ECONOMICS

Whatdoesitmeantome?

FACTOR MARKETS
and the
PRODUCTION FUNCTION:
*Derived Demand
*Inframarginal Rent v. Pure Economic Rent

FACTOR MARKET:
Resources (land, labor,
capital, entrepreneurship)
are bought and sold in a
factor market.
PRODUCT MARKET:
Goods and services are
bought and sold in a
product market.

The elemental fact about resource

prices is that they are a major factor in
determining household income:

LAND. . . . . . . . . . . . . . . . . . .

RENT

LABOR. . . . . . . . . . . . . . . . . . WAGES
CAPITAL . . . . . . . . . . . . . . . INTEREST
ENTREPRENEURSHIP . . . .

PROFIT

Clip

MONOPOLY: one seller

MONOPSONY: one buyer.

BIG IDEAS ABOUT FACTOR OR RESOURCE

MARKETS:
1) The economic concepts are the same as
for product markets.
2) The demand for a factor of production is
derived from the demand for the good or
service produced from that resource.
3) A firm tries to hire additional units of a
resource up to the point where the resources
marginal revenue product (MRP) is equal to
its marginal resource cost (MRC).

4) In hiring labor, a firm will do best if it hires up

to the point where MRP = the wage rate. Wages
are the marginal resource cost of labor.
5) If you want a high wage:
a) make something people will pay a lot for.
b) work for a highly productive firm.
6) Real wages depend on productivity.
7) Productivity depends on real capital, human
capital, labor quality, and technology.
Activity 49

Can you give some

ideas of what is
bought and sold in a
factor market? a
product market?

PERCENTAGE DISTRIBUTION OF
NATIONAL INCOME -- 1992
Wages and Salaries

73.3%

Interest

8.8%

Corporate Profits

8.3%

Proprietors Income

8.5%

Rental Income *

.1%

*not the same as pure economic rent

The relationship between

the quantity of inputs
(workers) and quantity of
output (candy bars) is
called the PRODUCTION
FUNCTION.
FUNCTION

MARGINAL REVENUE PRODUCT is the

change in total revenue resulting from the use of
one additional unit of a resource, or
TR
MRP = --------------------Q of resource
MARGINAL RESOURCE COST is the change in
total cost resulting from the use of one
additional unit of a resource, or
TC (resource)
MRC = --------------------Q (resource)

The profit maximizing rule for

employing resources is:

MRP = MRC

The marginal product

(or marginal physical
product (MPP))
(MPP) of any
input into production is
the increase in the
quantity of output
obtained from an
additional unit of that
input.

Workers

Output

13

18

22

25

27

28

Workers

Output

13

18

22

25

27

28

*MPP

]- 7

Notice that as the number

of workers increases, the
marginal product declines.
This is called

DIMINISHING
MARGINAL PRODUCT.

]- 6
]- 5
]- 4
]- 3

As the number of
workers increases, the
employees must share
equipment and space.

]- 2
]- 1

*MPP=Marginal
Physical Product

Workers

Output

As the quantity of input increases, the

production function gets flatter. This
shows the property of DIMINISHING
MARGINAL PRODUCT.

0
28

26
24

13

22
20

18

18
16

22

14
12

25

10
8

27

6
4

28

In a perfectly competitive market, the product

price is the same. What is the total revenue?
Workers

Output

13

18

22

25

27

28

*MPP

]- 7
]- 6
]- 5
]- 4
]- 3
]- 2
]- 1

Price

TR

$2

$2

14

$2

26

$2

36

$2

44

$2

50

$2

54

$2

56

What is the MARGINAL REVENUE PRODUCT?

PRODUCT
Workers

Output

13

18

22

25

27

28

*MPP

]- 7
]- 6
]- 5
]- 4
]- 3
]- 2
]- 1

Price

TR

$2

$2

14

$2

26

$2

36

$2

44

$2

50

$2

54

$2

56

MRP

]- 14
]- 12
]- 10
]- 8
]- 6
]- 4
]- 2

What is Marginal Physical Product?

Why does Marginal Physical Product decline as
output increases?
What is Marginal Revenue Product?
How is Marginal Revenue Product calculated?
Why does Marginal Revenue Product decline as
output increases?

In this perfectly competitive market, how many

workers would be employed if wages were:
Workers

Output

13

18

22

25

27

28

*MPP

]- 7
]- 6
]- 5
]- 4
]- 3
]- 2
]- 1

Price

TR

$2

$2

14

$2

26

$2

36

$2

44

$2

50

$2

54

$2

56

MRP

$13.95
]- 14
]- 12
]- 10
]- 8
]- 6
]- 4
]- 2

1
$11.95
2
$ 9.95
3
$ 7.95
4

In an imperfectly competitive market, the product

price varies. What is the total revenue?
Workers

Output

13

18

22

25

27

28

*MPP

]- 7
]- 6
]- 5
]- 4
]- 3
]- 2
]- 1

Price

TR

2.80

2.60

18.20

2.40

31.20

2.20

39.60

2.00

44.00

1.85

46.25

1.75

47.25

1.65

46.20

What is the MARGINAL REVENUE PRODUCT?

PRODUCT
Workers

Output

13

18

22

25

27

28

*MPP

]- 7
]- 6
]- 5
]- 4
]- 3
]- 2
]- 1

Price

TR

MRP

2.80

]- 18.20

2.60

18.20

]- 13.00

2.40

31.20

]- 8.40

2.20

39.60

]- 4.40

2.00

44.00

]- 2.25

1.85

46.25

]- 1.00

1.75

47.25

]- -1.05

1.65

46.20

What is the evidence that this is an

imperfectly competitive market?
Why does the MRP of the imperfectly
competitive firm fall more rapidly than
the MRP of perfect competition?
What are the implications of this?

