© 2009 South-Western, a part of Cengage Learning, all rights reserved
C H A P T E R
The M arkets for the
The M arkets for the
Factors of Production
Factors of Production
E
conomics
P R I N C I P L E S O FP R I N C I P L E S O FN. Gregory
N. Gregory
Mankiw
Mankiw
Premium PowerPoint Slides by Ron Cronovich
18
In this chapter,
In this chapter,
look for the answers to these questions:
look for the answers to these questions:
§
What determines a competitive firm’s demand forlabor?
§
How does labor supply depend on the wage?What other factors affect labor supply?
§
How do various events affect the equilibrium wage and employment of labor?§
How are the equilibrium prices and quantities of other inputs determined?1
Factors of Production and Factor M arkets
§
Factors of production:§
Labor§
Land§
Capital:THE MARKETS FOR THE FACTORS OF PRODUCTION 3
Derived Demand
§
Markets for the factors of production are like markets for goods & services, except:§
Demand for a factor of production is a derived demandTHE MARKETS FOR THE FACTORS OF PRODUCTION 4
Two Assumptions
1. We assume
§
in the market for the product it produces§
in the labor market2. We assume
§
Each firm’s supply of output and demand for inputs are derived from this goal.THE MARKETS FOR THE FACTORS OF PRODUCTION 5
Our Example: Farmer Jack
§
Farmer Jack sells wheat in a perfectly competitive market.§
He hires workers in a perfectly competitive labor market.§
When deciding how many workers to hire, Farmer Jack maximizes profits by thinking at the margin:THE MARKETS FOR THE FACTORS OF PRODUCTION 6
Our Example: Farmer Jack
§
Cost of hiring another worker:§
Benefit of hiring another worker: Jack can§
The size of this benefit depends on Jack’sproduction function: the relationship between the quantity of inputs used to make a good and the quantity of output of that good.
THE MARKETS FOR THE FACTORS OF PRODUCTION 7
0
No. of workers
Q
Farmer Jack’s Production Function
3000
M arginal Product of Labor (M PL)
THE MARKETS FOR THE FACTORS OF PRODUCTION 9
The V alue of the M arginal Product
§
Problem:§
Cost of hiring another worker§
Benefit of hiring another worker§
Solution:§
Value of the marginal product:A C T I V E L E A R N I N G
A C T I V E L E A R N I N G 11
Computing M PL and VM PL Computing M PL and VM PL
10
P= $5/bushel.
Find MPL
and VMPL, fill them in the blank spaces of the table.
Then graph a curve with
VMPLon the
vertical axis,
Lon horiz axis.
3000
L (number of workers) The VMPLcurve
THE MARKETS FOR THE FACTORS OF PRODUCTION 13
Farmer Jack’s Labor Demand
Suppose wage
W= $2500/week.
How many workers should Jack hire?
Answer:
L (number of workers) The VMPLcurve
0 1,000 2,000 3,000 4,000 5,000 $6,000
0 1 2 3 4 5
THE MARKETS FOR THE FACTORS OF PRODUCTION 14
VM PL and Labor Demand
For any competitive, profit-maximizing firm:
§
To maximize profits, WL VMPL
Shifts in Labor Demand
Labor demand curve W
THE MARKETS FOR THE FACTORS OF PRODUCTION 16
Things that Shift the Labor Demand Curve
§
§
§
§
Example:If firm gets more equipment (capital), then workers will be more productive; MPLand VMPLrise, labor demand shifts upward.
THE MARKETS FOR THE FACTORS OF PRODUCTION 17
The Connection Between Input Demand
& Output Supply
§
Recall: Marginal Cost (MC)= cost of producing an additional unit of output =
§
Suppose W= $2500, MPL= 500 bushels§
If Farmer Jack hires another worker,§
In general:THE MARKETS FOR THE FACTORS OF PRODUCTION 18
The Connection Between Input Demand
& Output Supply
§
Notice:§
To produce additional output,§
As Lrises,§
causing§
causingTHE MARKETS FOR THE FACTORS OF PRODUCTION 19
The Connection Between Input Demand
& Output Supply
§
The competitive firm’s rule for demanding labor:§
Divide both sides by MPL:§
Substitute MC= W/MPLfrom previous slide:§
This is the competitive firm’s rule for supplying output.§
Hence,THE MARKETS FOR THE FACTORS OF PRODUCTION 20
Labor Supply
§
Trade-off betweenThe more time you spend working,
§
The Labor Supply Curve
An increase in W is an increase in
People respond by
W
L S1
W1
THE MARKETS FOR THE FACTORS OF PRODUCTION 22
Things that Shift the Labor Supply Curve
THE MARKETS FOR THE FACTORS OF PRODUCTION 23
Equilibrium in the Labor M arket
The wage adjusts to balance supply and demand for labor.
The wage always equals
W
L D S
In each of the following scenarios, use a diagram of the market for (domestic) auto workers to find the effects on their wage and employment.
A. Baby Boomers who worked in the auto industry
retire.
B. Car buyers’ preferences shift toward imported autos.
C. Technological progress boosts productivity in the auto manufacturing industry.
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22
Changes in labor
Changes in labor
-
-
market equilibrium
market equilibrium
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22
Answers to A
Answers to A
25
The market for autoworkers The market for
autoworkers
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22
Answers to B
Answers to B
26
The market for autoworkers The market for
autoworkers
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22
Answers to C
Answers to C
W
The market for autoworkers The market for
THE MARKETS FOR THE FACTORS OF PRODUCTION 28
Productivity and W age Growth in the U.S.
Recall one of the Ten Principles:
A country’s standard of living depends on its ability to produce g&s.
Our theory implies
We see this in the data.
2.5
THE MARKETS FOR THE FACTORS OF PRODUCTION 29
The Other Factors of Production
§
With land and capital, must distinguish between:§
purchase price§
rental price§
The wage is§
The determination of the rental prices of capital and land is analogous to the determination of wages…THE MARKETS FOR THE FACTORS OF PRODUCTION 30
How the Rental Price of Land Is Determined
Firms decide how much land to rent by comparing
The rental price of land adjusts to balance supply and demand for land.
P
Q D = VMP S
The market for land
THE MARKETS FOR THE FACTORS OF PRODUCTION 31
How the Rental Price of Capital Is Determined
Firms decide how much capital to rent by comparing
The rental price of capital adjusts to balance supply and demand for capital.
P
Q D = VMP S
The market for capital
The market for capital
THE MARKETS FOR THE FACTORS OF PRODUCTION 32
Rental and Purchase Prices
§
Buying a unit of capital or land§
The rental income in any period equals the value of the marginal product (VMP).§
Hence, the equilibrium purchase price of a factor depends onLinkages A mong the Factors of Production
§
In most cases, factors of production are used together in a way that makes each factor’s productivity§
Example: an increase in the quantity of capital§
The marginal product and rental price of capital fall.THE MARKETS FOR THE FACTORS OF PRODUCTION 34