1. 1 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 The Demand for Factors of Production SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE

2. 2 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 In this chapter you will learn 13.1 How factor prices are determined 13.2 What determines the demand for a factor 13.3 What determines the elasticity of factor demand 13.4 How to arrive at the optimal combination of factors to use in the production process

3. 3 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Chapter 13 Topics 13.1 Factor Pricing & Demand 13.2 Determinants of Factor Demand 13.3 Elasticity of Factor Demand 13.4 Optimal Combination of Factors

4. 4 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Factor Pricing & Demand Reasons to study how factor prices are determined: n Money-income determination n Resource allocation n Cost minimization n Policy issues

5. 5 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Marginal Productivity Theory of Factor Demand n Factor demand is a derived demand n Depends on: –productivity of factor –price of the good it helps to produce

6. 6 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Marginal Productivity Theory of Factor Demand n Marginal Revenue Product (MRP) –productivity Marginal Product (MP) eventually diminishesMarginal Product (MP) eventually diminishes n Factor demand is a derived demand

7. 7 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 diminishing returns sets in with the second worker hired Table 13-1

8. 8 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Marginal Productivity Theory of Factor Demand n Marginal Revenue Product (MRP) –productivity Marginal Product (MP) eventually diminishesMarginal Product (MP) eventually diminishes n Factor demand is a derived demand –product price Marginal Revenue Product (MRP)Marginal Revenue Product (MRP)

9. 9 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP Productprice The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 $2 2 2 2 2 2 2 2 Table 13-1

10. 10 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 $2 2 2 2 2 2 2 2 $ 0 14 14 26 26 36 36 44 44 50 50 54 54 56 56 Table 13-1

11. 11 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 $2 2 2 2 2 2 2 2 $ 0 14 14 26 26 36 36 44 44 50 50 54 54 56 56 $ 14 Table 13-1

12. 12 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 $2 2 2 2 2 2 2 2 $ 0 14 14 26 26 36 36 44 44 50 50 54 54 56 56 $ 14 12 12 Table 13-1

13. 13 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 $2 2 2 2 2 2 2 2 $ 0 14 14 26 26 36 36 44 44 50 50 54 54 56 56 $ 14 12 12 10 10 8 6 4 2 Table 13-1

14. 14 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Marginal Productivity Theory of Factor Demand n rule for employing factors –MRP=MRC n MRP is a factor demand schedule –consider the case of pure competition (product price is constant)

15. Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 $2 2 2 2 2 2 2 2 $ 0 14 14 26 26 36 36 44 44 50 50 54 54 56 56 $ 14 12 12 10 10 8 6 4 2 0 1 2 3 4 5 6 7 8 141210 8 6 4 2 factor price (wage rate) Quantity of factor demanded Figure 13-1 15 Table 13-1

16. Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 $2 2 2 2 2 2 2 2 $ 0 14 14 26 26 36 36 44 44 50 50 54 54 56 56 $ 14 12 12 10 10 8 6 4 2 0 1 2 3 4 5 6 7 8 141210 8 6 4 2 factor price (wage rate) Quantity of factor demanded Figure 13-1 The purely competitive seller’s demand for a factor The purely competitive seller’s demand for a factor 16 Table 13-1

17. Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP ] ] ] ] ] ] The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 $2 2 2 2 2 2 2 2 $ 0 14 14 26 26 36 36 44 44 50 50 54 54 56 56 $ 14 12 12 10 10 8 6 4 2 0 1 2 3 4 5 6 7 8 141210 8 6 4 2 factor price (wage rate) Quantity of factor demanded Figure 13-1 What about imperfect product market competition? 17 Table 13-1

18. Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 0 1 2 3 4 5 6 7 8 141210 8 6 4 2 factor price (wage rate) Quantity of factor demanded Figure 13-2 $2.80 2.60 2.60 2.40 2.40 2.20 2.20 2.00 2.00 1.85 1.85 1.75 1.75 1.65 1.65 18 Table 13-2

19. Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 0 1 2 3 4 5 6 7 8 141210 8 6 4 2 factor price (wage rate) Quantity of factor demanded Figure 13-2 ] ] ] ] ] ] $2.80 2.60 2.60 2.40 2.40 2.20 2.20 2.00 2.00 1.85 1.85 1.75 1.75 1.65 1.65 $ 0 18.20 18.20 31.20 31.20 39.60 39.60 44.00 44.00 46.25 46.25 47.25 47.25 46.20 46.20 $ 18.20 13.00 13.00 8.40 8.40 4.40 4.40 2.25 2.25 1.00 1.00 -1.05 -1.05 19 Table 13-2

20. Units of factorTotalproduct MarginalproductMP ProductpriceTotalrevenue Marginalrevenue product MRP The Demand for Labour ] ] ] ] ] ] 01234567 0 7131822252728 7654321 0 1 2 3 4 5 6 7 8 141210 8 6 4 2 factor price (wage rate) Quantity of factor demanded Figure 13-2 ] ] ] ] ] ] $2.80 2.60 2.60 2.40 2.40 2.20 2.20 2.00 2.00 1.85 1.85 1.75 1.75 1.65 1.65 $ 0 18.20 18.20 31.20 31.20 39.60 39.60 44.00 44.00 46.25 46.25 47.25 47.25 46.20 46.20 $ 18.20 13.00 13.00 8.40 8.40 4.40 4.40 2.25 2.25 1.00 1.00 -1.05 -1.05 20 Table 13-2 The imperfectly competitive seller’s demand for a factor The imperfectly competitive seller’s demand for a factor

