factor siness econ

8/13/2019 Factor siness econ

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Copyright 2002, Pearson Education Canada1

UNIT-5

FACTOR PRICING -I

MARGINAL PRODUCTIVITY THEORY AND

DEMAND


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Firm and Household Decisions (Figure 10.1)


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Derived Demand

Derived demand is a demand for resources(inputs) that is dependent on the demand for

the outputs those resources can be used toproduce.


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Inputs

The productivity of an input is the amount ofoutput produced per unit of that input.

Complementary inputs are factors of productionthat can be used together to enhance eachother.

Substitutable inputs are factors of productionthat can be used in place of each other.


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Marginal Product (MP) & MarginalRevenue Product (MRP)

The marginal product of labour (MPL) is theadditional output produced by one additional

unit of labor.The marginal revenue product (MRP) refers to

the additional revenue a firm earns by

employing one additional unit of an input,ceteris paribus.

MRPL= MPLx PX


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Marginal Revenue Product per Hour ofLabour in Sandwich Production (Table 10.1)


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Deriving a Marginal Revenue ProductCurve from Marginal Product (Figure 10.2)

The marginal revenue productof labour is the price of output,Px, times the marginal product

of labour, MPL. In competition, MRPLis the

market value of labours

marginal product.

As long as output price isconstant, the MRPLcurve hasthe same downward slope asthe MPL curve.


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Marginal Revenue Product and Factor Demand

for a Firm Using One Variable Input (Labour)(Figure 10.3)

A competitive firm using only one variable factor of production will use that factor

as long as its marginal revenue product exceeds its unit cost. A perfectly

competitive firm will hire labour as long as MRPLis greater than the going wage.


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The Two Profit-Maximizing Conditions AreSimply Two Views of the Same Choice Process(Figure 10.4)


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A Firm Employing Two VariableFactors of Production

Suppose that the firm can vary its employmentof both labour and capital.

How can the firms demand for labour and

capital be characterized?

When more than one factor vary, we must

consider the impact of a change in one factorprice on the demand for other factors.


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Two Effects When the Price of anInput Changes

The factor substitution effect is the tendency offirms to substitute away from a factor whoserelative price has risen and toward a factor

whose relative price has fallen.

The output effect is the tendency of a firm toincrease output when the price of an input falls;

which in turn increases the demand for allinputs.

These effects explain the downward slopinginput demand curve.


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Land Markets

Land has perfectly inelastic supply; the supply is strictlyfixed.

Demand-determined price refers to the price of a goodthat is fixed in supply; it is determined exclusively bywhat firms and households are willing to pay for thegood.

Pure rent is the return to any factor of production that is

fixed in supply.

The firm will use land up to the point where MRPH= PHwhere H is land (hectares).


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The Firms Profit-MaximizingCondition in Input Markets

PL= MRPL = (MPLx PX) Labour Market

PK = MRPK= (MPKx PX) Capital Market

PH = MRPH= (MPHx PX) Land Market

MPL = MPK = MPH

PL PK PH


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Input Demand Curves

Several factors contribute to shifts in inputdemand curves:

demand for outputs

complementary and substitutable inputs

prices of other inputs

technological change


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Marginal Productivity Theory ofIncome Distribution

At equilibrium, all factors of production end upreceiving rewards determined by their

productivity as measured by marginal revenueproduct.


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Review Terms & Concepts

complementary inputs

demand determined price

derived demand factor substitution effect

marginal product oflabour (MPL)

marginal productivitytheory of incomedistribution

marginal revenue product(MRP)

output effect of a factorprice change

productivity of an input

pure rent

substitutable inputs technological change

factor siness econ

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