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Principles of Microeconomics: Ch. 18 Second Canadian Edition
Chapter 18
The Markets for the Factors of Production
© 2002 by Nelson, a division of Thomson Canada Limited
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Overview
The Market for the Factors of Production
Labour Market EquilibriumOther Factors of Production - Land and
Capital
Principles of Microeconomics: Ch. 18 Second Canadian Edition
The Market for the Factors of Production
Factors of Production are the inputs used to produce goods and services.
– What are the major factors of production?
– What determines how much each factor of production is paid?
– What determines how much of each factor of production will be purchased?
Principles of Microeconomics: Ch. 18 Second Canadian Edition
The Market for the Factors of Production
The demand for a factor of production is a Derived Demand.
A firm’s demand for a factor of production is derived from its decision to supply a good in another market.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
A Firm’s Demand For LabourLabour markets, like other markets in the
economy, are governed by the forces of supply and demand.
Most labour services, rather than being final goods ready to be enjoyed by consumers, are inputs into the production of other goods.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
A Firm’s Demand For Labour:The Competitive Profit-Maximizing
FirmA Competitive Firm
–is a price taker, for both the product it sells (e.g. apples) and the input it buys (e.g. apple pickers)
–has the goal to maximize profitsThe firm’s supply of apples and its
demand for workers are derived from its primary goal of maximizing profits.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
The Production Function and The Marginal Product of Labour
Illustrates and describes the relationship between the quantity of inputs used and the quantity of output from production.
Output
Input
Principles of Microeconomics: Ch. 18 Second Canadian Edition
The Marginal Product of Labour
Marginal Product of Labour: The increase is the amount of output from an additional unit of labour.
MPL = (Q2 - Q1) ÷ (L2 - L1)Example:
MPL = (180 - 100) ÷ (2 - 1) = 80– The second unit of labour adds 80
additional bushels of apples picked
Principles of Microeconomics: Ch. 18 Second Canadian Edition
The Diminishing Marginal Product of Labour
As the number of workers increases, the marginal product of labour declines.
As more and more workers are hired, each additional worker contributes less to the production.– The production function gets flatter as
the number of workers rises.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
The Marginal Product of Labour: How many workers to hire?
To maximize profits, the firm considers how much profit each worker would bring in. . .
Value of the Marginal Product
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Value of the Marginal Product...
… is the marginal product of the input (MPL) multiplied by the market price of the output:
VMPL = (MPL) x (PQ )– VMPL is measured in dollars and
diminishes as the number of workers rises because the market price of the good (PQ) is constant.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Value of the Marginal Product
Value of Marginal Product Curve
VMPL
Quantity of labour
Principles of Microeconomics: Ch. 18 Second Canadian Edition
“How Many Workers Do I Hire?”
Value of Marginal Product Curve
VMPL
Quantity of labour
?
Principles of Microeconomics: Ch. 18 Second Canadian Edition
How many workers to hire?
To maximize profit, the firm hires workers up to the point where the VMPL is equal to the cost of the labour, i.e. market wage.
VMPL = WAGEThe value-of-marginal-product curve is
the labour demand curve for a competitive, profit-maximizing firm.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
“How Many Workers Do I Hire?”VMPL & WAGE
Quantity of labour
MarketWage
VMPL Curve
Principles of Microeconomics: Ch. 18 Second Canadian Edition
“How Many Workers Do I Hire?”VMPL & WAGE
Quantity of labour
MarketWage
VMPL Curve
Principles of Microeconomics: Ch. 18 Second Canadian Edition
“How Many Workers Do I Hire?”VMPL & WAGE
Quantity of labour
MarketWage
Profit-MaxQuantity
VMPL Curve
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Quick Quiz!Define “marginal product
of labour” and the “value of the marginal product of labour.”
Describe how a competitive, profit-maximizing firm decides how many workers to hire.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Overview
The Market for the Factors of Production
Labour Market EquilibriumOther Factors of Production - Land and
Capital
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Labour-Market EquilibriumLabour supply and labour demand
together determine the equilibrium wage, and shifts in the supply or demand curve for labour cause the equilibrium wage to change.
