Chapter 18 The anatomy of factor markets The four factors of production are Labor Capital Land natural resources Entrepreneurship Markets for labor services Labor services the physical and mental work effort that people supply to produce goods and services Labor market a collection of people and firms who trade labor services Price of labor services is the wage rate Casual labor labor services that are traded day by day Job labor service that s traded on a contract In some labor markets a labor union organizes labor which introduces an element of monopoly on the supply side of the labor market o A bargaining process between the union and the employer determines the wage rate Markets for Capital Services Capital the tools instruments machines buildings and other constructions that been produced in the past and that businesses now use to produce goods and services Capital goods are traded in goods markets Rental market a market in which the services of capital are hired i e car rental Markets for Land Services and Natural Resources Land consists of all the gifts of nature natural resources Services of land the market for land as a factor of production the use of land Nonrenewable natural resources resources that can be used only once oil gas coal o Prices of nonrenewable natural resources are determined in global commodity markets and are called commodity prices Entrepreneurship Entrepreneurial services are not traded in markets Entrepreneurs receive the profit or bear the loss that results from their business decisions The Demand for a Factor of Production Derived demand the demand for a factor of production o Derived from the demand for the goods and services that the labor produces To decide the quantity of a factor of production to hire a firm compares the cost of hiring an additional unit of the factor with its value to the firm The cost of hiring an additional unit of a factor of production is the factor price Value of marginal product the value to the firm of hiring one more unit of a factor of production o Value of marginal product the price of a unit of output the marginal product A Firm s Demand for Labor o The value of the marginal product of labor and the wage rate together determine the quantity of labor demanded by a firm o Quantity of labor should be when the value of marginal product equals the wage rate If value of marginal product exceeds the wage rate firm should hire more If wage rate exceeds value of marginal product firm should fire more o A change in the wage rate brings a change in the quantity of labor demanded and a movement along the demand for labor curve o A change in any other influence on a firm s labor hiring plans changes the demand for labor and shifts the entire curve Changes in a Firm s Demand for Labor The price of the firm s output o The higher the price of a firm s output the greater is the firm s demand for labor o A higher price for the firm s output increases the value of the marginal product of labor o If the price of the firm s output increases the demand for labor increases and the demand for labor curve shifts rightward The prices of other factors of production o If the price of using capital decreases relative to the wage rate a firm substitutes capital for labor and increases the quantity of capital it uses o The demand for labor will decrease when the price of using capital falls If the price of a bread making machine falls the firm might decide to fire a worker and install a machine o New technologies decrease the demand for some types of labor and increase the demand for other types A bread making firm might install a new automated machine and fire most of his workforce But the firms that manufacture and service automated machines hire more labor Technology Decreases if The wage rate increases Movement along the demand curve The quantity of labor demanded by a firm Increases if The wage rate decreases Shifts in the demand curve for labor Decreases if The price of the firm s output decreases The price of a substitute for labor falls The price of a complement rises A new technology decreases the marginal product of labor Market Demand for Labor A firm s demand for labor Increases if The price of the firm s output increases The price of a substitute for labor rises The price of a complement of labor falls A new technology increases the marginal product of labor We determine the market demand for labor by adding together the quantities of labor demanded by all the firms in the market at each wage rate The market demand for labor curve slopes downward Market Supply of Labor Market supply of labor is derived from the supply of labor decisions made by individual households Reservation wage the minimum amount someone will work for Substitution effect offering a higher wage rate to induce someone to work longer hours Income effect an increase in income creates an increase in the demand for leisure and creates a decrease in the quantity of labor Competitive Labor Market Equilibrium A Labor Market with a Union Labor market equilibrium determines the wage rate and employment Labor union an organizes group of workers that aims to increase the wage rate and influence other job conditions Influences on labor supply o One way to raise the wage rate is to decrease the supply of labor by influencing job qualification standards i e doctors lawyers Influences on labor demand a union tries to increase the demand for the labor of its members in four main ways o Increasing the value of marginal product of its members by organizing and sponsoring training schemes and apprenticeship programs and by professional certification o Lobbying for import restrictions and encouraging people to buy goods made by unionized workers o Supporting minimum wage laws which increase the cost of employing low skilled labor and lead firms to substitute high skilled union labor for low skilled nonunion labor o Lobbying for restrictive immigration laws to decrease the supply of foreign workers Labor Market Equilibrium with a Union o Supply curve moves to the left and demand curve moves to the right