1. Factor Markets
Chapter 25

2. Resources have a derived demand
Market for resources
Resources have a derived demand
Demand for resources depends on the demand for the good it makes

3. If demand for a good is high, then demand for the resource that makes the good is high as well
Also the price of the good will be high AND the price of the resources will be high

4. Demand for Resources P P2 P1 D2 D Q Q1 Q2

5. Example Vanessa has a muffin shop. She needs
Natural resources (flour, sugar, toppings, milk)
Labor resources (muffin chef, employees)
Capital resources (ovens, mixers, muffin pans, muffin cups)
Vanessa’s muffins are really popular in her Buckhead store. As a result her demand for those resources will increase.

6. Causes of Demand for Resources
Product Demand
Good resource makes
Productivity of resources
Technology (capital equipment)
Quality of resource
Quantity of other available resources

7. Prices of other resources
Price of Substitute resources
Substitute resource becomes cheaper, firms will switch and demand for original resource will fall
Called the substitution effect
Output effect
Lower resource price for one item (ex. Technology) means it is cheaper to produce so can afford to produce more goods which creates higher demand for OTHER resources (complements)

8. Complementary Resources
If complementary resources are cheaper, demand for all resources increases

9. Market Structure for Resources
Perfect Competition
Monopolistic Competition
Oligopoly
Monopsony

10. Whatever type of market structure a firm was in the PRODUCT market will be the same type they are in the FACTOR market
Ex. A perfectly competitive producer will be perfectly competitive in the resource market
A firm that is a producer in the product market will be a buyer in the factor market

11. Price Setting
Firms that were price TAKERS (perfect competition) in the product market will be WAGE TAKERS in the factor market
Wage is the price of a resource
Firms can hire as much as they want at the going market price
Supply of labor is horizontal as a result

12. Supply Curve of Labor for a Perfectly Competitive MarketD
Labor Q1

13. Factor Market Terms Marginal Revenue Product (MRP)
Change in total revenue that results from employing one more unit of a resource
MRP = ∆TR/∆L
Marginal Resource Cost (MRC)
Change in total cost that results from employing one more unit of a resource
MRC = ∆TC/∆L
Marginal Physical Product (MPP)
Change in quantity of output that results from employing one more unit of a resource
MPP = ∆Q/∆L

14. Perfect Competition
Firms have to pay whatever labor wage the market gives them (wage takers) – there are too many firms out there for anyone to try any other wage
Paying lower wages will just lose you workers- they can go to another firm who pays more
If a firm hires another resource (say labor), their costs will go up by whatever amount they pay that resources
In other words, the MRC of the labor is EXACTLY equal to the wage paid to the worker
The firm will hire another worker only if the MRP (additional revenue that worker brings in) is equal to or greater than the wage they have to pay that worker

15. Imperfectly Competitive Markets: MC, Oligopoly, Monopoly
MRP (Marginal revenue product) will decline (get smaller as you produce more) for two reasons:
Law of Diminishing marginal returns – as you produce more, workers get crowded so they slow down and the amount a new worker can produce begins to fall
The price of the product that the resource makes has to be lowered if these firms want to sell more goods/services
This means that if firms want to sell more stuff, they will have to lower their prices in order to convince consumers to buy it. So the additional revenue the new sales bring in will be smaller than older sales at higher prices.

16. Difference between MPP and MRP
MPP tells you how many more muffins Vanessa can make if she hires another worker
MRP tells how much more revenue Vanessa will earn from those extra muffins produced by the additional worker

17. Demand Curve for Resources
Demand curves for resources are downward sloping ALWAYS – this means that as the price of the resource falls, firms are willing and able to buy more of it
Elasticity of demand in the resource market depends upon the elasticity of demand for the good
The more sensitive demand for the good, the more sensitive demand for the resources

18. Rule for employing resources
Just like in the product market there is a profit maximizing amount of resources
Rule for employing resources
MRC=MRP
Hire more resources as long as additional revenue earned from that resource exceeds the additional cost
Example: if one more worker costs Vanessa $12 per hour she should hire them ONLY if the product they make earns her more than $12 in revenue

19. Least Cost Rule Optimal combination of resources
Least cost combination of resources - when the last dollar spent on each resource has the same marginal product – if a firm spends $29 on labor and $50 on capital, the labor bought with the 29th dollar should produce the same marginal product as the capital that was bought with the 50th dollar
Cost is minimized when this equal point is reached
Found when: Marginal Product of Labor (MPL)/Price of labor = Marginal Product of Capital (MPC) / Price of Capital

20. Daniel sells croissants in a perfectly competitive market for $2 each
Labor
Output quantity 10 70 20
130 30
180 40
220 50
250 60
270
280

21. Daniel sells croissants in a perfectly competitive market for $2 each
Labor
Output quantity
MPP (change in TP/change in L) 10 70 7 20
130 6 30
180 5 40
220 4 50
250 3 60
270 2
280 1
Every time Daniel hires another worker, MPP shows us how much additional they can produce

22. Daniel sells croissants in a perfectly competitive market for $2 each
Labor
Output quantity
MPP (change in TP/change in L) TR 10 70 7
140 20
130 6
260 30
180 5
360 40
220 4
440 50
250 3
500 60
270 2
640
280 1
560
If each croissant sells for $2 each this is Daniel’s total revenue chart

23. Daniel sells croissants in a perfectly competitive market for $2 each
Labor
Output quantity
MPP (change in TP/change in L) TR MR 10 70 7
140 2 20
130 6
260 30
180 5
360 40
220 4
440 50
250 3
500 60
270
540
280 1
560
This is the additional revenue earned by Daniel from each new worker from each new croissant that is made

24. Daniel sells croissants in a perfectly competitive market for $2 each
Labor
Output quantity
MPP (change in TP/change in L) TR MR
MRP 10 70 7
140 20
130 6
260
120 30
180 5
360
100 40
220 4
440 80 50
250 3
500 60
270 2
540
280 1
560
This is the additional revenue earned by Daniel from each new worker

25. What are you worth to your employer?
Labor (workers per hour)
Total Product
Marginal Product
Marginal Revenue
Marginal Revenue Product (MRP = MP*MR)
Marginal Resource Cost 1 25 2 45 3 60 4 70 5 75 6 7
Vanessa’s Muffins
Price per muffin is $3
Cost per worker is $8

26. What are you worth to your employer?
Labor (workers per hour)
Total Product
Marginal Product
Marginal Revenue
Marginal Revenue Product
Marginal Resource Cost 3 8 1 25 75 2 45 20 60 15 4 70 10 30 5 6 -5
-15 7
-10
-30
Vanessa’s Muffins
Price per muffin is $3
Cost per worker is $8