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Unit IV: Factor Markets
Factor Markets • When firms need to purchase a factor of production, they buy them from the factor market.
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
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
The Labor Market
What is the lowest wage you would be willing to do this job…
The Labor Market • Made up of firms and workers • Demand – Employers willingness to hire a worker at each given wage • Supply – Workers willingness to work at each given wage
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.
Derived Demand Activity • On a separate sheet of blank paper, please do the following: – Write a specific product market and affiliated factor market (Adidas shoes and Rubber) – Write a scenario that will affect the product market (Adidas spends 50 million dollars on a new advertisement campaign). – MAKE IT UNIQUE BUT NOT CONFUSING! – Pass the paper behind you (group at the end…walk to the front)
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?
Bringing it Back • Each group will read their market and scenario they received. – Every student must write the market and scenario they hear in their notes • Each group will then explain the affect the scenario had on their labor market. – Every student must write the effect in their notes.
First, we need to learn some important terms
What is marginal product? When an additional input is used, how does that impact the total product?
So what is the marginal product of_______? Land Seeds Labor Time
The Marginal Product of Labor (MPL) • Change in the amount of output from an additional unit of labor.
The Production Function Quantity of Apples Production function 300 280 240 What is the MPL of the 2 nd worker? 180 Answer = 80 Apples 100 0 1 2 3 4 5 Quantity of Apple Pickers
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 0 1 2 3 4 5 Quantity of Apple Pickers
The Marginal Resource Cost (MRC) • How much an additional input costs
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
Market for Apples Quantity Total Revenue 300 280 240 What is the MRP of the 3 rd worker? ? 180 Answer = $60 100 0 1 2 3 4 5 Quantity of Apple Pickers
Market for Apples Quantity Total Revnue 300 280 Notice, the MRP of labor decreases as more workers are added 240 180 100 0 1 2 3 4 5 Quantity of Apple Pickers
How would you determine how many farmers to hire?
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.
Wage MRP Curve Competitive Firm Market wage Marginal revenue product (demand curve for labor) 0 Profit-maximizing quantity Quantity of Apple Pickers
Economic Rent How much would you have to be paid per hour to work this job?
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” But, a firm is willing I would gladly rent The economic to give me $150, 000 out this building for to the firm year! $50, 000 $100, 000 a is a year.
Alternative Input Combinations How do firms decide how many different combinations of inputs to use?
If you were the grocery store owner, which combination would you choose? Costs to the firm 1 self-checkout station = $2, 000 1 cashier = $1, 600 Option A Option B • 20 self-checkout stations • 4 cashiers • 10 self-checkout stations • 10 cashiers
Cost-Minimization Rule • The firm would add and subtract 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 MP(input 1) / MRC(input 1) = MP(input 2) / MRC(input 2) • Because of diminishing marginal returns: – If the number is too high, the firm would increase that input – If the number is too low, the firm would decrease that input
Lets do two practice scenarios
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 MP(input 1) / MRC(input 1) = MP(input 2) / MRC(input 2) MPL / Wage = MPK / Rent
Scenario 1 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
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
Scenario 2 2 units of output per dollar spent on labor < 4 unit of output per dollar spent on capital • This hire would use less workers and rent more capital – This would increase the MPL/Wage – This would decrease the. MPK / Rent MPL / Wage = MPK/Rental rate