Ch 18: The Markets For the Factors of Production

1. Ch 18: The Markets For the Factors of Production • What are the “factors of production”? • Remember the circular flow model?????

2. Factor Markets differ from “goods markets” • ………..because the DEMAND for a factor is DERIVED • ………meaning the demand is derived from the decision to supply a good • Ex: the demand for “great econ teachers” is derived from the decision to “supply” the AP Econ curriculum

3. Labor (or any other factor of production) – governed by laws of Supply and Demand • ………assumptions……… • Perfect competition for BOTH the market for the good and the market for the labor • Price and Wage “TAKERS” • GOAL - Profit max.

4. Production Function • Y– axis … • ….output • X – axis…. • ….input or (factor of production) • So what lesson did we learn from the production function??????? • Diminishing Marginal Product

5. Value of the Marginal Product • How many workers to hire????? • Consider how much profit each worker would bring in. • Profit = TR – TC …right?......... • ….so the profit from an additional worker is the ….. • “Workers Contribution” to revenue - Wage

6. Workers Contribution to revenue????? • Convert the MPof Labor (MPL) into the Value of the MPL (VMPL) (also Marg Rev Prod.) • Simply Price of the good x MPL = VMPL • P x MPL = VMPL • ……because market price is constant and we experience diminishing MPL,……then the VMPL also diminishes

7. …….so how many workers do we hire ??? • Wage (W) = VMPL • …..so your Labor D curve is a reflection of the VMPL (for a competitive profit max. firm)

8. …….REMEMBER……VMPL = P x MPL... and the VMPL is the D curve. • ……so if the P increases or decreases, then VMPL…… and so the D curve will….. • …….or if the MP changes, then the VMPL will …….and so the D curve will……..

9. ……also REMEMBER….. • A profit max COMPETITIVE firm will produce where P = MC and hire where W = VMPL …if P x MPL = W…. …then P = W / MPL...and W / MPL = MC…. ….then P = MC • *remind…VMPL also called Marg Rev Prod

10. Shifting Labor Demand Curve • Output Price (P x MPL) = VMPL • Technology (increases the MPL of each worker…(P x MPL) = VMPL....so increases the VMPL • Supply of other factors ….will affect MPL of each worker

11. Supply of Labor • ….reflects how Labor / Leisure tradeoff responds to change in opportunity cost. • ….an increase in W will increase the Labor you will supply …..think of the “law of supply” • ….but an increase in Labor supplied by you = a decrease in leisure time • W increase = increase in opportunity cost of leisure

12. Shifting Labor Supply Curve • ***whenever people change the amount of work they will provide at a given wage • Change taste (lifestyle) – ex- women • Change in alternative opportunities (better opportunities in other fields) …or change in landscape of the industry.. • How would you like to be an investment banker now? • Immigration

13. Productivity and Wages • Principle: Productivity = Standard of Living • Wages = Productivity as measured by VMPL • 3 Determinants of Productivity/Standard of Living: • Physical capital • Human capital • Technological knowledge

14. Capital Income • Simplified for our model- income households earn from the rent of their capital • Reality- most firms own their own capital • ……but the income earned from the use of this is eventually returned to households in forms of stock dividends, bond interest