1. Copyright © 2004 South-Western Factors of Production What do you think is the most important price you will encounter throughout your life? The price of your labor!!!

2. Copyright © 2004 South-Western Factors of Production Factors of Production (inputs, resources) Inputs used to produce goods and services Land, labor (L), capital (K), entrepreneurship

3. Copyright © 2004 South-Western Why Factor Prices Matter Occupational Outlook Quarterly Derived Demand results from … the demand for a specific product/service When D rises, P …… rises!!

4. Copyright © 2004 South-Western Why Factor Prices Matter

5. Copyright © 2004 South-Western The Demand for Labor Determination of equilibrium wages Examine the link between The production of goods and the demand for labor

6. Copyright©2003 Southwestern/Thomson Learning Quantity of Apples 0 Price of Apples Demand Supply Demand Supply Quantity of Apple Pickers 0 Wage of Apple Pickers (a) The Market for Apples(b) The Market for Apple Pickers P QL W Governed by the forces of supply and demand.

7. Copyright © 2004 South-Western Marginal Productivity and Factor Demand Competitive firm Seller of goods Buyer of labor Price taker Profit maximizing Profit = TR - TC

8. Copyright © 2004 South-Western Marginal Productivity and Factor Demand Production Function relationship between quantity of inputs used to make a good quantity of output of that good

9. The Production Function Copyright©2003 Southwestern/Thomson Learning Production function Quantity of Apple Pickers 0 Quantity of Apples 300 280 240 180 100 12345

10. Copyright © 2004 South-Western Marginal Productivity and Factor Demand Marginal product of labor increase in the amount of output from an additional unit of labor MP L =  Q/  L MP L = (Q 2 – Q 1 )/(L 2 – L 1 )

11. Copyright © 2004 South-Western Marginal Productivity and Factor Demand Diminishing Marginal Product of Labor Q increases and MP L declines Each additional worker contributes less to production than the prior worker.

12. Copyright © 2004 South-Western Marginal Productivity and Factor Demand 1.List the four Factors of Production. 2.What derives the demand for labor? 3.Which Factor of Production accounts for most of the income/ 4.Define Marginal Product of Labor. 5.Define Diminishing Marginal Product of Labor.

13. Copyright © 2004 South-Western Marginal Productivity and Factor Demand Value of Marginal Product – VMP L is … The total monetary benefit of hiring each worker VMP L = (P of output) * MP L Worker contribution = worker revenue – wage (W) The extra revenue from hiring an additional worker

14. Copyright © 2004 South-Western Marginal Productivity and Factor Demand Units of LaborTotal Product (# cups/hour) Marginal Product of Labor Value of Marginal Produce 00--- 188$2*8 = $16 21810 3268 4326 5364 6382 Lemonade Stand

15. Copyright © 2004 South-Western Marginal Productivity and Factor Demand Units of LaborTotal Product (# cups/hour) Marginal Product of Labor Value of Marginal Produce 00--- 188$2*8 = $16 21810$20 326816 432612 53648 63824 Lemonade Stand

16. Copyright © 2004 South-Western Marginal Productivity and Factor Demand Hiring Labor is a … Comparison between The marginal benefit of the next worker (VMP L ) The marginal cost (MC) of the next worker. HIRE: VMP L >= W (wage) NEVER HIRE:VMP L < W STOP HIRING:VMP L = W This is the profit-maximizing hiring decision for ANY factor of production.

17. Value of the Marginal Product Copyright©2003 Southwestern/Thomson Learning 0 Quantity of Apple Pickers 0 Value of the Marginal Product Value of marginal product (demand curve for labor) Market wage Profit-maximizing quantity VMP L = W P = MC

18. Copyright © 2004 South-Western Marginal Productivity and Factor Demand Units of LaborTotal Product (# cups/hour) Marginal Product of Labor Value of Marginal Produce 00--- 188$2*8 = $16 21810$20 326816 432612 53648 63824 Lemonade Stand

19. Equilibrium in a Labor Market Copyright©2003 Southwestern/Thomson Learning Wage (price of labor) 0 Quantity of Labor Supply Demand Equilibrium wage,W Equilibrium employment,L

20. Copyright © 2004 South-Western Shifts of the Factor Demand Curve 1.Changes in the price of goods 1.P rising may mean more workers hired. 2.D curve shifts right since VMP increases.

21. Copyright © 2004 South-Western Shifts of the Factor Demand Curve 1.Changes in the supply of other factors. 1.Tools (capital) improve labor. 2.More land usually means more labor hired.

22. Copyright © 2004 South-Western Shifts of the Factor Demand Curve 1.Changes in technology. 1.Better technology usually means a more productive labor force.

23. Copyright © 2004 South-Western Demand in the Market for Land and Capital How does the owner of a firm determine how much land and capital to employ? Same way the firm hires labor R = ‘rental rate’ MC of hiring the next unit of land or capital Maximize profits = VMP Land = R Land Maximize profits = VMP Capital = R Capital

24. Copyright © 2004 South-Western Supply in the Market for Land and Capital Supply of Land is nearly vertical or ??? inelastic! Why? Only so much land. Supply of Capital is less steep or ??? Very elastic! Why? Easier to generate and/or use capital.

