Chapter 18: The Markets for the Factors of Production-The demand for a factor of production is a derived demand; a firm’s demand for a factor of production is derived from its decision to supply a good in another market The Demand for Labor - Labor forces are governed by the forces of supply and demand - Most labor services are inputs into the production of other goods - Competitive firm: only has to decide how many apples to sell and how many workers to hire since it is a price taker - Production function: the relationship between the quantity of inputs used to make a good and the quantity of output of that good- Marginal product of labor: the increase in the amount of output from an additional unit of labor - Diminishing marginal product: the property whereby the marginal product of an input declines as the quantity of the input increases; the production function gets flatter as the input increases- The profit from an additional worker is the worker’s contribution to revenue minus the worker’s wage - To find the worker’s contribution to revenue, we convert the marginal product of labor into the value of marginal product (apples to dollars)o If apples sell for 10 a bushel and the additional worker produces 80 bushes of apples, then the worker produces 800 of revenue- Value of the marginal product: the marginal product of an input times the price of the output; diminishes as number of workers rise o Aka marginal revenue product: it is the extra revenue the firm gets from hiring an additional unit of a factor of production - A competitive, profit maximizing firm hires workers up to the point where the value of the marginal product of labor equals the wage - The value of marginal product curve is the labor demand curve for a competitive profit maximizing firm - When the output price changes, the value of the marginal product changes, and the labor demand curve shifts o An increase in the price of apples raises the value of the marginal product of each worker who picks apples and therefore increases labor demand from the firms that supply apples - Technology raises the marginal product of labor which in turn increases the demand for labor and shifts the labor demand curve to the right >> labor augmenting- It is also possible for the technological change to reduce labor demand >> labor saving technological change; however history suggests that technology brings labor augmenting - Other factors of production can affect the marginal product of other factorso Fall in the supply of ladders will reduce the marginal product of apple pickersThe Supply of Labor - Trade off between labor and leisure lies behind the labor supply curve - Opportunity cost between labor and leisure- The labor supply curve reflects how workers’ decisions about the labor leisure trade off respond to a change in that opportunity cost o An upward sloping labor supply curve: means that an increase in the wage induces workers to increase the quantity of labor they supply; more hours of work means less leisure o A backward sloping labor supply curve: even though you got an increase in the wage, the worker decides to enjoy more leisure >> ignore this for now- Labor supply curve shifts when ppl change the amount they want to work o Changes in tastes: women used to not work, now they doo Changes in alternative opportunities: if pear pickers get paid more, then some apple pickers may choose to switch occupations o Immigration: immigrants to US raises US supply of labor Equilibrium in the Labor Market - Any event that changes the supply or demand for labor must change the equilibrium wage and the value of the marginal product by the same amount because these must always be equal - Shifts in labor supply o Immigration increases the number of workers willing to pick apples so the supply of labor shifts to the right. Now the quantity of labor exceeds the quantity demanded. This surplus of labor decreases wages, which makes it profitable for firms to hire more workers. As the number of workers in each apple orchard rises, the marginal product of a worker falls, and so does the value of the marginal product >> now wage and value of the marginal product are lower than before - Shifts in labor demando Increase in the popularity of apples causes their price to rise >> higher price for apples, raise the value of the marginal product, wage rises, equilibrium employment rises- Labor supply and labor demand together determine the equilibrium wage and shifts in the supply or demand curve for labor cause the equilibrium wage to change - Theory and history confirm the close connection between productivity and real wages The Other Factors of Production: Land and Capital- Capital: the equipment and structures used to produce goods and services - Purchase price: of land or capital is the price a person pays to own that factorof production indefinitely- Rental price: is the price a person pays to use that factor for a limited period of time - Rental price of land and capital: like a wage; determined by supply and demand - The demand for land and capital is determined just like the demand for labor >> when deciding how much land and how many ladders to rent, it follows the same logic as how much workers to hire o Firm increases the quantity hired until the value of the factor’s marginal product equals the factor’s price >> demand curve for each factor reflects the marginal productivity of that factor - Labor, land and capital each earn the value of their marginal contribution to the production process- The rental price and the purchase price are related: buyers are willing to pay more for a piece of land or capital if it produces a valuable stream of rental income; the rental income at any point in time equals the value of that factor’s marginal product >> equilibrium purchase price of land or capital depends on both the current value of the marginal product and the value of the marginal product expected to prevail in the future - A factor with a high supply has a low marginal product and a low price- A scarce supply of a product has a high marginal product and a high price- When the supply of a factor falls its equilibrium price rises - A change in supply of any one factor alters the earning of all the factors - Neoclassical theory of distribution: the amount paid to each factor of production depends on the supply and demand for that
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