Copyright © 2004 South-Western Factors of Production What do you think is the most important price you will encounter throughout your life? The price of

Copyright © 2004 South-Western

Factors of Production

• What do you think is the most important price you will encounter throughout your life?

• The price of your labor!!!


Factors of Production

• Factors of Production (inputs, resources)• Inputs used to produce goods and services

• Land, labor (L), capital (K), entrepreneurship


Why Factor Prices Matter

• Occupational Outlook Quarterly

• Derived Demand results from …

the demand for a specific product/service

When D rises, P ……

rises!!


Why Factor Prices Matter


The Demand for Labor

• Determination of equilibrium wages• Examine the link between

• The production of goods and the demand for labor

Copyright©2003 Southwestern/Thomson Learning

Quantity ofApples

0

Price ofApples

Demand

Supply

Demand

Supply

Quantity ofApple Pickers

0

Wage ofApple

Pickers

(a) The Market for Apples (b) The Market for Apple Pickers

P

Q L

W

Governed by the forces of supply and demand.


Marginal Productivity and Factor Demand

• Competitive firm• Seller of goods • Buyer of labor• Price taker• Profit maximizing

• Profit = TR - TC



• Production Function• relationship between

• quantity of inputs used to make a good

• quantity of output of that good

The Production Function


Productionfunction

Quantity ofApple Pickers

0

Quantityof Apples

300280

240

180

100

1 2 3 4 5



• Marginal product of labor • increase in the amount of output from an additional

unit of labor

• MPL = Q/L

• MPL = (Q2 – Q1)/(L2 – L1)



• Diminishing Marginal Product of Labor• Q increases and MPL declines

• Each additional worker contributes less to production than the prior worker.



1. List the four Factors of Production.

2. What derives the demand for labor?

3. Which Factor of Production accounts for most of the income/

4. Define Marginal Product of Labor.

5. Define Diminishing Marginal Product of Labor.



Value of Marginal Product – VMPL is …• The total monetary benefit of hiring each worker

VMPL = (P of output) * MPL

Worker contribution = worker revenue – wage (W)

The extra revenue from hiring an additional worker



Units of Labor Total Product(# cups/hour)

Marginal Product of Labor

Value of Marginal Produce

0 0 --- ---

1 8 8 $2*8 = $16

2 18 10

3 26 8

4 32 6

5 36 4

6 38 2

Lemonade Stand






0 0 --- ---

1 8 8 $2*8 = $16

2 18 10 $20

3 26 8 16

4 32 6 12

5 36 4 8

6 38 2 4

Lemonade Stand



• Hiring Labor is a …• Comparison between

• The marginal benefit of the next worker (VMPL)

• The marginal cost (MC) of the next worker.

• HIRE: VMPL >= W (wage)

• NEVER HIRE: VMPL < W

• STOP HIRING: VMPL = W

This is the profit-maximizing hiring decision

for ANY factor of production.

Value of the Marginal Product


0 Quantity ofApple Pickers

0

Value of the

MarginalProduct

Value of marginal product(demand curve for labor)

Marketwage

Profit-maximizing quantity

VMPL = W

P = MC






0 0 --- ---

1 8 8 $2*8 = $16

2 18 10 $20

3 26 8 16

4 32 6 12

5 36 4 8

6 38 2 4

Lemonade Stand

Equilibrium in a Labor Market


Wage(price of

labor)

0 Quantity ofLabor

Supply

Demand

Equilibriumwage, W

Equilibriumemployment, L


Shifts of the Factor Demand Curve

1. Changes in the price of goods1. P rising may mean more workers hired.

2. D curve shifts right since VMP increases.



1. Changes in the supply of other factors.1. Tools (capital) improve labor.

2. More land usually means more labor hired.



1. Changes in technology.1. Better technology usually means a more

productive labor force.


Demand in the Market for

Land and CapitalHow does the owner of a firm determine how

much land and capital to employ?Same way the firm hires labor

•R = ‘rental rate’ • MC of hiring the next unit of land or capital

•Maximize profits = VMPLand = RLand

•Maximize profits = VMPCapital = RCapital


Supply in the Market for

Land and CapitalSupply of Land is nearly vertical or ???

inelastic! Why?

Only so much land.

Supply of Capital is less steep or ???

Very elastic! Why?

Easier to generate and/or use capital.


Equilibrium Markets for Land and Capital


Quantity ofLand

0

RentalPrice of

Land

Demand

Supply

Demand

Supply

Quantity ofCapital

0

RentalPrice ofCapital

Q

P

Land Capital

P

Q


THE SUPPLY OF LABOR

• Trade off

Labor (working and wages)Leisure

• An upward-sloping labor supply curve means that an increase in the wages induces workers to increase the quantity of labor they supply.

V.


The Supply of Labor

Complete the sentence:

“They would need to pay me at least $ ____ /hour before I did that job. Anything less than or equal to this amount and I will pass and choose not to work that job.”


Work v. Leisure

Cost-benefit Decision• Benefit of one hour of work = wages used to

consume goods and services.• Cost of one hour of work: the utility which could be

gained from leisure.• P of leisure = wage you give up.


Work v. Leisure

Cost-benefit Decision• Will work when

• MUWage > MULeisure

• Will NOT work when• MUWage < MULeisure

Equilibrium is when

MUWage = MULeisure

Supply of Labor Curve


Wage(price of

labor)

0 Quantity ofLabor

Supply


Shifts in the Market Labor Supply Curve

1. Changes in Preferences and Social Norms1. List two you know about.



1. Changes in Population1. List one you know about.



1. Changes in Opportunities1. List two you know about.



1. Changes in Wealth1. List one you know about.


Input Combinations

Let’s talk construction!

Carpenters use tools to build houses,

but here are different combinations of

labor and capital that will get the

same house built. One man with a nail

gun could be more productive

than several men with hammers

and nails. The firm must decide if that more expensive, but more productive, nail gun is a better choice than several men with inexpensive hammers.

How does a firm decide which method of producing is best?


Input Combinations

Let’s talk construction!

Substitutes – two factors that can do essentially the same work.

List two you know about.

Complements – two factors that must be combined to produce output.

List two know about.


Determining the Optimal Input Mix

Least-cost Combination of Inputs is when the …

firm hires factor so that the marginal product/dollar spent on each is the same.


Cost Minimization

A city needs to dig a 100-foot drainage ditch. They hire MicroP6 for the job. MicroP6 has two combinations:

Combo 1: a rented backhoe and skilled driver.

Combo 2: ten unskilled workers each with a shovel.


Cost Minimization


Cost of Labor Cost of CapitalTotal Cost of

Producing 100’ of Ditch Digging

Combo 1 One skilled driver = $500

Rented Backhoe = $2500

Combo 2 Ten unskilled workers = $100 * 10 = $1000

Ten shovels = $25 * $10 = $240

What are the Total Costs?


Cost Minimization






$3000


Ten shovels = $25 * $10 = $240

$1250

Which does the city choose?


Cost Minimization

What about productivity?

Combo1 can produce a 300’ ditch in the same time it takes Combo 2 to produce a 100’ ditch.





$3000


Ten shovels = $25 * $10 = $240

$1250

Which does the city choose?


Marginal Productivity Theory of

Income Distribution

The division of income among the economy’s factors of production is determined by each factor’s marginal productivity at the market equilibrium.

What about the distribution of income for different types of labor within the broader labor market?


Marginal Productivity Theory and

Wage Inequality1. Compensating differentials

1. Police officer in Chicago (pop. 2.85M)

2. Police officer in Hanover, ID (pop. 3,790)

They perform essentially the same task.

Whose is usually more dangerous?

What about the distribution of income for different types of labor within the broader labor market?



Wage Inequality

1. Differences in Talent1. Top Chef, Hall of Fame athlete, award willing

author

2. Beginning chef, minor-league athlete, beginning author

They perform essentially the same task.

Whose would you sample?



Wage Inequality

1. Difference in Human CapitalHuman Capital is the accumulated

education, experience and training possessed by an individual.

It’s associated with

more productivity and thus

a higher wage.



Wage Inequality

1. Market Powerunions

2. Efficiency Wages

above competitive wage

3. Discrimination

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Copyright © 2004 South-Western Factors of Production What do you think is the most important price you will encounter throughout your life? The price of