1. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Market for the Factors of Production The demand for a factor of production is a derived demand. u A firm’s demand for labor, land, and capital is derived from its decision to produce and sell goods and services

2. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Versatility of Supply and Demand... (a) The Market for Apples(b) The Market for Apple Pickers Quantity of Apples Quantity of Apple Pickers QL P W 00 Price of Apples Wage of Apple Pickers Demand Supply

3. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. How the Competitive Firm Decides How Much Labor to Hire

4. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Production Function... 0 0 50 100 150 200 250 300 350 0123456 Quantity of Apple Pickers Quantity of Apples 1 2 3 4 5

5. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Diminishing Marginal Product of Labor ( MPL =  Q/  L) u When other inputs are fixed, the marginal product of labor declines as the number of workers increases,. u As more and more workers are hired, each additional worker contributes less to production than the prior one. u The production function becomes flatter as the number of workers rises. This is called diminishing marginal product of labor.

6. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Value of the Marginal Product of Labor VMPL = MPL X P u The value of the marginal product of labor is the marginal product of labor multiplied by the market price of the output. VMPL = MPL X P

7. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Value of the Marginal Product and the Demand for Labor u The profit maximizing firm hires workers up to the point where the value of marginal product of labor equals the wage. VMPL = Wage If VMPL > Wage, hire more If VMPL < Wage, hire fewer

8. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Value of the Marginal Product and the Demand for Labor The value-of-marginal-product curve is the labor demand curve for a competitive, profit-maximizing firm.

9. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Value of the Marginal Product of Labor... 0Quantity of Apple Pickers 0 Value of the Marginal Product Value of marginal product (demand curve for labor) Market wage Profit-maximizing quantity

10. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. What Causes the Labor Demand Curve to Shift? u Output Price u If price of output rises, VMPL (= P x MPL) rises for each number of workers hired … demand for labor shifts UP u Technological Change u If workers produce more (MPL rises), the VMPL (= P x MPL) rises for each number of workers hired … demand for labor shifts UP u Supply of Other factors u If more capital is available for each worker, MPL rises, VMPL (= P x MPL) rises … and demand for labor shifts UP

11. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Labor Supply Curve An upward-sloping labor supply curve means that an increase in the wages gets workers to increase the quantity of labor that they supply. u When wages in an industry increase some people work longer hours some people who would otherwise stay home go to work in the industry some people migrate from other places and other industries to the higher paying jobs INCENTIVES MATTER

12. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Labor Supply Curve Supply Wage (price of labor) Quantity of Labor 0

13. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. What Causes the Labor Supply Curve to Shift? u Changes in Tastes u Changes in Alternative Opportunities u Immigration

14. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Equilibrium employment, L Equilibrium in the Labor Market... Supply Wage (price of labor) Quantity of Labor 0 Demand Equilibrium wage, W

15. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Review u The three most important factors of production are labor, land, and capital. u The demand for factors, such as labor, is a derived demand that comes from firms that use labor, land, and capital to produce goods and services. u Competitive, profit-maximizing firms hire each factor up to the point at which the value of the marginal product of the factor equals its price.

16. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Shift in Labor Supply... Wage (price of labor) W1W1 0Quantity of Labor L1L1 Supply, S 1 Demand 2....reduces the wage... 3....and raises employment. 1. An increase in labor supply... S2S2 W2W2 L2L2

17. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Shift in Labor Supply u An increase in the supply of labor : Initially results in a surplus of labor. Puts downward pressure on wages. Makes it profitable for firms to hire more workers. Results in diminishing marginal product of labor  MPL down. Lowers the value of the marginal product  VMPL = P x MPL down. Gives a new equilibrium.

18. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Shift in Labor Demand... Wage (price of labor) W1W1 0 Quantity of Labor L1L1 Supply Demand, D 1 2....increases the wage... 3....and increases employment. 1. An increase in labor demand... D2D2 W2W2 L2L2

19. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Shifts in Labor Demand An increase in the demand for labor : reflects an increase in the VMPL makes it profitable for firms to hire more workers Puts upward pressure on wages. Gives a new equilibrium.  Higher wages match the new, higher VMPL

20. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Productivity and Wage Growth in the United States

21. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Productivity and Wage Growth around the World

22. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Prices of Land and Capital u The purchase price is what a person pays to own a factor of production indefinitely. u The rental price is what a person pays to use a factor of production for a limited period of time.

23. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Markets for Land and Capital... Quantity of Land Quantity of Capital QQ P P 00 Rental Price of Land Rental Price of Capital Demand Supply (a) The Market for Land(b) The Market for Capital

24. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Equilibrium in Markets for Land and Capital u Each factor’s rental price must equal the value of their marginal product. u They each earn the value of their marginal contribution to the production process.

25. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Linkages Among the Factors of Production Factors of production are used together. u The marginal product of any one factor depends on the quantities of all factors that are available.

26. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u The three most important factors of production are labor, land, and capital. u The demand for factors, such as labor, is a derived demand that comes from firms that use the factors to produce goods and services. u Competitive, profit-maximizing firms hire each factor up to the point at which the value of the marginal product of the factor equals its price.

27. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u The supply of labor arises from individuals’ tradeoff between work and leisure. u An upward-sloping labor supply curve means that people respond to an increase in the wage by enjoying less leisure and working more hours.

28. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u The price paid to each factor adjusts to balance the supply and demand for that factor. u Because factor demand reflects the value of the marginal product of that factor, in equilibrium each factor is compensated according to its marginal contribution to the production of goods and services.

29. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u Because factors of production are used together, the marginal product of any one factor depends on the quantities of all factors that are available. u As a result, a change in the supply of one factor alters the equilibrium earnings of all the factors.

30. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Graphical Review

31. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Versatility of Supply and Demand... (a) The Market for Apples(b) The Market for Apple Pickers Quantity of Apples Quantity of Apple Pickers QL P W 00 Price of Apples Wage of Apple Pickers Demand Supply

32. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Production Function... 0 0 50 100 150 200 250 300 350 0123456 Quantity of Apple Pickers Quantity of Apples 1 2 3 4 5

33. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Value of the Marginal Product of Labor... 0Quantity of Apple Pickers 0 Value of the Marginal Product Value of marginal product (demand curve for labor) Market wage Profit-maximizing quantity

34. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Labor Supply Curve Supply Wage (price of labor) Quantity of Labor 0

35. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Equilibrium in the Labor Market... Equilibrium employment, L Supply Wage (price of labor) Quantity of Labor 0 Demand Equilibrium wage, W

36. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Shift in Labor Supply... Wage (price of labor) W1W1 0Quantity of Labor L1L1 Supply, S 1 Demand 2....reduces the wage... 3....and raises employment. 1. An increase in labor supply... S2S2 W2W2 L2L2

37. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Shift in Labor Demand... Wage (price of labor) W1W1 0 Quantity of Labor L1L1 Supply Demand, D 1 2....increases the wage... 3....and increases employment. 1. An increase in labor demand... D2D2 W2W2 L2L2

38. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Markets for Land and Capital... Quantity of Land Quantity of Capital QQ P P 00 Rental Price of Land Rental Price of Capital Demand Supply (a) The Market for Land(b) The Market for Capital