1 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 The Demand for Factors of Production SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE

11© 2005 McGraw-Hill Ryerson Ltd.© 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13Microeconomics, Chapter 13

The Demand for The Demand for Factors of ProductionFactors of Production

SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGESLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE


In this chapter you will learnIn this chapter you will learnIn this chapter you will learnIn this chapter you will learn

13.113.1 How factor prices are determined How factor prices are determined

13.213.2 What determines the demand for a What determines the demand for a factorfactor

13.313.3 What determines the elasticity of What determines the elasticity of factor demandfactor demand

13.413.4 How to arrive at the optimal How to arrive at the optimal combination of factors to use in the combination of factors to use in the production processproduction process


Chapter 13 TopicsChapter 13 Topics13.113.1 Factor Pricing & Demand Factor Pricing & Demand

13.2 13.2 Determinants of Factor DemandDeterminants of Factor Demand

13.313.3 Elasticity of Factor Demand Elasticity of Factor Demand

13.413.4 Optimal Combination of Factors Optimal Combination of Factors


Factor Pricing & DemandFactor Pricing & Demand

Reasons to study how factor prices are Reasons to study how factor prices are determined:determined:

Money-income determinationMoney-income determination Resource allocationResource allocation Cost minimizationCost minimization Policy issuesPolicy issues


Marginal Productivity Theory Marginal Productivity Theory of Factor Demandof Factor Demand

Factor demand is a derived demandFactor demand is a derived demand Depends on:Depends on:

– productivity of factorproductivity of factor– price of the good it helps to produceprice of the good it helps to produce



Marginal Revenue Product (MRP)Marginal Revenue Product (MRP)– productivityproductivity

• Marginal Product (MP) eventually Marginal Product (MP) eventually diminishesdiminishes

Factor demand is a derived demandFactor demand is a derived demand


Units ofUnits offactorfactor

TotalTotalproductproduct

MarginalMarginalproductproduct

MPMP

The Demand for LabourThe Demand for Labour

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diminishing diminishing returns sets returns sets in with the in with the

second second worker hiredworker hired

diminishing diminishing returns sets returns sets in with the in with the

second second worker hiredworker hired

Table 13-1Table 13-1



Marginal Revenue Product (MRP)Marginal Revenue Product (MRP)– productivityproductivity

• Marginal Product (MP) eventually Marginal Product (MP) eventually diminishesdiminishes

Factor demand is a derived demandFactor demand is a derived demand

quantity factor in changeunit onerevenue totalin change

product

revenue

Marginal

– product priceproduct price• Marginal Revenue Product (MRP)Marginal Revenue Product (MRP)





MPMPProductProduct

priceprice


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$2$2 22 22 22 22 22 22 22






MPMPProductProduct

pricepriceTotalTotal

revenuerevenue


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$2$2 22 22 22 22 22 22 22

$ 0$ 0 1414 2626 3636 4444 5050 5454 5656






MPMPProductProduct


revenuerevenue

MarginalMarginalrevenuerevenue

product MRPproduct MRP

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$2$2 22 22 22 22 22 22 22

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$ 14$ 14






MPMPProductProduct


revenuerevenue



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$2$2 22 22 22 22 22 22 22

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$ 14$ 14 1212






MPMPProductProduct


revenuerevenue



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$2$2 22 22 22 22 22 22 22

$ 0$ 0 1414 2626 3636 4444 5050 5454 5656

$ 14$ 14 1212 1010 88 66 44 22




rule for employing factorsrule for employing factors– MRP=MRCMRP=MRC

quantity factor in changeunit onecost (factor) totalin change

cost

resource

Marginal

MRP is a factor demand scheduleMRP is a factor demand schedule– consider the case of pure competition consider the case of pure competition

(product price is constant)(product price is constant)




MPMPProductProduct


revenuerevenue



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$2$2 22 22 22 22 22 22 22

$ 0$ 0 1414 2626 3636 4444 5050 5454 5656

$ 14$ 14 1212 1010 88 66 44 22

0 1 2 3 4 5 6 7 80 1 2 3 4 5 6 7 8

141412121010 88 66 44 22fa

cto

r p

rice

fact

or

pri

ce(w

age

rate

)(w

age

rate

)

Quantity of factor demandedQuantity of factor demanded

Figure 13-1Figure 13-1

1515





MPMPProductProduct


revenuerevenue



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$2$2 22 22 22 22 22 22 22

$ 0$ 0 1414 2626 3636 4444 5050 5454 5656

$ 14$ 14 1212 1010 88 66 44 22

0 1 2 3 4 5 6 7 80 1 2 3 4 5 6 7 8

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cto

r p

rice

fact

or

pri

ce(w

age

rate

)(w

age

rate

)



The purely The purely competitivecompetitive

seller’s demand seller’s demand forfor

a factora factor

The purely The purely competitivecompetitive

seller’s demand seller’s demand forfor

a factora factor

1616





MPMPProductProduct


revenuerevenue



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$2$2 22 22 22 22 22 22 22

$ 0$ 0 1414 2626 3636 4444 5050 5454 5656

$ 14$ 14 1212 1010 88 66 44 22

0 1 2 3 4 5 6 7 80 1 2 3 4 5 6 7 8

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cto

r p

rice

fact

or

pri

ce(w

age

rate

)(w

age

rate

)



What about imperfect What about imperfect product market product market competition?competition?

What about imperfect What about imperfect product market product market competition?competition?