Profit maximization by competitive firms demanding labour, ensures that the equilibrium wage always equals the value of the marginal product.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Labour-Market Equilibrium: Shifts in the Supply and Demand of LabourThe wage adjusts to balance the
supply and demand for labour.Shift in Supply of labour: may be
caused by increased number of available labour.
Shift in Demand for labour: may be caused by an increased demand for the final product produced by labour.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Shifts in the Supply and Demand of Labour
Shifts in Supply of Labour: Result in a surplus of labour, which
puts downward pressure on wages, which
makes it profitable for firms to hire more workers, which results in diminishing marginal product, which lowers the value of the marginal product.
Gives a new equilibrium...
Principles of Microeconomics: Ch. 18 Second Canadian Edition
“How Many Workers Do I Hire?”VMPL & WAGE
Quantity of labour
MarketWage
Profit-MaxQuantity
VMPL Curve
S0 S1
Principles of Microeconomics: Ch. 18 Second Canadian Edition
“How Many Workers Do I Hire?”VMPL & WAGE
Quantity of labour
MarketWage
Profit-MaxQuantity
VMPL Curve
S0 S1
Principles of Microeconomics: Ch. 18 Second Canadian Edition
“How Many Workers Do I Hire?”VMPL & WAGE
Quantity of labour
MarketWage
Profit-MaxQuantity
VMPL Curve
S0 S1
Principles of Microeconomics: Ch. 18 Second Canadian Edition
What causes productivity and wages to vary so much over time?
Physical Capital: when workers work with a larger quantity of equipment and structures, they produce more.
Human Capital: when workers are more educated, they produce more.
Technological Knowledge: When workers have access to more sophisticated technologies, they produce more.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Quick Quiz!
How does the immigration of workers affect labour supply, labour demand, the marginal product of labour, and the equilibrium wage?
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Overview
The Market for the Factors of Production
Labour Market EquilibriumOther Factors of Production - Land and
Capital
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Other Factors of Production: Land and Capital
Capital: refers to the stock of equipment and structures used for production.– The economy’s capital represents the
accumulation of goods produced in the past that are being used in the present to produce new goods and services.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Two Prices for Land & Capital
Purchase Price:
–the price a person pays to own that factor of production indefinitely.
Rental Price:
–the price a person pays to use that factor for a limited period of time.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Determining the Rental Price and Quantity of Land and Capital
Rental Price:– The rental price of land and the rental
price of capital are determined by supply and demand.
Quantity Purchased:– The firm increases the quantity hired until
the value of the factor’s marginal product equals the factor price.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
The Market for Land/Capital
P
Q
Supply
Demand
Rental Price of Land/Capital
Quantity of Land/Capital
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Profit Maximizing Quantities for Land/Capital
Market Price
Profit-Max Quantity
VMP
Factor Price
Quantity of Land/Capital
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Determining the Rental Price and Quantity of Land and Capital
Labour, land, and capital each earn the
value of their marginal contribution to the
production process.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Determining the Purchase Price and Quantity of Land and Capital
Equilibrium Purchase Price:
–depends on both the current value of the marginal product and the value of the marginal product expected to prevail in the future.
– Land and Capital are paid the value of their marginal product.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Linkages Among the Factors of Production
The factors of production not only depend on the demand and supply of
the products they are used to produce, but they are also dependent upon each
other.
Economic Interdependence
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Economic Interdependence between Factors of Production
An event that changes the supply of any factor of production can alter the earnings of all the factors.
The change in earnings of any factor can be found by analyzing the impact of the event on the value of the marginal product of that factor.
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Quick Quiz!What determines the
income of the owners of land and capital?
How would an increase in the quantity of capital affect the incomes of those who already own capital? How would it affect the incomes of workers?
Principles of Microeconomics: Ch. 18 Second Canadian Edition
Overview
The Market for the Factors of Production
Labour Market EquilibriumOther Factors of Production - Land and
Capital