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Input Demand: The Laborand Land Markets

Input Markets: Basic ConceptsLabor MarketsLand MarketsThe Firm’s Profit-Maximization Condition in Input MarketsInput Demand CurvesResource Allocation and the Mix of Output in Competitive Markets

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INPUT DEMAND: THE LABORAND LAND MARKETS

FIGURE 10.1 Firm and Household Decisions

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INPUT MARKETS: BASIC CONCEPTS

DEMAND FOR INPUTS: A DERIVED DEMAND

derived demand The demand for resources (inputs) that is dependent on the demand for the outputs those resourcescan be used to produce.

productivity of an input The amount of output produced per unit of that input.

Inputs are demanded by a firm if and only if households demand the good or serviceproduced by that firm.

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INPUT MARKETS: BASIC CONCEPTS

INPUTS: COMPLEMENTARY AND SUBSTITUTABLE

Inputs can be complementary or substitutable.

DIMINISHING RETURNS

marginal product of labor (MPL) The additional output produced by one additional unit of labor.

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INPUT MARKETS: BASIC CONCEPTS

TABLE 10.1 Marginal Revenue Product per Hour of Labor in Sandwich Production (One Grill)

(1)TOTAL LABOR

UNITS (EMPLOYEES)

(2)TOTAL

PRODUCT (SANDWICHES PER

HOUR)

(3)MARGINAL

PRODUCT OF LABOR (MPL)

(SANDWICHES PER HOUR)

(4)PRICE (PX) (VALUE

ADDED PER SANDWICH)a

(5)MARGINALREVENUEPRODUCT(MPL X PX)

(PER HOUR)

0 0

1 10 10 $ .50 $ 5.00

2 25 15 .50 7.50

3 35 10 .50 5.00

4 40 5 .50 2.50

5 42 2 .50 1.00

6 42 0 .50 0

aThe “price” is essentially profit per sandwich; see discussion in text.

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INPUT MARKETS: BASIC CONCEPTS

MARGINAL REVENUE PRODUCT

marginal revenue product (MRP) Theadditional revenue a firm earns by employing one additional unit of input, ceteris paribus.

MRPL = MPL x PX

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INPUT MARKETS: BASIC CONCEPTS

FIGURE 10.2 Deriving a MarginalRevenue Product Curvefrom Marginal Product

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LABOR MARKETS

A FIRM USING ONLY ONE VARIABLEFACTOR OF PRODUCTION: LABOR

A profit-maximizing firm will add inputs—in the case of labor, it will hire workers—as long as the marginal revenue product of that input exceeds the market price of that input—in the case of labor, the wage.

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LABOR MARKETS

FIGURE 10.3 Marginal Revenue Product and Factor Demand for a Firm Using One Variable Input (Labor)

When a firm uses only one variable factor of production, that factor’s marginal revenueproduct curve is the firm’s demand curve for that factor in the short run.

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LABOR MARKETS

FIGURE 10.4 The Two Profit-Maximizing Conditions Are Simply Two Views of the Same Choice Process

Comparing Marginal Revenue and Marginal Cost to Maximize Profits

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LABOR MARKETS

FIGURE 10.5 The Trade-Off Facing Firms

Assuming that labor is the only variable input, if society values a good more than it costsfirms to hire the workers to produce that good, the good will be produced. In general, thesame logic also holds for more than one input. Firms weigh the value of outputs asreflected in output price against the value of inputs as reflected in marginal costs.

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LABOR MARKETS

A FIRM EMPLOYING TWO VARIABLE FACTORSOF PRODUCTION IN THE SHORT AND LONG RUN

In firms employing just one variable factor of production, a change in the price of that factor affects only the demand for the factor itself. When more than one factor can vary, however, we must consider the impact of a change in one factor price on the demand for other factors as well.

