Factor Markets: Land, Labor, and Capital

1. Factor Markets:Land, Labor, and Capital AP Economics Mr. Bordelon

2. Demand in theMarkets for Land and Capital • Remember, we’re making the assumption that markets for g/s are perfectly competitive. If that’s true, then the derived demand in the labor market applies to land and capital. • Rental rate. For land and capital, rental rate is the cost, explicit or implicit, of using a unit of that asset for a given period of time.

3. Demand in theMarkets for Land and Capital • VMPLand. In maximizing profits, landowner will rent more land until VMPLand = rental rate. • VMPCapital. In maximizing profits, business owner will rent more equipment until VMPCapital = rental rate. • In other words, additional cost vs. additional output.

4. Demand in theMarkets for Land and Capital • What if the business already owns the land or capital? • Doesn’t matter. There is the implicit/opportunity cost of using it for a specific purpose rather than for something else. • Key point: Profit-maximizing firms employ additional units of land and capital until cost of last unit employed, explicit or implicit, equals the VMP of that unit.

5. Demand in theMarkets for Land and Capital • You could probably guess that the slope for this curve will be negative not just due to law of demand, but also diminishing returns.

6. Supply in theMarkets for Land and Capital Take a look at this beautiful supply and demand graph. Notice that Sland is relatively inelastic. Why? Because it’s a good bet you’re not going to be finding any new land any time soon, short of planting a flag on another planet. But even more realistic, converting land from one use to another becomes more and more expensive to do so. (Who remember this concept? Tell me in class, and you will get another of Chantal’s cookies.)

7. Supply in theMarkets for Land and Capital Now look at it from the capital end. Scapital is relatively elastic. Why? Because the supply of capital is responsive to price. Capital is paid for with investment spending, planned or unplanned, or even investment savings. The amount of savings investors make available is relatively responsive to the rental rate for capital.

8. Supply in theMarkets for Land and Capital • Supply curve for a factor of production will shift as the factor becomes more or less available. Duh. • With diminishing returns, when supply of land or capital changes, MP will also have to change. • When supply of land or capital decreases, MP and rental rate increase. • When supply of land or capital increases, MP and rental rate decrease.

9. Equilibrium inLand and Capital Markets • Equilibrium rental rate and quantity in land and capital markets are where supply and demand meet. Duh.

10. Marginal Productivity Theory • Marginal Productivity Theory of Income Distribution. Every factor of production is paid the equilibrium value of its marginal product. • In an economy-wide factor market, the price paid for each factor is equal to the increase in the value of output generated by the last unit of that factor employed in the market. • If a unit of labor is paid more than a unit of capital, it is because at the equilibrium quantity of each factor, value of MPL > MPK.

11. Marginal Productivity Theory • Marginal Productivity Theory of Income Distribution. Every factor of production is paid the equilibrium value of its marginal product. • In a labor market for computer programmers is at equilibrium, wage rate earned by all computer programmers equals the market’s equilibrium VMP—the value of the MP of the last computer programmer hired.