21. 21 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 n Market Demand for a Factor –sum the individual demand (MRP) curves for all firms hiring that factor Marginal Productivity Theory of Factor Demand

22. 22 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Chapter 13 Topics 13.1 Factor Pricing & Demand 13.2 Determinants of Factor Demand 13.3 Elasticity of Factor Demand 13.4 Optimal Combination of Factors 

23. 23 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Determinants of Factor Demand n Changes in Product Demand n Changes in Productivity –quantities of other factors –technological progress –quality of the variable factor

24. 24 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Determinants of Factor Demand n Changes in the Prices of Other Factors –Substitute Factors of Production substitution effectsubstitution effect output effectoutput effect net effectnet effect –Complementary Factors of Production n Occupational Employment Trends –fastest growing occupations

25. 25 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Chapter 13 Topics 13.1 Factor Pricing & Demand 13.2 Determinants of Factor Demand 13.3 Elasticity of Factor Demand 13.4 Optimal Combination of Factors  

26. 26 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Elasticity of Factor Demand n what determines the elasticity of factor demand?

27. 27 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Determinants of E rd n Ease of Factor Substitutability n Elasticity of Product Demand n Factor Cost as a Proportion of Total Cost

28. 28 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Chapter 13 Topics 13.1 Factor Pricing & Demand 13.2 Determinants of Factor Demand 13.3 Elasticity of Factor Demand 13.4 Optimal Combination of Factors   

29. 29 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Optimal Combination of Factors n The Least-cost Rule

30. 30 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Optimal Combination of Factors n The Least-cost Rule n The Profit-maximizing Rule

31. 31 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 QTP MP TR MRP ] ] ] ] ] ] ] ] ] ] ] ] 01234567 012222833374042 1210 6 5 4 3 2 $ 0 24 24 44 44 56 56 66 66 74 74 80 80 84 84 $ 24 20 20 12 12 10 10 8 6 4 QTPMPTR MRP ] ] ] ] ] ] ] ] ] ] ] ] 01234567 013222832353738 13 9 6 4 3 2 1 $ 0 26 26 44 44 56 56 64 64 70 70 74 74 76 76 $ 26 18 18 12 12 8 6 4 2 Labour (price = $8) Capital (price = $12) Table 13-5 what is the least-cost combination of labour & capital to use in producing 50 units of output?

32. 32 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 QTP MP TR MRP ] ] ] ] ] ] ] ] ] ] ] ] 01234567 012222833374042 1210 6 5 4 3 2 $ 0 24 24 44 44 56 56 66 66 74 74 80 80 84 84 $ 24 20 20 12 12 10 10 8 6 4 QTPMPTR MRP ] ] ] ] ] ] ] ] ] ] ] ] 01234567 013222832353738 13 9 6 4 3 2 1 $ 0 26 26 44 44 56 56 64 64 70 70 74 74 76 76 $ 26 18 18 12 12 8 6 4 2 Labour (price = $8) Capital (price = $12) Table 13-5 will 50 units of output maximize the firm’s profit?

33. 33 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 QTP MP TR MRP ] ] ] ] ] ] ] ] ] ] ] ] 01234567 012222833374042 1210 6 5 4 3 2 $ 0 24 24 44 44 56 56 66 66 74 74 80 80 84 84 $ 24 20 20 12 12 10 10 8 6 4 QTPMPTR MRP ] ] ] ] ] ] ] ] ] ] ] ] 01234567 013222832353738 13 9 6 4 3 2 1 $ 0 26 26 44 44 56 56 64 64 70 70 74 74 76 76 $ 26 18 18 12 12 8 6 4 2 Labour (price = $8) Capital (price = $12) Table 13-5 No: MRP L = $12 P L = $8 firm should hire more labour No: MRP L = $12 P L = $8 firm should hire more labour

34. 34 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 QTP MP TR MRP ] ] ] ] ] ] ] ] ] ] ] ] 01234567 012222833374042 1210 6 5 4 3 2 $ 0 24 24 44 44 56 56 66 66 74 74 80 80 84 84 $ 24 20 20 12 12 10 10 8 6 4 QTPMPTR MRP ] ] ] ] ] ] ] ] ] ] ] ] 01234567 013222832353738 13 9 6 4 3 2 1 $ 0 26 26 44 44 56 56 64 64 70 70 74 74 76 76 $ 26 18 18 12 12 8 6 4 2 Labour (price = $8) Capital (price = $12) Table 13-5 profit-maximizing conditions are satisfied when firm employs 5 units of labour & 3 units of capital

35. 35 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Marginal Productivity Theory of Income Distribution n income gets distributed according to contribution to output n criticisms: –inequality –market imperfections

36. 36 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 Chapter 13 Topics 13.1 Factor Pricing & Demand 13.2 Determinants of Factor Demand 13.3 Elasticity of Factor Demand 13.4 Optimal Combination of Factors    