Ch 18: The Markets for the Factors of ProductionTuesday, November 18, 20141:50 AM -What determines which job will pay you a higher wage?-Capital: the economy's stock of equipment and structures-Factors of production: the inputs used to produce goods and servicesoLabor, land, and capital are the three most important factors-A firm's demand for a factor of production is derived from its decision to supply a good in another marketoEx: the demand for gas station attendants is inseparably linked to the supply of gasoline-Labor is the most important factor of production, because workers receive most of the total income earned in the U.S. economyThe Demand for Labor-Labor markets, like other markets in the economy, are governed by the forces of supply and demand. -Most labor services are inputs into the production of other goods. -The basic tools of supply and demand apply to goods and to labor services.-The Competitive Profit-Maximizing FirmoLook at how a typical firm, such as an apple producer, decides what quantity of labor to demand. Each week the firm must decide how many apple pickers to hire and. We make twoassumptions about this firm:1. The firm is competitive both in the market for apples (where the firm is a seller) and in the market for apple pickers (where the firm is a buyer). A competitive firm is a price taker2. The firm is profit maximizing, thus the firm doesn’t care about the number of workers it has or number of apples it produces. It only cares about the profit. -The Production Function and the Marginal Product of LaboroThe firm must consider how the number of apple pickers affects the quantity of apples itcan harvest and selloProduction function: the relationship between the quantity of inputs used to make a good and the quantity of output of that good. As the quantity of the input increase, the production function gets flatter, reflecting the property of diminishing marginal product. oMarginal product of labor: the increase in the amount of output from an additional unit of laboroDiminishing marginal product: the property whereby the marginal product of an input declines as the quantity of the input increase-The Value of the Marginal Product and the Demand for LaboroValue of the marginal product: the marginal product of an input times the price of the outputoBecause the market price is constant for a competitive firm while the marginal product declines with more workers, the value of the marginal product diminishes as the number of workers rises.1. Marginal revenue product: it is the extra revenue the firm gets from hiring an additional unit of a factor of productionoA competitive, profit-maximizing firm hires workers up to the point where the value of the marginal product of labor equals the wageoThe value of marginal product curve is the labor demand curve for a competitive, profit-maximizing firm. -What Causes the Labor-Demand Curve to Shift?oThe labor demand curve reflect the value of the marginal product of laboroThe Output Price-The value of the marginal product is marginal product times the price of the firm's output-When the output price changes, the value of marginal product changes, and labor-demand curve shifts. -An increase in the price raises the value of the marginal product for each worker,and therefore increases labor demand -Conversely, a decrease in the price of apples reduces the value of the marginal product and decreases labor demandoTechnological Change-Technological advances typically raise the marginal product of labor, which in turn increases the demand for labor and shifts the labor-demand curve to the right. -It is also possible for a technological change to reduce labor demand. The invention of cheap industrial robots, for example, could reduce the marginal product of labor, shifting the labor-demand curve left. This is called labor-saving technological change. -Most technological progress is instead labor-augmenting. oThe Supply of Other Factors-The quantity available of one factor of production can affect the marginal product of other factors-A fall in the supply of ladders, for example, will reduce the marginal product of apple pickers and this the demand for apple pickers. The Supply of Labor-The Trade-Off Between Work and LeisureoThe more hours you spend working, the fewer hours you have to watch TV, enjoy dinner with friends, etc. oThe trade-off between labor and leisure lies behind the supply curve.oThe labor-supply curve reflects how workers' decisions about the labor-leisure tradeoff respond to a change in that opportunity cost. oAn upward sloping labor supply curve means that an increase in the wage induces workers to increase the quantity of labor they supply. oLabor-supply curves can slope backwards but that is ignored for this chapter. -What Causes the Labor-Supply Curve to Shift?oShifts whenever people change the amount they want to work at a given wageoChanges in Tastes: A generation or two ago, it was the norm for women to stay at home and raise children. Today, family sizes are smaller, and more mothers choose to work. This is an increase in the supply of labor. oChanges in Alternative Opportunities: The supply of labor in any one labor market depends on the opportunities available in other labor markets. oImmigration: When immigrants come to the U.S., for example, the supply of labor in the U.S. increases, and the supply of labor in the immigrants' home countries falls. Equilibrium in the Labor Market-The wage adjusts to balance the supply and demand for labor. -The wage equals the value of the marginal product of labor. -The price of labor (the wage) depends on supply and demand. Because the demand curve reflects the value of the marginal product of labor, in equilibrium workers receive the value of theirmarginal contribution to the production of goods and services. -Any event that changes the supply or demand curve for labor must change the equilibrium wage and the value of the marginal product by the same amount because these must always be equal. Value of the Marginal Product€+ _ _MarketWage Quantity of Apple PickersProfit-maximizingquantity -Shifts in Labor Supply-Shifts in Labor DemandS1Wage (price of labor)S2When labor supply increases from S1 to S2, perhaps because of an immigration of new workers, the equilibrium wage falls from W1 to W2. At this lower wage, firms hire more labor, so employment rises from L1 to L2. The change in the wage reflects a change in the value of the