1 Factors of Prodution Unit 3: The Nature and Function of Factor Markets
2 4 Factors of Production Labor Capital Land Entrepreneurship
4 Factor Markets Factors of production (labor, capital, and land) are paid a factor price determined in a factor market Entrepreneurs are paid in terms of profit or loss
5 Labor Markets Sellers of labor = workers, people looking for employment. They are the suppliers in the labor market Consumers of labor = firms, people looking for workers. They are the consumers or buyers in the labor market The cost of labor is often referred to as a wage (for a day, week, month, year)
6 Labor Markets Labor is supplied in combination with human capital The skills obtained from education, on-the-job training, and work experience Each person has a fixed amount of time to work but individual ability and human capital vary Productivity depends on how well the skills of a worker match the skills required by an employer
7 Capital Markets Capital goods = tools, instruments, machines, buildings, and other construction used to produce goods and services Capital goods are sold in those same markets we studied in Unit 2: The Nature and Function of Product Markets For this unit, when we mention capital we mean these types of capital goods.
8 Financial Capital Markets Financial capital = the funds that firms use to buy and operate capital goods. Financial markets = where firms get the funds that they use to buy capital Firms are the consumers or buyers of financial capital, savers are the suppliers of financial capital The price of financial capital is often referenced in terms of an interest rate (or % per year)
9 Financial Capital For this unit, we won t be referring to financial capital when we are analyzing capital goods in the factor market.
10 Financial Markets 2 Types of financial markets Stock market Bond market Stock market shares in the stocks of companies are traded. Stocks are certificates which show a value of ownership in a firm Bond market bonds issued by firms and governments are traded. Bonds are promises to pay specified sums of money on specified dates
11 Land Markets Land = the gifts of nature. Meaning, the raw materials on or under the land in addition to the land itself. The market for land as a factor of production is, really, the market for the output of land of all types. These outputs are rented meaning owners of the land are allowing the raw materials to be extracted for a price but ownership is not necessarily transferred the price is expressed as dollars per unit of land utilized for raw material extraction The market for raw materials is usually referred to as a commodity market
12 Demand for Factors of Production The demand for the factors of production is based upon the demand for the goods and/or services the factors are used to produce Thus demand for the factors of production is dependent upon the demand for those goods/services We call this derived demand
13 Derived Demand If the demand for a good or service increases, then the demand for the factors of production used to produce that good or service also increases (and vice versa) However like demand for a good or service: There is an inverse relationship between the price of a resource (or factor) and the quantity of the resource demanded (i.e. a downward sloping demand curve)
14 EX: The Demand for Labor
15 Value of Marginal Product To decide the quantity of the factor of production to hire, a firm compares the cost of hiring an additional unit of the factor with its value to the firm. Cost = Price of one more unit of the factor(or Marginal Resource Cost or MRC) Example: The wage of one more worker Value of marginal product (or Marginal Revenue Product or MRP) = the price of a unit of output multiplied by the marginal product of the add l factor of production MRP = P x x MP L
16 Marginal Revenue Product Example Max s Wash and Wax Car wash = $3 Quantity of Labor (workers) Total Product (car washes per hour) A 0 0 Marginal Product (washes per additional worker) Value of Marginal Product (or in TR) In dollars per add l worker B $15 C $12 D $9 E $6 F $3
17 Demand for a Factor As the value of marginal product (or MRP) decreases (as the quantity of a factor increases), there is a simple rule for maximizing profit: Hire/buy the factor up to the point at which the value of marginal product (MRP) equals the factor price This is known as Marginal Productivity Theory
18 Marginal Productivity Theory Law of Diminishing Returns = declining Marginal Productivity Marginal Revenue Product (MRP) = in Total Revenue divided by in factor quantity Hire/Buy a Factor where MRP = MRC (Marginal Resource Cost) Marginal Resource Cost = in Total Resource Cost divided by in factor quantity
19 Demand Curve for a Factor Demand for Labor
20 Demand = Marginal Revenue Product (MRP) Another way to look at the demand for labor is by equating firms demand for labor with the marginal revenue product of labor the firm will receive in return for the wage earned by the worker Meaning that D = MRP
21 Value of Marginal Product Example Max s Wash and Wax Car wash = $3 Worker s Wage = $9/hr Quantity of Labor (workers) Total Product (car washes per hour) A 0 0 Marginal Product (washes per additional worker) Value of Marginal Product (dollars per add l worker) B $15 C $12 D $9 E $6 F $3
22 Changes to Demand of a Factor 1.The Price of the Firm s Output 2.The Prices of other Factors of Production 3.Technology
23 The Price of the Firm s Output The higher the price of a firm s output, the greater is its demand for a factor A change in the price of a firm s output leads to a shift in the firm s demand for the factor Price of the output increases, the demand for the factor increases and the demand for the factor curve shifts outward
24 Value of Marginal Product Example Max s Wash and Wax Car wash = $5 Worker s Wage = $9/hr Quantity of Labor (workers) Total Product (car washes per hour) A 0 0 Marginal Product (washes per additional worker) Value of Marginal Product (dollars per add l worker) B $25 C $20 D $15 E $10 F $5
25 The Prices of other Factors of Production If the price of using capital decreases relative to the wage rate, a firm will substitute capital for labor and increases the quantity of capital it uses EX: The price of a car wash machine falls, so Max buys one machine and lays off one worker
26 Technology New technologies decrease the demand for a factor and increase the demand for other types of the same factor or of other factors EX: During the 1980 s and 1990 s the electronic telephone exchange decreased the demand for telephone operators and increased the demand for computer programmers and electrical engineers
27 Practice problem Greg s Grooming hires workers to groom dogs. The market for dog grooming is perfectly competitive The price of a grooming is $20 The labor market is competitive The wage rate is $40 a day Workers Groomings per day
28 Answer the following 1. Calculate the marginal product of hiring the 3rd worker 2. Calculate the value of the marginal product of the 3 rd worker 3. How many workers will Greg s hire to maximize its profit? 4. How many dogs a day will Greg s groom to maximize its profit? 5. If the wage rate rises to $60 a day, how many workers will Greg s hire? 6. If Greg s installs a machine that doubles the productivity of workers and the price of grooming falls to $10, how many workers will Greg s hire at $40 a day?
29 Supply of a Factor The supply of a factor increases as the price of the factor increases. This is a positive relationship between factor price and quantity of the factor supplied
30 The Supply Curve of Labor This relationship between price and quantity supplied holds true for all types of factors EXCEPT land.
31 Influences on the Supply of a Factor Labor: Adult Population an increase in the adult population increases the supply of labor Preferences a change in peoples desire to work or desire to do certain types of work will increase/decrease the supply of labor Time in School and Training the education or experience necessary to do a job (or REQUIRED to do a job) can increase or decrease the supply of labor
32 Influences on the Supply of a Factor Capital Goods All the influences of supply of goods we covered in Unit 2 apply to the supply of capital goods Financial Capital Population an increase in population increases the number of savers which increases the supply of financial capital Average income as average income increases, the supply of financial capital increases as well Expected future income as peoples expectations on increased future earnings improves (e.g. expectations of the rate of return on investments), the supply of financial capital increases as well.
33 Factor Market Equilibrium The intersection of factor demand and factor supply is where the equilibrium price and quantity of the factor is determined
34 Labor Market Equilibrium We will be covering labor markets in class in a few days. Until then, lets do an exercise on labor market equilibrium.