In this chapter, look for the answers to these questions: § What determines a competitive firm’s demand for

  C H A P T E R

18 The M arkets for the The M arkets for the

  Factors of Production Factors of Production P R I N C I P L E S O F P R I N C I P L E S O F conomics

  E N. Gregory N. Gregory Mankiw Mankiw

  Premium PowerPoint Slides _{© 2009 South-Western, a part of Cengage Learning, all rights reserved} by Ron Cronovich In this chapter, In this chapter, look for the answers to these questions: look for the answers to these questions:

  § What determines a competitive firm’s demand for

  labor?

  § How does labor supply depend on the wage?

  What other factors affect labor supply?

  § How do various events affect the equilibrium wage

  and employment of labor?

  § How are the equilibrium prices and quantities of

  other inputs determined?

1 Factors of Production and Factor M arkets

  Factors of production : §

  § Labor § Land § Capital :

  Prices and quantities of these inputs are § determined by supply & demand in factor _{THE MARKETS FOR THE FACTORS OF PRODUCTION} markets.

  2

  Derived Demand § Markets for the factors of production are like markets for goods & services, except:

  § Demand for a factor of production is a derived demand

THE MARKETS FOR THE FACTORS OF PRODUCTION

  3 Two Assumptions

  1. We assume

  in the market for the product it produces

  § § in the labor market

  2. We assume § Each firm’s supply of output and demand for _{THE MARKETS FOR THE FACTORS OF PRODUCTION} inputs are derived from this goal.

4 Our Example: Farmer Jack

  Farmer Jack sells wheat in a perfectly § competitive market.

  He hires workers in a perfectly competitive labor § market.

  When deciding how many workers to hire, §

  Farmer Jack maximizes profits by thinking at the margin: § If the benefit from hiring another worker exceeds _{THE MARKETS FOR THE FACTORS OF PRODUCTION} the cost, Jack will hire that worker.

  5

  Our Example: Farmer Jack § Cost of hiring another worker: § Benefit of hiring another worker:

  Jack can The size of this benefit depends on Jack’s § production function : the relationship between the quantity of inputs used to make a good and _{THE MARKETS FOR THE FACTORS OF PRODUCTION} the quantity of output of that good.

  6 Farmer Jack’s Production Function Q L

  (bushels 3,000 (no. of of wheat workers)

  2,500 per week) ut tp u

  2,000 o f o ty

  1,500 1 1000 ti n a u

  1,000 2 1800

  Q 500

  3 2400 4 2800

  1

  2

  3

  4

  5 5 3000 _{THE MARKETS FOR THE FACTORS OF PRODUCTION}

  No. of workers

  7 M arginal Product of Labor (M PL) § Marginal product of labor

THE MARKETS FOR THE FACTORS OF PRODUCTION

  8

  § Problem:

  § Cost of hiring another worker § Benefit of hiring another worker

THE MARKETS FOR THE FACTORS OF PRODUCTION

9 The V alue of the M arginal Product

  5

  4

  3

  2

  1

  The VMPL curve 1,000 2,000 3,000 4,000 5,000 $6,000

  Answers

  1

  A C T I V E L E A R N I N G A C T I V E L E A R N I N G

  (no. of workers)

  L

  (bushels of wheat)

  Q

  1 VMPL MPL

  10 P = $5/bushel.

  § Solution:

  § Value of the marginal product :

  A C T I V E L E A R N I N G A C T I V E L E A R N I N G

  1

  1 Computing M PL and VM PL Computing M PL and VM PL

  Find MPL and VMPL, fill them in the blank spaces of the table. Then graph a curve with

  2 1000

  VMPL on the

  vertical axis, L on horiz axis.

  3000

  5 2800

  4 2400

  3 1800

1 Answers

12 L (number of workers)

  13 Farmer Jack’s Labor Demand

  14 VM PL and Labor Demand

  1

  W L D

  Labor demand curve

  15 Shifts in Labor Demand

  VMPL THE MARKETS FOR THE FACTORS OF PRODUCTION

  § To maximize profits, W L

  For any competitive, profit-maximizing firm:

  5 THE MARKETS FOR THE FACTORS OF PRODUCTION

  Suppose wage

  4

  3

  2

  1

  1,000 2,000 3,000 4,000 5,000 $6,000

  L (number of workers) The VMPL curve

  How many workers should Jack hire? Answer:

  W = $2500/week.

THE MARKETS FOR THE FACTORS OF PRODUCTION

  Things that Shift the Labor Demand Curve § § §

  § Example:

  If firm gets more equipment (capital), then workers will be more productive; MPL and VMPL rise, labor _{THE MARKETS FOR THE FACTORS OF PRODUCTION} demand shifts upward.