In this imperfectly competitive market, how many

workers would be employed if wages were:
Workers

Output

13

18

22

25

27

28

*MPP

]- 7
]- 6
]- 5
]- 4
]- 3
]- 2
]- 1

MRP

$13.95

Price

TR

2.80

]- 18.20

2.60

18.20

]- 13.00

2.40

31.20

]- 8.40

2.20

39.60

]- 4.40

2.00

44.00

]- 2.25

1.85

46.25

]- 1.00

1.75

47.25

$ 7.95

]- -1.05

1.65

46.20

1
$11.95
2
$ 9.95
2

Given the same costs, what can

we conclude about the number of
workers hired in perfectly
competitive product markets
compared to imperfectly
competitive product markets?
More workers will be hired under perfectly
competitive product markets.
Activity 50

The labor demand curve shifts because:

1) An increase or decrease in the price
of output.
An increase in the price of widgets, increases the
MP of each worker, and increases the demand for
labor in widget factories.

2) Change in technology.

Improvements in widget technology increases the

MP of labor, which increases the demand for labor in
widget factories.

3) A change in the supply of linked

factors of production.

A fall in the supply of iron to make widgets will

decrease the MP of widget workers and decrease
the demand for widget workers.

The labor supply curve shifts because:

1) A change in attitudes regarding work.
Prior to World War II, few women worked outside the
home. A changing attitude regarding working has
increase the supply of labor for females.

2) Change in opportunity
Changing opportunities may cause a worker in one
field to seek work in a higher paying position
elsewhere.

3) Immigration policies.
An increase in the immigration will increase the
supply of labor.

The Supply of and Demand for Labor in a

Competitive Labor Market.
Wage
rate ($)

S1

P
S2
S = MRC

W1

w2

D=MRP
L1 L2

Q of labor for total

labor market

D=mrp
Q

Q of labor for an
individual firm

When the supply of labor increases from S1 to S2, the

wage rate falls from W1 to W2 and firms begin to hire
more labor increasing quantity from L1 to L2.

The Supply of and Demand for Labor in

Monopsonistic Labor Market.
MRC
Wage
rate ($)

S
b

Wc
Wm
MRP = D

Qm Qc
Q
Q of Labor
In a monopsony, the employers marginal resource (labor) cost curve
(MRC) lies above the labor supply curve S. Equating MRC with MRP
at point b, the monopsonist will hire Qm workers (compared with Qc in
competition) and pay wage rate Wm (compared with the competitive
wage Wc).

OPTIMAL
COMBINATION
OF RESOURCES

Firms can vary the amount of resources

they use. Considering the
combinations of resources to use
requires us to look at two questions:
1) what combination of resources will
minimize costs at a specific level of
output?
2) what combination of resources will
maximize profit?

The Least-Cost Rule:

A firm is producing a specific output with the
least-cost combination of resources when the
last dollar spent on each resource yields the
same marginal product.

DERIVED DEMAND

The demand
for any
resource is
derived from
the demand
for the
products that
the resource
can produce.

. . . . and because Q went up,

there is a derived demand for
resources (labor) in the factor
market (causing W and Q to go
up).

When there is demand for

the good or services in the
product market (causing P
and Q to go up). . . .

P1

W1

D
Q

Q1

Product Market

D
QL

QL1

Resource Market

Q of
Labor

IMPORTANT:
IMPORTANT do NOT
label the supply curve for
the labor market as S. . . .

. . . . .label it MFC
(marginal factor cost)

MFC

P1

W1

D
Q

Q1

Product Market

D
Q

Q1

Resource Market

IMPORTANT:
IMPORTANT do NOT
label the demand curve for
the labor market as D. . .

. . . . .label it MRP
(marginal revenue
product)

MFC

P1

W1

D1

MRP1

D
Q

Q1

Product Market

MRP
Q

Q1

Resource Market

INFRAMARGINAL RENT
vs
PURE ECONOMIC RENT
in the Labor Market

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There are two types of rent:
1) Inframarginal rent
2) Economic rent

INFRAMARGINAL RENT
Firms demand labor from households..
..households
Wage
supply labor to
S
the firms.
The number of
workers hired is
Q..

D
Q

Quantity

and the wage

rate is W.

INFRAMARGINAL RENT
If you notice, many workers are willing to
work below the equilibrium wage.
Even though
Wage
they are willing
S
to work for less,
they are paid the
equilibrium wage
W
rate. This means
workers are
receiving added
profit above what
D
they are paid
Quantity
for
Q
This added profit is called INFRAMARGINAL RENT.

PURE ECONOMIC RENT

First we label the derived demand and
supply curves correctly.
In any industry,
Wage
the firm will hire
MFC
only so many
workers. So at
some Q, the
W
supply curve
becomes
perfectly
MRP
inelastic.
Q

Quantity

PURE ECONOMIC RENT

MFC

Wage

In the short run,

if derived
demand for labor
increases
without a change
in the supply of
labor, MRP
MRP1
increases.
MRP
Quantity

PURE ECONOMIC RENT

MFC

Wage
W1
W

MRP1
MRP
Q

Quantity

Individuals who
were willing to
work for W are
now earning W1
and are now
earning PURE
ECONOMIC
RENT.

The End

Created by:
Virginia Meachum, Economics Teacher, Coral Springs High School
SOURCES:
Principles of Economics, by Gregory Mankiw (Thompson, 2006)
Steve Reff, Economics Teacher, Tucson, AZ