factor markets: factor demand ap economics mr. bordelon

Factor Markets:Factor Demand

AP EconomicsMr. Bordelon

Factors of Production

• Land. Natural resources• Labor. Work done by human beings (for pay).• Capital

– Physical capital. Manufactured productive resources such as equipment, buildings, tools, and machines (manmade resources).

– Human capital. Improvement in labor created by education and knowledge embodied in the workforce (knowledge and skills).

• Entrepreneurship. Risk-taking activities that bring together resources for innovative production.

Allocation of Resources

• Factor markets are similar to product markets, which allocate goods among consumers.

• Key differences– Derived demand. Demand for the factor is

derived from demand for the firm’s output.– Factor markets consist of the largest share of

income for U.S. households. (Labor!)

Distribution of Income

• Most Americans get most of their income in the form of wages and salary—think of it as income by selling labor.

• Other sources– physical capital: ownership of stock in a company– rent: payments on leased land– profits

• Factor distribution of income. How total income of the economy is divided among labor, land, capital, and entrepreneurship.

Marginal Productivityand Factor Demand

• Most factor markets in the U.S. economy are perfectly competitive. Why?

• Most buyers and sellers of factors are price-takers because they are too small relative to the market to do anything but accept market price.– Labor: an individual alone can not influence

wages effectively.• Assumption: All firms are price-takers in their output

markets, operating in perfect competition.

Value of the Marginal Product

• Going back to the Joslyns’ Farm, this is the TP and MPL curve from earlier, with the MPL curve based on this table.

• Remember, the slope on both of these curves is caused by diminishing returns.

• Assume for a moment that workers are paid $200 each and wheat sells at $20 per bushel. How many workers should the Joslyns’ hire?• AP Note: Get used to this question. It is your friend.


• First, use the production function to get TC and MC.• Second, apply optimal output rule (MR = MC) and determine

optimal output.• Third, once optimal output is determined, go back to

production function and find optimal number of workers (number of workers needed to produce optimal quantity of output).


• Joslyns are deciding whether to hire Shane. Increase in cost from employing another worker is the wage rate, W.

• The benefit to the Joslyns from employing Shane is the value of the extra output Shane can produce.

• This value of MPL is found by VMPL = (MPL)(P) (price of output).


• Whether the Joslyns hire Shane depends on whether the value of Shane’s output is more than Shane’s cost.

• VMPL > W: hire• VMPL = W: hire, but stop after this• VMPL < W: what are you, nuts? This is a bad

idea.


• Marginal decisions require making the best choice, equating marginal benefit with marginal cost.• If not equal, continue to hire until MC of one more

unit would exceed marginal benefit.

• For the Joslyn’s to maximize profit, they will employ workers up to whereVMPL = W

Value of Marginal Product

• Key point: This rule applies to all factors of production, not just labor (though most commonly tested).

• Value of MP for all factors is (MP)(P).• Profit-maximizing firms will add more units of

each factor until the value of MP of the last unit is equal to factor’s price.

Value of Marginal Product

• A profit-maximizing firm will choose the level of output at which the price of the good produced equals the MC of producing that good.

• Key point: If level of output is chosen so that P = MC (perfect competition), then it is also true that with the amount of labor required to produce that output level, then VMPL = W.

Value of MP andFactor Demand

This curve is the VMP curve of labor. Again, it will slope downward because of diminishing marginal returns.

Joslyns will hire workers until VMPL = W. Here, the wage rate is $200. Stupid question: How many workers will the Joslyns’ employ to meet optimal output?


If you said 5, you get a cookie. A special sweet carob-filled vegan cookie from Chantal’s kitchen.

Serious, Chantal. We want the cookies. Bring them to us tomorrow.


• Key point: VMPL curve is individual firm’s labor demand curve.

• Key point: Firm’s value of MP curve for all factors of production is that firm’s individual demand curve for that factor of production.

• In other words, what Tyler said earlier about making a similar analysis for each factor is correct. Which means he gets two cookies from Chantal.

Shifts of Factor Demand Curve

• Changes in the price of goods. If the price of the good that is produced with a factor changes, so will the value of the MP of the factor.– For labor, if P changes, VMPL will change at any given level of

employment.• Changes in supply of other factors (inputs). If more land

or capital becomes available (or scarce), you can expect the factor demand curve to shift.

• Changes in technology. Technology will typically increase demand for a given factor because it reduces costs and raises the MP of the factor.

Shifts of Factor Demand Curve

In these graphs, notice that only the derived demand for labor (individual firm’s demand for labor) shifted, BUT NOT the market wage rate. Wages can remain the same and you’d still see a shift in the demand for factor as appropriate. The cost of the factor can remain the same without it shifting the curve.

factor markets: factor demand ap economics mr. bordelon

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