25. Copyright © 2004 South-Western Equilibrium Markets for Land and Capital Copyright©2003 Southwestern/Thomson Learning Quantity of Land 0 Rental Price of Land Demand Supply Demand Supply Quantity of Capital 0 Rental Price of Capital Q P LandCapital P Q

26. Copyright © 2004 South-Western THE SUPPLY OF LABOR Trade off Labor (working and wages)Leisure An upward-sloping labor supply curve means that an increase in the wages induces workers to increase the quantity of labor they supply. V.

27. Copyright © 2004 South-Western The Supply of Labor Complete the sentence: “They would need to pay me at least $ ____ /hour before I did that job. Anything less than or equal to this amount and I will pass and choose not to work that job.”

28. Copyright © 2004 South-Western Work v. Leisure Cost-benefit Decision Benefit of one hour of work = wages used to consume goods and services. Cost of one hour of work: the utility which could be gained from leisure. P of leisure = wage you give up.

29. Copyright © 2004 South-Western Work v. Leisure Cost-benefit Decision Will work when MU Wage > MU Leisure Will NOT work when MU Wage < MU Leisure Equilibrium is when MU Wage = MU Leisure

30. Supply of Labor Curve Copyright©2003 Southwestern/Thomson Learning Wage (price of labor) 0 Quantity of Labor Supply

31. Copyright © 2004 South-Western Shifts in the Market Labor Supply Curve 1.Changes in Preferences and Social Norms 1.List two you know about.

32. Copyright © 2004 South-Western Shifts in the Market Labor Supply Curve 1.Changes in Population 1.List one you know about.

33. Copyright © 2004 South-Western Shifts in the Market Labor Supply Curve 1.Changes in Opportunities 1.List two you know about.

34. Copyright © 2004 South-Western Shifts in the Market Labor Supply Curve 1.Changes in Wealth 1.List one you know about.

35. Copyright © 2004 South-Western Input Combinations Let’s talk construction! Carpenters use tools to build houses, but here are different combinations of labor and capital that will get the same house built. One man with a nail gun could be more productive than several men with hammers and nails. The firm must decide if that more expensive, but more productive, nail gun is a better choice than several men with inexpensive hammers. How does a firm decide which method of producing is best?

36. Copyright © 2004 South-Western Input Combinations Let’s talk construction! Substitutes – two factors that can do essentially the same work. List two you know about. Complements – two factors that must be combined to produce output. List two know about.

37. Copyright © 2004 South-Western Determining the Optimal Input Mix Least-cost Combination of Inputs is when the … firm hires factor so that the marginal product/dollar spent on each is the same.

38. Copyright © 2004 South-Western Cost Minimization A city needs to dig a 100-foot drainage ditch. They hire MicroP6 for the job. MicroP6 has two combinations: Combo 1: a rented backhoe and skilled driver. Combo 2: ten unskilled workers each with a shovel.

39. Copyright © 2004 South-Western Cost Minimization A city needs to dig a 100-foot drainage ditch. They hire MicroP6 for the job. MicroP6 has two combinations: Cost of LaborCost of Capital Total Cost of Producing 100’ of Ditch Digging Combo 1One skilled driver = $500 Rented Backhoe = $2500 Combo 2Ten unskilled workers = $100 * 10 = $1000 Ten shovels = $25 * $10 = $240 What are the Total Costs?

40. Copyright © 2004 South-Western Cost Minimization A city needs to dig a 100-foot drainage ditch. They hire MicroP6 for the job. MicroP6 has two combinations: Cost of LaborCost of Capital Total Cost of Producing 100’ of Ditch Digging Combo 1One skilled driver = $500 Rented Backhoe = $2500 $3000 Combo 2Ten unskilled workers = $100 * 10 = $1000 Ten shovels = $25 * $10 = $240 $1250 Which does the city choose?

41. Copyright © 2004 South-Western Cost Minimization What about productivity? Combo1 can produce a 300’ ditch in the same time it takes Combo 2 to produce a 100’ ditch. Cost of LaborCost of Capital Total Cost of Producing 100’ of Ditch Digging Combo 1One skilled driver = $500 Rented Backhoe = $2500 $3000 Combo 2Ten unskilled workers = $100 * 10 = $1000 Ten shovels = $25 * $10 = $240 $1250 Which does the city choose?

42. Copyright © 2004 South-Western Marginal Productivity Theory of Income Distribution The division of income among the economy’s factors of production is determined by each factor’s marginal productivity at the market equilibrium. What about the distribution of income for different types of labor within the broader labor market?

43. Copyright © 2004 South-Western Marginal Productivity Theory and Wage Inequality 1.Compensating differentials 1.Police officer in Chicago (pop. 2.85M) 2.Police officer in Hanover, ID (pop. 3,790) They perform essentially the same task. Whose is usually more dangerous? What about the distribution of income for different types of labor within the broader labor market?

44. Copyright © 2004 South-Western Marginal Productivity Theory and Wage Inequality 1.Differences in Talent 1.Top Chef, Hall of Fame athlete, award willing author 2.Beginning chef, minor-league athlete, beginning author They perform essentially the same task. Whose would you sample?

45. Copyright © 2004 South-Western Marginal Productivity Theory and Wage Inequality 1.Difference in Human Capital Human Capital is the accumulated education, experience and training possessed by an individual. It’s associated with more productivity and thus a higher wage.

46. Copyright © 2004 South-Western Marginal Productivity Theory and Wage Inequality 1.Market Power unions 2. Efficiency Wages above competitive wage 3. Discrimination