Chapter 18 Markets for Factors of Production

The Anatomy of Factor Markets

Recall the four factors of production
o Land (natural resources)
o Labor
o Capital
o Entrepreneurship
Market for Labor Services
o Labor services physical and mental work effort that people supply to produce
goods and services
o Labor market collection of people and firms to trade labor services
Many buyers and sellers
Competitive
Labor union organizes labor element of monopoly
Bargaining process between union and employer determines wage
rate
o Price of labor services = wage rate
Wage rate determined by supply and demand
o Casual labor labor services traded day by day
o Job labor services traded on a contract
Market for Capital Services
o Capital tools, instruments, machines, buildings, and other constructions that
have been produced in the past and that businesses now use to produce goods and
services
o Capital goods traded in goods markets (e.g. toothpaste)
o A market for capital services = rental market market in which the services of
capital are hired
E.g. vehicle rental service
Price = rental rate
o Most capital services usually not traded in a market
Firm buys capital and uses it itself
Has implicit price that arises from depreciation and interest costs
implicit rental rate
Markets for Land Services and Natural Resources
o Land consists of all the gifts of nature natural resources
o Market for land is the market for the services of land the use of land
o Price = rental rate
o Nonrenewable natural resources are resources that can be used only once
E.g. oil, coal, natural gas
Price determined in global commodity markets commodity prices
Entrepreneurship
o Services not traded in markets
o Entrepreneurs receive the profit or bear the loss that results from their business
decisions

The Demand for a Factor of Production

This is a derived demand from the demand for the goods and services that the labor
produces
The quantities of factors of production demanded are a consequence of the firms output
decision
A firm hires the quantities of factors of product that produce the firms profit-maximizing
output
To decide on the quantity
o Firm compares the cost of hiring an additional unit of the factor with its value to
the firm
o Factor price cost of hiring an additional unit of a factor of production
o Factors price of marginal product value to the firm of hiring one more unit of a
FOP
o Value of marginal product = price of unit of output * marginal product of the
factor of production
Value of Marginal Product
o Total product number of loaves per hour that each quantity of labour can
produce
o Marginal product of labour the change in total product that results from a oneunit increase in the quantity of labour employed
A firms demand for labour
o Value of marginal product of labour tells us what an additional worker is worth to
a firm, as well the revenue that the firm earns by hiring one more worker
o Wage rate tells us what an additional worker costs a firm
o Value of the marginal product of labour and the wage rate determines the quantity
of labour demanded by a firm
o To max. profit
Hire the quantity of labour at which the value of marginal product equals
the wage rate
If VMP > wage increase profit by hiring one more worker
If VMP < wage increase profit by laying off one worker
If VMP = wage firm cannot increase its profit by changing number of
worker it employs
The quantity of labour demanded by a firm is the quantity at which the
value of marginal product of labour equals the wage rate
A Firms demand for labour curve
o Derived from its value of marginal product curve
o Change in the wage rate brings a change in the quantity of labour demanded and a
movement along the demand for labour curve
o A change in any other influence on a firms labour-hiring plans changes the
demand for labour and shifts the demand for labour curve
Changes in a Firms Demand for Labour
o Firms demand for labour depends on
The Price of the firms output
Higher the price of the firms output, the greater the firms demand
for labour

Higher price for firms output increases the VMP

Change in price of a firms output leads to a shift in the firms
demand for labour curve
o If price of the firms output increases, the demand for
labour increases and the demand for the labour curve shifts
right
The Prices of Other Factors of Production
If price of capital decreases relative to the wage rate, a firms
substitutes capital for labour and increases the quantity it uses
Usually, demand for labour will decrease when the price of capital
falls
Demand for labour could increases if the lower price of capital
sufficiently large increase in the scale of production
o Occurs in the long run when the firm can change the size of
its plant
Technology
New technology decrease the demand for some types of labour and
increase the demand for other types
E.g. if new automated bread making machine available, employer
might install one of these machines and lay off most of his
workforce decrease in demand
o But firms that manufacture and service these machines hire
more labour increase in demand

SUMMARY
Movement along demand curve for labour
o Quantity decreases if wage rate increases
o Quantity increases if wage rate decreases
Shifts in the demand curve for labour
o Demand decreases
Price of firms output decrease
Price of a substitute for labour falls
Price of a complement rise
New technology or new capital decreases the marginal product of labour
o Demand increases
Price of firms output increase
Price of a substitute for labour rises
Price of a complement falls
New technology or new capital increases the marginal product of labour