Markets for Factors of production

Question 1

Recall the three types of factors of production

What is the factors of production?

Answer 1

Labour, land, capital(equipment and structures used to produce a good)

Factors of production: the inputs used to produce goods and services.

Question 2

What is the markets for the factors of production?

Answer 2

It is like the market for goods and services except:
Demand for a factor of production is a *derived demand–derived from a firm’s decision to supply a good in another market
(probably from the goods and services market demand. ex. a computer programming job is higher in demand since technology dominates the world today. So firms need more computer programmers rather than retail associates)

The supply and demand market for goods and services basically determines how many people and wages they need to create a certain good, which will meet the derived demand.

Question 3

There are two assumptions about the labour market:

Answer 3

1. We assume all markets are competitive.
   The typical firm is a price taker
   -in the market for the product it produces
   -and in the labour market
2. We assume that firms only care about maximizing profits
   • Each firm’s supply of output and demand for inputs are derived from this goal.

Question 4

In the example of Farmer Jack, what is the cost of hiring another worker?

What is the benefit of hiring another worker?

What economic thing does the size of this benefit depend on an what is the definition of that term?

Answer 4

Cost of another worker: wages-cost/price of labour

Benefit: Increases the unit of output, which increases revenue

The “economic thing” is production function which is the relationship between the quantity of input used to make a good and the quantity of output, of that good

Question 5

What does a production function graph look like?

Answer 5

The quantity of output is on the y-axis since it is dependant on the amount of labour on the x-axis. The production function curve itself is half a hill.

Question 6

What is the marginal product of labour? What is the MPL formula?

Answer 6

It is the increase in one extra unit of output that occurs with the extra unit of input(labour) used to make that good.

MPL=change in Q(of ouput)/ change in L (labour)

Question 7

What is the value of the marginal product of labour?

Answer 7

—The marginal product of input times the price of the output
-Problem: cost of hiring another worker(wage) is measured in dollars
AND
-Benefit of hiring another worker (MPL) is measured in units of output
Solution: convert MPL to dollars

VMPL=value of the marginal product of labour=PXMPL.

the value of marginal product of labour(VMPL) essentially lets us compare P and MPL in the same units.

Economists sometimes calls VMPL the firm’s marginal revenue product(the extra revenue the firm gets from hiring an additional unit of factor of production.

Question 8

What is the diminishing marginal product related to?

Answer 8

When the marginal product of labour(change in Q output/Change in L) declines, the property is called diminishing marginal product

Question 9

Where do rational people think at?

Answer 9

They think at the margin.

Question 10

What happens when production function graph exhibits a diminishing marginal product?

Answer 10

MPL falls as labour in increases. (As labour increases, the amount each additional worker makes is less)

Question 11

Which way does the value of marginal product of labour slope if the graph exhibits diminishing marginal product?

Answer 11

It slopes downward, due to the diminishing marginal product.

Question 12

What is the profit maximizing point in a VMPL curve?

Answer 12

Where the wage(horizontal line from the y-axis) intersects with the VMPL curve. x-axis is the workers.

VMPL=W(this is the point which maximizes profits on a VMPL curve)

“A competitive, profit maximizing firm hires workers up to the point where the value of the marginal product of labour equals wage”

Question 13

It has been noted in this deck of flashcards that firms make decisions by choosing the Q of labour, where the value of the marginal product equals wage. As a result,

Answer 13

the value-of-the-marginal-product curve is the labour demand curve for a competitive, profit-maximizing firm.

Question 14

What shifts the labour demand curve? (Include the economics way and the normal way)

Answer 14

Economics way:
Recall: VMPL= P x MPL
Anything that increases P or MPL at each : will increase VMPL and shift the labour demand curve upward.

Normal way:
Changes in output price, P
Technological advances( which affects MPL)
The supply of other factors( which affects MPL)

ex. if firm gets more equipment(capital), then workers will be more productive; MPL and VMPL rise, labour demand curve then shifts upward.