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LABOR MARKETS

Substitution and Output Effects of a Change in Factor Price

TABLE 10.2 Response of a Firm to an Increasing Wage Rate

TECHNOLOGY

INPUT REQUIREMENTSPER UNIT OF OUTPUT

UNIT COST IFPL = $1PK = $1

(PL x L) + (PK x K)

UNIT COST IFPL = $2PK = $1

(PL x L) + (PK x K)K L

A (capital intensive) 10 5 $15 $20

B (labor intensive) 3 10 $13 $23

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LABOR MARKETS

TABLE 10.3 The Substitution Effect of an Increase in Wages on a Firm Producing 100 Units of Output

TO PRODUCE 100 UNITS OF OUTPUT

TOTALCAPITAL

DEMANDED

TOTALLABOR

DEMANDED

TOTALVARIABLE

COST

When PL = $1, PK = $1, firm uses technology B 300 1,000 $1,300

When PL = $2, PK = $1, firm uses technology A

1,000 500 $2,000

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LABOR MARKETS

factor substitution effect The tendency of firms to substitute away from a factorwhose price has risen and toward a factor whose price has fallen.

output effect of a factor price increase(decrease) When a firm decreases (increases) its output in response to a factor price increase (decrease), this decreases (increases) its demand for all factors.

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LABOR MARKETS

MANY LABOR MARKETS

If labor markets are competitive, the wages in those markets are determined by the interaction of supply and demand. As we have seen, firms will hire workers only as long as the value of their product exceeds the relevant market wage. This is true in all competitive labor markets.

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LAND MARKETS

demand determined price The price of a good that is in fixed supply; it is determined exclusively by what firms and households are willing to pay for the good.

pure rent The return to any factor of production that is in fixed supply.

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LAND MARKETS

The supply of land of a given quality at a given location is truly fixed in supply. Its valueis determined exclusively by the amount that the highest bidder is willing to pay for it.Because land cannot be reproduced, supply is perfectly inelastic.

FIGURE 10.6 The Rent on Land Is Demand Determined

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LAND MARKETS

A firm will pay for and use land as long as the revenue earned from selling the productproduced on that land is sufficient to cover the price of the land. Stated in equation form, the firm will use land up to the point at which MRPA= PA, where A is land (acres).

RENT AND THE VALUE OF OUTPUT PRODUCED ON LAND

The demand for land is a derived demand. Agricultural or even desert land will be developed when there is a demand for housing because land is a key input used in the production of housing.

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THE FIRM’S PROFIT-MAXIMIZATION CONDITION IN INPUT MARKETS

Profit-maximizing condition for the perfectly competitive firm is

PL = MRPL = (MPL x PX)

PK = MRPK = (MPK x PX)

PA = MRPA = (MPA x PX)

where L is labor, K is capital, A is land (acres), X is output, and PX is the price of that output.

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INPUT DEMAND CURVES

SHIFTS IN FACTOR DEMAND CURVES

If product demand increases, product price will rise and marginal revenue product (factor demand) will increase—the MRP curve will shift to the right. If product demand declines, product price will fall and marginal revenue product (factor demand) will decrease—the MRP curve will shift to the left.

The Demand for Outputs

The production and use of capital enhances the productivity of labor and normally increases the demand for labor and drives up wages.

The Quantity of Complementary and Substitutable Inputs

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INPUT DEMAND CURVES

When a firm has a choice among alternative technologies,the choice it makes depends to some extent on relative input prices.

The Prices of Other Inputs

Technological Change

Technological change can and does have a powerful influence on factor demands. As new products and new techniques of production are born, so are demands for new inputs and new skills. As old products become obsolete, so, too, do the labor skills and other inputs needed to produce them.

technological change The introduction of new methods of production or new products intended to increase the productivity of existing inputs or to raise marginal products.

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RESOURCE ALLOCATION AND THE MIX OF OUTPUT IN COMPETITIVE MARKETS

marginal productivity theory of income distribution At equilibrium, all factors of production end up receiving rewards determined by their productivity as measured by marginal revenue product.

THE DISTRIBUTION OF INCOME

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LOOKING AHEAD

We have now completed our discussion of competitive labor and land markets. The next chapter takes up the complexity of what we have been loosely calling the “capital market.” There we discuss the relationship between the market for physical capital and financial capital markets, and look at some of the ways that firms make investment decisions.

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demand determined pricederived demandfactor substitution effectmarginal product of labor

(MPL)marginal productivity theory

of income distributionmarginal revenue product

(MRP)

REVIEW TERMS AND CONCEPTS

output effect of a factor price increase (decrease)

productivity of an input

pure rent

technological change

Equations:

MRPL = MPL x PX

W*= MRPL