U5: Factor Markets

5.1 Introduction to Factor Markets

● Derived demand: The demand for resources is determined (derived) by the products they help produce. (Ex. The demand for carpenters is derived from the demand of homes)

● The four factor payments are:

○ Rent

○ Wage

○ Interest

○ Profit

Marginal Revenue Product (MRP)

○ Change in revenue when one more worker is employed; demand for labor

○ In a perfectly competitive market, it is found by multiplying MP x P (MR = P)

○ In an imperfectly competitive market, the MRP is found by multiplying MP x MR

○ If the price of a product increases, it is going to drive up the demand for labor because it increases the MRP.

○ When the marginal product of labor is equal to the average product of labor, MC is equal to minimum AVC.

○ It falls due to diminishing marginal product - each worker makes less than the previous worker due to diminishing marginal returns (lower fixed inputs and variable inputs)

○ If at least one input is fixed while the other inputs are variable, then the output will increase at a decreasing rate, since there are not enough tasks.

○ Firms hire when MRP = MFC (wage)

● Marginal factor cost (MFC): The additional cost of an additional resource/worker.

● Minimum Wage: price floor

● Perfect Competition:

● Monopsony: the market structure

● Monopsonist: the individual who has the following firm graph:

5.2 Changes in Factor Demand and Factor Supply

● What shifts the demand for labor?

○ Change in the demand for the product

○ Change in the productivity of the resource

○ Change in the price of related resources (substitutes and complements) shifts the supply for labor?

○ Number of qualified workers (immigration)

○ Government regulation/licensing

○ Cultural expectations

5.3 Profit-Maximizing Behavior in Perfectly Competitive Factor Markets

● The market (or industry) is a standard supply and demand curve

● The equilibrium wage in the market establishes the wages firms pay its workers

● The supply of workers derives from the amount of workers willing to work at various wages

● The demand curve (in a perfectly competitive labor market) derives from the demand for the products produced by the workers and each individual worker’s productivity when it comes to producing said products

● Firms are capable of hiring as many workers as possible at the market wage. This results in the labor supply curve for the firms as horizontal at the market wage.

● Remember, the market wage equals the cost of hiring workers so the supply curve is equivalent to the marginal resource cost (MRC)

● Any changes in the market wage will result in a shift of the firm’s MRC supply

● The demand curve = marginal revenue product (MRP) of the firms workers and has a downward slope

MFC and MRP are measures used to determine the amount of output and the price per unit of a product that will maximize profits, almost like when supply equals demand. To maximize profits, firms will hire the number of workers where MFC=MRP

*MRP is the change in total production that comes from an additional unit of labor

● As changes occur in a firm’s worker productivity, demand for a firm’s products, and prices of said products (all change MRP), the demand curve will shift proportionally

● A firm’s supply curve shifts with market wage

Decrease in Supply of Workers

○ ↑ wage

○ ↑ MRC/MFC

○ ↓ Qworkers

Increase in MRP

○ Because of better training for workers, implementation of new technology, etc., the MRP shifts right and the firm hires more workers

○ Firms will hire workers as long as the MRP of the last worker that was hired is ≥ the cost of hiring that worker (MRC)

■ *Firms will not hire workers when the MRC is greater than the MRP

Calculating MRP

● Production costs include all expenses associated with making a product, whether it be a good or service. These costs can be broken down into either fixed costs or variable costs.

● Fixed costs are stable and continuous costs of operating a business that is not dependent on production levels. These costs generally account for overhead costs (e.g. salaries, building rental payments, utility costs, etc.)

● Variable costs are costs directly related to production levels (e.g. cost of materials used in production, cost of operating machinery)

○ Includes all the expenses of making the product as current levels.

Resource Market

○ Supply is MRC (Marginal Revenue Cost)

○ Demand for Labor curve is MRP (Marginal Revenue Product)

■ Mirror Image of MC

5.4 Monopsonistic Markets

● A monopsonistic market occurs when there is one buyer and many sellers; the opposite of a monopoly in which there is only one seller with many buyers. In terms of labor, the buyer is the employer and the seller are the potential workers.

Things to Remember

○ For monopsonies, the MFC is greater than supply.

○ Monopsonistic Firms are wage makers.

○ Monopsony is an example of imperfect competition.

○ A monopsonist cannot indulge in wage discrimination.

○ Monopsonies hires workers when MRP = MRC