Market for Factors of Production

1. Market for Factors of Production

2. Factors of Production • Inputs used to make another good • Land, Labor, Capital • Factor Markets • The demand for a factor of production is a derived demand • It is derived from the supply decision to produce the good/service that it is a factor of

3. Demand for Labor • Governed by supply and demand • Labor demand is derived demand • Labor is an input into the production process of final goods

4. Labor Market Wages Supply of Labor W* Derived Demand for Labor L* Labor

5. Assumptions • Firm is competitive in both markets • In the goods it sells and the labor it buys • Price Taker • Accept market price of good • Pay market price for wages • Decisions • How much to produce • How much labor to hire • Firm is profit maximizing

6. Production Function • Relationship between the quantity of inputs (labor, land, capital) and the quantity of outputs (the good/service the firm sells) • Marginal Product of Labor (MPL) • How much production increases from one more unit of labor • Diminishing marginal product • The marginal product of an input decreases as the quantity of the input increases

7. Production Function Low Marginal Productivity Quantity of Output Production function flattens out because as more input (labor) is used it becomes less productive, and so each new unit of labor leads to less units of output High Marginal Productivity Quantity of Input (labor)

8. Value of Marginal Product of Labor (VMPL) • Just that the value of the MPL • Marginal product of labor times the price of the output it produces • Declines as labor input increases because MPL decreases • Profit Max • When VMPL equals the market wage, that is the quantity of labor that max’s profit • Because VMPL is essential marginal benefit and market wage is marginal cost • As always, point of interest is where MB = MC

9. VMPL Marginal Benefit Where MC = MB is profit max quantity Market Wage Rate Value of marginal product of labor = demand for labor (just like demand for any good is also the value curve of that good) Marginal Cost Profit Maximizing Quantity of Labor Quantity of Labor

10. Shifts in Labor Demand • Change in Price of output • VMPL = MPL * P • MPL stays same but P changes so VMPL shifts out • Technological Change • Technological advance can increase MPL • Think rise in demand for programmers (information age) • Or rise in demand for financial analysists (pre bust) • Labor saving Tech can lower MPL • Think automation in manufacturing • Supply of other factors can change MPL

11. Labor Supply • Either work or play • Labor supply curve represents trade-off between work and leisure • The market wage rate is the opportunity cost to leisure • Shifts in Labor Supply • Change in tastes • Change in other alternative opportunities • Immigration

12. Upward Sloping Labor Supply as a Community or an Individual Wage Worker with low leisure value enters first even if wages low. OR You’re willing to give up your first hour of leisure for lower wage because leisure not as valuable Worker with highest leisure value enters last only when wages are high. OR You only give up your last (16th) hour of work if the wage is really high because the value of that leisure hour is high. Quantity Labor

13. Now, how elastic is labor supply in reality? • Good Question • Probably fairly steep (inelastic) • But that’s an empirical question • And depends on how you define the market

14. Labor Market Equilibrium • Wages in the market adjust to balance supply and demand • Equilibrium wage equals the marginal value product of labor in the market • Changes in supply or demand change the market wage rate and labor quantity • Change the value marginal product of labor

15. Shift in Labor Supply Wage S’ S’’ Employment goes up and wage goes down. Marginal value product of labor also goes down. W1 W2 D L1 L2 Quantity Labor

16. Shift in Labor Demand Wage S Employment goes up and wage goes up. Marginal value product of labor also goes up. W2 W1 D’ D’’ L1 L2 Quantity Labor

17. Standards of living are dependent on our ability to produce goods and services • Wages = value of productivity of labor • More productive = higher wages • Education • Today we are better off than yesterday • Higher real wages • More productive • Higher standard of living

20. Wage and benefit costs, both before and after adjusting for inflation, grew more slowly in 2009 than in any year since the U.S. government began tracking data in 1982, as double-digit unemployment weakened workers' ability to command higher pay. In the past 12 months, the cost of wages and benefits received by workers other than those employed by the federal government rose 1.5%, according to the Labor Department's employment cost index. In the same period, consumer prices rose 2.7%. Source: Wall Street Journal January 30, 2010

21. Skill or education premium rising over time as technological change brings higher demand for skilled workers, and trade with emerging markets reduces demand for unskilled labor

22. Some disagree with neo-classical assumptions and results So how is it that an executive can earn more than 300x times the average wage of production workers? What explains bankers' bonuses? For post-Keynesianism, these are still unresolved questions. James Galbraith suggest that differential pay rates between different sectors are determined by different degrees of monopoly, with knowledge intensive sectors enjoying greater market power.

23. Other Factor Markets • All other input factor markets are derived in the same way • The price of an input will be brought into line with its value marginal product • A producer will buy an input until its price equals its value marginal product