  16 The Connection Between Input Demand & Output Supply

  § Recall: Marginal Cost (MC)

  = cost of producing an additional unit of output =

  § Suppose W = $2500, MPL = 500 bushels § If Farmer Jack hires another worker, _{THE MARKETS FOR THE FACTORS OF PRODUCTION} § In general:

  17 The Connection Between Input Demand & Output Supply

  Notice: §

  To produce additional output, § § As L rises, causing

  § causing

  § Hence, _{THE MARKETS FOR THE FACTORS OF PRODUCTION} §

  18

  & Output Supply § The competitive firm’s rule for demanding labor: § Divide both sides by MPL: § Substitute MC = W/MPL from previous slide: §

  This is the competitive firm’s rule for supplying output.

  § Hence,

THE MARKETS FOR THE FACTORS OF PRODUCTION

19 The Connection Between Input Demand

  § Trade-off between The more time you spend working,

  §

THE MARKETS FOR THE FACTORS OF PRODUCTION

20 Labor Supply

  21 The Labor Supply Curve

  An increase in W is an increase in People respond by

  W L S

  1 W

  1 L

  1

THE MARKETS FOR THE FACTORS OF PRODUCTION

THE MARKETS FOR THE FACTORS OF PRODUCTION

22 Things that Shift the Labor Supply Curve

  The wage adjusts to balance supply and demand for labor. The wage always equals

THE MARKETS FOR THE FACTORS OF PRODUCTION

23 Equilibrium in the Labor M arket

  A C T I V E L E A R N I N G A C T I V E L E A R N I N G

  W L D S

2 Changes in labor

  Car buyers’ preferences shift toward imported autos.

  Changes in labor - - market equilibrium market equilibrium

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  B.

  Baby Boomers who worked in the auto industry retire.

  A.

  In each of the following scenarios, use a diagram of the market for (domestic) auto workers to find the effects on their wage and employment.

  2

C. Technological progress boosts productivity in the auto manufacturing industry.

  A C T I V E L E A R N I N G A C T I V E L E A R N I N G

  2

2 Answers to A Answers to A

  The market for The market for autoworkers autoworkers

  W S

  1 W

  1 D

  1 L L

  1

  25 A C T I V E L E A R N I N G A C T I V E L E A R N I N G

2 Answers to B Answers to B

  2

  The market for The market for autoworkers autoworkers

  W S

  1 W

  1 D

  1 L L

  1

26 A C T I V E L E A R N I N G A C T I V E L E A R N I N G

2 Answers to C

  2

  Answers to C The market for

  The market for autoworkers autoworkers

  W S

  1 W

  1 D

  1 L L

  1

  27 Recall one of the Ten Principles:

  A country’s standard of living depends on its ability to produce g&s.

  Our theory implies We see this in the data.

THE MARKETS FOR THE FACTORS OF PRODUCTION

28 Productivity and W age Growth in the U.S.

THE MARKETS FOR THE FACTORS OF PRODUCTION

29 The Other Factors of Production

  The market for land

  The market for land

  P Q D = VMP S

  Firms decide how much land to rent by comparing The rental price of land adjusts to balance supply and demand for land.

  The determination of the rental prices of capital and land is analogous to the determination of wages…

  The wage is §

  § purchase price § rental price §

  § With land and capital, must distinguish between:

  2.0% 2.1% 1959-2006 growth rate of real wages growth rate of produc- tivity time period

  2.5 2.6 1995-2006 1.2 1.4 1973-1995 2.8 2.8 1959-1973

THE MARKETS FOR THE FACTORS OF PRODUCTION

30 How the Rental Price of Land Is Determined

  How the Rental Price of Capital Is Determined

  The market Firms decide how The market for capital

  for capital P

  much capital to rent

  S

  by comparing

  D = VMP

  The rental price of capital adjusts to

  Q

  balance supply and _{THE MARKETS FOR THE FACTORS OF PRODUCTION} demand for capital.

  31 Rental and Purchase Prices Buying a unit of capital or land

  § § The rental income in any period equals the value of the marginal product (VMP). Hence, the equilibrium purchase price of a factor

  § _{THE MARKETS FOR THE FACTORS OF PRODUCTION} depends on

  32 Linkages A mong the Factors of Production In most cases, factors of production are used

  § together in a way that makes each factor’s productivity Example: an increase in the quantity of capital

  § § The marginal product and rental price of capital fall. _{THE MARKETS FOR THE FACTORS OF PRODUCTION} § Having more capital

  33

  CONCLUSION § The theory in this chapter is called the

  It states that §

  § factor prices determined by

  each factor is paid

  § Most economists use this theory a starting point

  § for understanding the distribution of income.

  The next two chapters explore this topic further. _{THE MARKETS FOR THE FACTORS OF PRODUCTION} §

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