a separate sheet of blank paper, please do the following:
Write a specific product market and an affiliated factor market (Adidas shoes and Rubber)
Write a scenario that will affect any one of the markets. (Adidas spends 50 million dollars on a new advertisement campaign).
MAKE IT UNIQUE BUT NOT CONFUSING!
Pass the paper to another group

11. Partner Activity Read your market and the scenario.
Determine how this will impact the markets.
Then, graph and provide a written description of the market change.
What happens to price/wage?
What happens to quantity?

12. Bringing it Back
Each group will read their market and scenario they received.
Each group will then explain the affect the scenario had on their labor market.

13. Hiring Decision

14. First, we need to review some important terms

15. What is marginal product?
When an additional input is used, how does that impact the total product?

16. So what is the marginal product of_____________?
Land
Labor
Seeds
Time

17. The Marginal Product of Labor (MPL)
Change in the amount of output from an additional unit of labor.

18. The Production Function
Quantity
of Apples
Production
function
300
280
What is the MPL of the 2nd worker?
240
180
Answer = 80 Apples
100 1 2 3 4 5
Quantity of
Apple Pickers

19. The Production Function
Quantity
of Apples
Production
function
300
280
Notice that the MPL decreases as the quantity of workers is increased
240
180
100 1 2 3 4 5
Quantity of
Apple Pickers

20. The Marginal Resource Cost (MRC)
How much an additional input costs

21. The Value of the Marginal Product
This is also called marginal revenue product or MRP. (Most people use this term)
How much additional revenue is earned when one more input is added.
Marginal Product X Price
It also eventually diminishes as the number of inputs increase

22. Market for Apples Market Price = $2
Quantity
Total Product
300
280
What is the MRP of the 3rd worker??
240
180
Answer = $120
100 1 2 3 4 5
Quantity of
Apple Pickers

23. Market for Apples
Quantity
Total Revenue
300
280
Notice, the MRP of labor decreases as more workers are added
240
180
100 1 2 3 4 5
Quantity of
Apple Pickers

24. How would you determine how many farmers to hire?

25. Profit Maximizing Firm in Labor Market
Hire workers where MRP = MRC
Never hire a worker if their MRP is less than their MRC (wage)!
The MRP of labor (MRPL) curve is the labor demand curve for a profit-maximizing firm.

26. MRP Curve Competitive Firm Wage Marginal revenue product
(demand curve for labor)
Market
wage
Profit-maximizing quantity
Quantity of
Apple Pickers

27. Worksheet Practice…

28. How much would you have to be paid per hour to work this job?
Economic Rent
How much would you have to be paid per hour to work this job?

29. Economic Rent
An excess payment made for a factor of production above the amount expected by its owner.
On a graph, the “price” for any physical capital is “rent” or “R”
The economic rent for this building to the firm is $100,000
I would gladly rent out this building for $50,000 a year.
But, a firm is willing to give me $150,000 a year!

30. Least Cost Combination

31. Cost-Minimization Rule
The firm adds and subtracts each input until the marginal product of the first input per dollar spent is the same as the marginal product of the second input per dollar spent
Because of diminishing marginal returns:
If input 1 > input 2, then the firm would increase input 1 and decrease input 2
If input 1 < input 2, then the firm would decrease input 1 and increase input 2
In other words: if the number you get is too big, then use MORE of that input. If the number you get is too small, then use LESS of that input.
MP(input 1) / MRC(input 1) = MP(input 2) / MRC(input 2)

32. Lets do two practice scenarios

33. MP(input 1) / MRC(input 1) = MP(input 2) / MRC(input 2)
Scenario 1
Lets do an example of when the marginal product of labor per dollar is more than the marginal product of capital per dollar
Marginal product of labor = 20 units
Marginal product of capital = 100 units
Wage = $10
Rental rate for capital = $100
MPL / Wage = MPK / Rent
MP(input 1) / MRC(input 1) = MP(input 2) / MRC(input 2)

34. Scenario 1 The firm would hire more workers and use less capital
2 units of output per dollar spent on labor > 1 unit of output per dollar spent on capital
The firm would hire more workers and use less capital
This would lower the MP of labor per dollar and increase the MP of capital per dollar
MPL / Wage = MPK / Rent

35. Scenario 2
Lets do an example of when the marginal product of labor per dollar is less than the marginal product of capital per dollar
Marginal product of labor = 20 units
Marginal product of capital = 100 units
Wage = $10
Rental rate for capital = $25
MPL / Wage = MPK / Rent

36. Scenario 2 This firm would use less workers and rent more capital
2 units of output per dollar spent on labor < 4 unit of output per dollar spent on capital
This firm would use less workers and rent more capital
This would increase the MPL/Wage
This would decrease the MPK/Rental rate
MPL / Wage = MPK / Rent

37. Monopsony
Think of it in terms of a monopoly (a market with one seller)
A monopsony is a market with one buyer.
It’s a firm that hires fewer workers than a competitive firm.
Reducing the number of jobs to overall lower wages and raising profits.