Factor Markets Flashcards
Factors
Labour
Capital
Land
Entrepreneurship
Factor prices and quantities are determined in the market by the equilibrium of supply and demand
Demand for Factors
A firms demand for a factor is a DERIVED DEMAND
The Demand for the factor occurs because the factor is used to produce a product rather than demand for the factor itself.
So the demand for CAPITAL is derived from the DEMAND for the product the capital produces
Marginal Product Definition
Marginal product is the change in total product (or output) that occurs with the addition of another unit of an input
The MP DECREASES as units of the factor INCREASE due to the LAS OF DIMINISHING RETURNS
Marginal Revenue Product (MRP) Definition
The change in TOTAL REVENUE resulting from the use of an additional unit of an input
In general, MRP = MR x MP
If the firm is a PRICE TAKER in the output market, then MR=P so that MRP=PxMP
MRP in Competitive Product Market
In general, MRP = MR x MP
If the firm is a PRICE TAKER in the output market, then MR=P so that MRP=PxMP
MRP in a Monopolist Product Market
As the units of inputs increase, MRP declines.
This is a result of the law of diminishing marginal returns since MP falls as the unit of inputs increase.
MRP curve is DOWNWARD sloping
Marginal Factor Cost (MFC)
The change in TOTAL COSTS resulting from the addition of one further unit of an input.
When should a firm stop adding units of factor?
It will be profitable for a firm to demand additional units of a factor up to the point at which the factors MRP is equal to its MFC
MRP For a competitive firm
MRP = MFC is the OPTIMIZING CONDITION.
If MRP equals MFC at the 3rd unit of labour, then that is the optimal
Demand for Labour
The labour demand curve and labour MRP curve are the same
A demand curve shows us how much would be demanded at each price level
If the wages INCREASE, the Q Demanded for labour will DECREASE
What are the variables that shift demand for Labour?
- Price of Outputs
- Prices of other Inputs
- Technology
- Productivity
Profit Maximizing Conditions for Input, and Output Markets
INPUT MARKETS
MRP = MFC
OUTPUT MARKETS
MR = MC
The Supply of Labour
The household chooses the number of hours per week of labour to supply.
Time is allocated between two activities
- Market Activity - The supply of labour
- Non-Market activity - Leisure (Recreation, education, etc.)
Leisure in the Supply of Labour
The price of leisure can be represented by its opportunity cost
The Opp cost of an hour of leisure is the foregone wages associated with that hour. Thus, we can use the wage rate as the price of leisure
When the WAGE RATE changes, the Q of Labour supplied changes. What TWO effects determines how it changes?
- SUBSITUTION EFFECT
As the wage rate increases, individuals allocate more time to market activities and less to non market activities.
The price of the non market activities increases as the wage rate increases.
People substitute away from LEISURE since it becomes more expensive
- INCOME EFFECT
As the wage rate increase, peoples incomes increase.
As income rise, consumers demand more of normal goods.
For most people, leisure is a normal good.
As incomes rise, income effect indicates that consumers will want more leisure and want to work less.
SO AS THE WAGE RATE INCREASES
- Quantity supplied of labour INCREASES from the substitution effect
- Quantity of labour DECREASES from the income effect