1717





MPMPProductProduct


revenuerevenue




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fact

or

pri

ce(w

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)(w

age

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)



$2.80$2.80 2.602.60 2.402.40 2.202.20 2.002.00 1.851.85 1.751.75 1.651.65

1818





MPMPProductProduct


revenuerevenue




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]]]]]]]]]]]]

$2.80$2.80 2.602.60 2.402.40 2.202.20 2.002.00 1.851.85 1.751.75 1.651.65

$ 0$ 0 18.2018.20 31.2031.20 39.6039.60 44.0044.00 46.2546.25 47.2547.25 46.2046.20

$ 18.20$ 18.20 13.0013.00 8.408.40 4.404.40 2.252.25 1.001.00 -1.05-1.05

1919





MPMPProductProduct


revenuerevenue




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or

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ce(w

age

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)(w

age

rate

)



]]]]]]]]]]]]

$2.80$2.80 2.602.60 2.402.40 2.202.20 2.002.00 1.851.85 1.751.75 1.651.65

$ 0$ 0 18.2018.20 31.2031.20 39.6039.60 44.0044.00 46.2546.25 47.2547.25 46.2046.20

$ 18.20$ 18.20 13.0013.00 8.408.40 4.404.40 2.252.25 1.001.00 -1.05-1.05

2020


The imperfectlyThe imperfectlycompetitive competitive

seller’sseller’sdemand for a demand for a

factorfactor

The imperfectlyThe imperfectlycompetitive competitive

seller’sseller’sdemand for a demand for a

factorfactor


Market Demand for a FactorMarket Demand for a Factor– sum the individual demand (MRP) curves sum the individual demand (MRP) curves

for all firms hiring that factorfor all firms hiring that factor








Determinants of Factor Determinants of Factor DemandDemand

Changes in Product DemandChanges in Product Demand Changes in ProductivityChanges in Productivity

– quantities of other factorsquantities of other factors– technological progresstechnological progress– quality of the variable factorquality of the variable factor


Determinants of Factor Determinants of Factor DemandDemand

Changes in the Prices of Other FactorsChanges in the Prices of Other Factors– Substitute Factors of ProductionSubstitute Factors of Production

• substitution effectsubstitution effect• output effectoutput effect• net effectnet effect

– Complementary Factors of ProductionComplementary Factors of Production Occupational Employment TrendsOccupational Employment Trends

– fastest growing occupationsfastest growing occupations







Elasticity of Factor DemandElasticity of Factor Demand

what determines the elasticity of factor what determines the elasticity of factor demand?demand?

price resource in change %

quantity resource in change %Erd


Determinants of EDeterminants of Erdrd

Ease of Factor SubstitutabilityEase of Factor Substitutability Elasticity of Product DemandElasticity of Product Demand Factor Cost as a Proportion of Total Factor Cost as a Proportion of Total

CostCost







Optimal Combination of Optimal Combination of FactorsFactors

The Least-cost RuleThe Least-cost Rule

)) C

C

L

L

(P capital of Price

)(MP capital of

product Marginal

(P labour of Price

)(MP labour of

product Marginal


Optimal Combination of Optimal Combination of FactorsFactors

The Least-cost RuleThe Least-cost Rule

The Profit-maximizing RuleThe Profit-maximizing Rule

)) C

C

L

L

(P capital of Price

)(MP capital of

product Marginal

(P labour of Price

)(MP labour of

product Marginal

1C

C

L

L

P

MRP

P

MRP


QQ TPTP MPMP TRTR MRPMRP

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$ 24$ 24 2020 1212 1010 88 66 44


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$ 0$ 0 2626 4444 5656 6464 7070 7474 7676

$ 26$ 26 1818 1212 88 66 44 22

Labour (price = $8)Labour (price = $8) Capital (price = $12)Capital (price = $12)


what is the least-cost combination what is the least-cost combination of labour & capital to use in of labour & capital to use in

producing 50 units of output?producing 50 units of output?

what is the least-cost combination what is the least-cost combination of labour & capital to use in of labour & capital to use in

producing 50 units of output?producing 50 units of output?



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$ 24$ 24 2020 1212 1010 88 66 44


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$ 26$ 26 1818 1212 88 66 44 22



will 50 units of output maximize the will 50 units of output maximize the firm’s profit?firm’s profit?

will 50 units of output maximize the will 50 units of output maximize the firm’s profit?firm’s profit?



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$ 0$ 0 2424 4444 5656 6666 7474 8080 8484

$ 24$ 24 2020 1212 1010 88 66 44


]]]]]]

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$ 0$ 0 2626 4444 5656 6464 7070 7474 7676

$ 26$ 26 1818 1212 88 66 44 22



No: No: MRPMRPLL = $12 = $12

PPLL = $8 = $8

firm should hire more labourfirm should hire more labour

No: No: MRPMRPLL = $12 = $12

PPLL = $8 = $8

firm should hire more labourfirm should hire more labour



]]]]]]

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$ 0$ 0 2424 4444 5656 6666 7474 8080 8484

$ 24$ 24 2020 1212 1010 88 66 44


]]]]]]

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$ 0$ 0 2626 4444 5656 6464 7070 7474 7676

$ 26$ 26 1818 1212 88 66 44 22



profit-maximizing conditions are profit-maximizing conditions are satisfied when firm employs 5 units satisfied when firm employs 5 units

of labour & 3 units of capitalof labour & 3 units of capital

profit-maximizing conditions are profit-maximizing conditions are satisfied when firm employs 5 units satisfied when firm employs 5 units

of labour & 3 units of capitalof labour & 3 units of capital


Marginal Productivity Theory Marginal Productivity Theory of Income Distributionof Income Distribution

income gets distributed according to income gets distributed according to contribution to outputcontribution to output

criticisms:criticisms:– inequalityinequality– market imperfectionsmarket imperfections






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1 © 2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 13 The Demand for Factors of Production SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE