THE ECONOMICS OF LABOR MARKETS

18
The Markets for the Factors of Production

The Markets for the Factors of Production
Factors of production are the inputs used to produce goods and services.

The Market for the Factors of Production
The demand for a factor of production is a derived demand.
A firm’s demand for a factor of production is derived from its decision to supply a good in another market.

THE DEMAND FOR LABOR
Labor markets, like other markets in the economy, are governed by the forces of supply and demand.

Figure 1 The Versatility of Supply and Demand
Copyright©2003 Southwestern/Thomson Learning
Quantity of
Apples
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Price of
Apples
Quantity of
Apple Pickers
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Wage of
Apple
Pickers
(a) The Market for Apples
(b) The Market for Apple Pickers

THE DEMAND FOR LABOR
Most labor services, rather than being final goods ready to be enjoyed by consumers, are inputs into the production of other goods.

The Production Function and the Marginal Product of Labor
The production function illustrates the relationship between the quantity of inputs used and the quantity of output of a good.

Table 1 How the Competitive Firm Decides How Much Labor to Hire
Copyright©2004 South-Western

Figure 2 The Production Function
Copyright©2003 Southwestern/Thomson Learning
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Apple Pickers
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Quantity
of Apples
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100
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The Production Function and the Marginal Product of Labor
The marginal product of labor is the increase in the amount of output from an additional unit of labor.
MPL = ΔQ/ΔL
MPL = (Q2 – Q1)/(L2 – L1)

The Production Function and the Marginal Product of Labor
Diminishing Marginal Product of Labor
As the number of workers increases, the marginal product of labor declines.
As more and more workers are hired, each additional worker contributes less to production than the prior one.
The production function becomes flatter as the number of workers rises.
This property is called diminishing marginal product.

The Production Function and the Marginal Product of Labor
Diminishing marginal product refers to the property whereby the marginal product of an input declines as the quantity of the input increases.

Figure 2 The Production Function
Copyright©2003 Southwestern/Thomson Learning
Quantity of
Apple Pickers
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Quantity
of Apples
300
280
240
180
100
1
2
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4
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The Value of the Marginal Product and the Demand for Labor
The value of the marginal product is the marginal product of the input multiplied by the market price of the output.
VMPL = MPL × P

The Value of the Marginal Product and the Demand for Labor
The value of the marginal product (also known as marginal revenue product) is measured in dollars.
It diminishes as the number of workers rises because the market price of the good is constant.

The Value of the Marginal Product and the Demand for Labor
To maximize profit, the competitive, profit-maximizing firm hires workers up to the point where the value of the marginal product of labor equals the wage.
VMPL = Wage

The Value of the Marginal Product and the Demand for Labor
The value-of-marginal-product curve is the labor demand curve for a competitive, profit-maximizing firm.

Figure 3 The Value of the Marginal Product of Labor
Copyright©2003 Southwestern/Thomson Learning
0
Quantity of
Apple Pickers
0
Value
of the
Marginal
Product

FYI—Input Demand and
Output Supply
When a competitive firm hires labor up to the point at which the value of the marginal product equals the wage, it also produces up to the point at which the price equals the marginal cost.

What Causes the Labor Demand Curve to Shift?
Output Price
Technological Change
Supply of Other factors

THE SUPPLY OF LABOR
The labor supply curve reflects how workers’ decisions about the labor-leisure tradeoff respond to changes in opportunity cost.
An upward-sloping labor supply curve means that an increase in the wages induces workers to increase the quantity of labor they supply.

Figure 4 Equilibrium in a Labor Market
Copyright©2003 Southwestern/Thomson Learning
Wage
(price of
labor)
0
Quantity of
Labor

What Causes the Labor Supply Curve to Shift?
Changes in Tastes
Changes in Alternative Opportunities
Immigration

EQUILIBRIUM IN THE LABOR MARKET
The wage adjusts to balance the supply and demand for labor.
The wage equals the value of the marginal product of labor.

Figure 4 Equilibrium in a Labor Market
Copyright©2003 Southwestern/Thomson Learning
Wage
(price of
labor)
0
Quantity of
Labor

EQUILIBRIUM IN THE LABOR MARKET
Labor supply and labor demand determine the equilibrium wage.
Shifts in the supply or demand curve for labor cause the equilibrium wage to change.

Figure 5 A Shift in Labor Supply
Copyright©2003 Southwestern/Thomson Learning
Wage
(price of
labor)
0
Quantity of
Labor

Shifts in Labor Supply
An increase in the supply of labor :
Results in a surplus of labor.
Puts downward pressure on wages.
Makes it profitable for firms to hire more workers.
Results in diminishing marginal product.
Lowers the value of the marginal product.
Gives a new equilibrium.

Figure 6 A Shift in Labor Demand
Copyright©2003 Southwestern/Thomson Learning
Wage
(price of
labor)
0
Quantity of
Labor

Shifts in Labor Demand
An increase in the demand for labor :
Makes it profitable for firms to hire more workers.
Puts upward pressure on wages.
Raises the value of the marginal product.
Gives a new equilibrium.

Table 2 Productivity and Wage Growth
in the United States.
Copyright©2004 South-Western

OTHER FACTORS OF PRODUCTION: LAND AND CAPITAL
Capital refers to the equipment and structures used to produce goods and services.
The economy’s capital represents the accumulation of goods produced in the past that are being used in the present to produce new goods and services.

OTHER FACTORS OF PRODUCTION: LAND AND CAPITAL
Prices of Land and Capital
The purchase price is what a person pays to own a factor of production indefinitely.
The rental price is what a person pays to use a factor of production for a limited period of time.

Equilibrium in the Markets for Land and Capital
The rental price of land and the rental price of capital are determined by supply and demand.
The firm increases the quantity hired until the value of the factor’s marginal product equals the factor’s price.

Figure 7 The Markets for Land and Capital
Copyright©2003 Southwestern/Thomson Learning
Quantity of
Land
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Rental
Price of
Land
Quantity of
Capital
0
Rental
Price of
Capital
(a) The Market for Land
(b) The Market for Capital

Equilibrium in the Markets for Land and Capital
Each factor’s rental price must equal the value of its marginal product.
They each earn the value of their marginal contribution to the production process.

Linkages among the Factors of Production
Factors of production are used together.
The marginal product of any one factor depends on the quantities of all factors that are available.

Linkages among the Factors of Production
A change in the supply of one factor alters the earnings of all the factors.

Linkages among the Factors of Production
A change in earnings of any factor can be found by analyzing the impact of the event on the value of the marginal product of that factor.

Summary
The economy’s income is distributed in the markets for the factors of production.
The three most important factors of production are labor, land, and capital.
The demand for a factor, such as labor, is a derived demand that comes from firms that use the factors to produce goods and services.

Summary
Competitive, profit-maximizing firms hire each factor up to the point at which the value of the marginal product of the factor equals its price.
The supply of labor arises from individuals’ tradeoff between work and leisure.
An upward-sloping labor supply curve means that people respond to an increase in the wage by enjoying less leisure and working more hours.

Summary
The price paid to each factor adjusts to balance the supply and demand for that factor.
Because factor demand reflects the value of the marginal product of that factor, in equilibrium each factor is compensated according to its marginal contribution to the production of goods and services.