Question 15

Connection between input demand and output supply:

How do you calculate the marginal cost in terms of input demand and output supply?

Answer 15

Recall that MC = change in TC/ change in Q

In this case, Total cost=Wage(W) and Q=MPL(since MPL is measured in the number of outputs)

Essentially in the case of an labour demand, MC= W/MPL

Question 16

What is the connection between input demand and output supply? (think of MC=W/MPL)

Answer 16

Input demand and output supply are essentially two sides of the same coin:
Remember p is the price for output

Notice: to produce additional output, L must increase(hire more labour)

• As L rises, MPL falls
• causing W/MPL to rise (think it as big number/small number. The MC therefore rises)
• causing MC to rise

MC=W/MPL

The competition firm’s rule for demanding labour:
PxMPL=W

Divide both sides by MPL:
P= W/MPL
Substitute MC=W/MPL into the previous equation:
P=MC

This is the competitive firm’s rule for supplying output, therefore input demand and output supply are related.

P is the output supply, and MC is the input demand(remember that MC is the extra output you get for adding an additional input to making the good.)

Question 17

Labour supply is the other side of the labour market. What are some decisions that lie in the supply side of the labour market?

Answer 17

There is a trade-off between work and leisure: The more time you spend working, the less time you have for leisure.

-The opportunity cost of leisure is wage

An increase in wage(W) is an increase in the opportunity cost of leisure.

Question 18

Will the trade-off between leisure and wage(working) shift the supply curve and why?

Answer 18

The trade-off will not shift the supply curve, but rather move along the curve. Since labour is the x-axis and wage is the y-axis, naturally leisure would become the opportunity cost.

It will not shift the curve due to change in wage(which would move along the supply curve)

As wage rates increase, the opportunity cost of leisure also increases(repeat, don’t mark yourself on this, it’s just to clarify)

Question 19

What are some things that do shift the labour supply curve?

Answer 19

• Change in tastes or attitudes regarding the labour-leisure trade-off
• opportunities for workers in other labour markets(ex. if wage earned by pear pickers suddenly increased, then apple pickers may choose to switch occupations)
• immigration

Question 20

What is the equilibrium of the labour market?

Answer 20

Where labour supply and labour demand intersect. It is where W=VMPL

Wage also adjusts the balance between labour demand and supply

Question 21

At the same time firms decide how many workers to hire, they are also taking into account the other costs of production(such as structures or materials needed to create the good or service). So there are two things that must be distinguished in order to understand a firm’s decisions:

What is the difference between rental price and purchase price?

Answer 21

Rental price:the price a person pays to use that factor(structure/material) for a limited period of time

Purchase price:the price a person pays to own that factor indefinitely.

Wage for example is a rental price.

The determination of the rental pricers of capital is analogous(comparable in certain respects) ot the determination of wages.

Question 22

How is the rental price of land determined?

Answer 22

Firms decide how much land to rent by comparing the price with the value of the marginal product (VMP) of land
D=VMP

The rental price of land adjusts to balance supply and demand for land.

Question 23

How is the rental price of Capital determined?

Answer 23

By comparing the price with the value of the marginal product (VMP) of capital.
D=VMP

The rental price of capital adjusts to balance supply and demand (just like the rental price for land)

Question 24

Rental and purchase prices:

If buying a unit capital or land yields a stream of rental income, what should the rental income equal to?

Answer 24

The rental income in any period should equal the value of the marginal product(VMP)

Hence, the equilibrium purchase price of a factor depends on both the current VMP as well as the VMP in the future.

Question 25

What happens in most cases in the linkages among the factors of production?

Answer 25

In most cases, factors of production are used together in a way that makes each factor’s productivity dependent on the quantities of other factors.

Ex. increase in the Q of capital(materials/investment in material to make goods)

• the marginal product and rental price of capitals fall.
• Having more capital makes workers more productive, MPL and W rise.