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• Analyze the labour demand of competitive, profit maximizing firms.

• Consider the household decisions that lie behind labour supply.

• Learn why equilibrium wages equal the value of the marginal product of labour.

• Consider how the other factors of production - land and capital - are compensated.

• Examine how a change in the supply of one factor alters the earnings of all other factors.

• Analyze the labour demand of competitive, profit maximizing firms.

• Consider the household decisions that lie behind labour supply.

• Learn why equilibrium wages equal the value of the marginal product of labour.

• Consider how the other factors of production - land and capital - are compensated.

• Examine how a change in the supply of one factor alters the earnings of all other factors.

In this topic you will…In this topic you will…In this topic you will…In this topic you will…

• Factors of production are the inputs used to produce goods and services.

• 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.

• Factors of production are the inputs used to produce goods and services.

• 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 MARKET FOR FACTORS OF THE MARKET FOR FACTORS OF PRODUCTIONPRODUCTION

THE MARKET FOR FACTORS OF THE MARKET FOR FACTORS OF PRODUCTIONPRODUCTION

• Labour markets, like other markets in the economy, are governed by the forces of supply and demand.

• Most labour services, rather than being final goods ready to be enjoyed by consumers, are inputs into the production of other goods.

• Labour markets, like other markets in the economy, are governed by the forces of supply and demand.

• Most labour services, rather than being final goods ready to be enjoyed by consumers, are inputs into the production of other goods.

THE DEMAND FOR LABOURTHE DEMAND FOR LABOURTHE DEMAND FOR LABOURTHE DEMAND FOR LABOUR

Quantity of Apples

Price of Apples

Demand

Supply

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

Quantity of Apple Pickers

P

Q

Wage of Apple

Pickers

0 0

Demand

Supply

W

L

Figure 1: The Versatility of Supply and Demand Figure 1: The Versatility of Supply and Demand Figure 1: The Versatility of Supply and Demand Figure 1: The Versatility of Supply and Demand

• How does a typical firm (apple producer) decides how much labour to demand?

• Two assumptions:1. The firm is competitive in the market for

apples (the firm is a seller) and in the market for apple pickers (the firm is a buyer). It is a price-taker and a wage-taker. It only has to decide how many workers to hire and how many apples to produce.

2. The firm is profit-maximizing.

• How does a typical firm (apple producer) decides how much labour to demand?

• Two assumptions:1. The firm is competitive in the market for

apples (the firm is a seller) and in the market for apple pickers (the firm is a buyer). It is a price-taker and a wage-taker. It only has to decide how many workers to hire and how many apples to produce.

2. The firm is profit-maximizing.

The Competitive Profit-Maximizing The Competitive Profit-Maximizing FirmFirm

The Competitive Profit-Maximizing The Competitive Profit-Maximizing FirmFirm

• The production function illustrates the relationship between the quantity of inputs used and the quantity of output of a good.

• The marginal product of labour is the increase in the amount of output from an additional unit of labour.

– MPL = Q/L

– MPL = (Q2 – Q1)/(L2 – L1)

• The production function illustrates the relationship between the quantity of inputs used and the quantity of output of a good.

• The marginal product of labour is the increase in the amount of output from an additional unit of labour.

– MPL = Q/L

– MPL = (Q2 – Q1)/(L2 – L1)

The Production Function and the The Production Function and the Marginal Product of LabourMarginal Product of Labour

The Production Function and the The Production Function and the Marginal Product of LabourMarginal Product of Labour

Table 1: How the Competitive Firm Decides Table 1: How the Competitive Firm Decides How Much Labour to Hire How Much Labour to Hire Table 1: How the Competitive Firm Decides Table 1: How the Competitive Firm Decides How Much Labour to Hire How Much Labour to Hire

-300500200203005

-100500400402804

100500600602403

300500800801802

$500$500$10001001001

00

∆Profit = VMPL - W$ 500

VMPL = P x MPL

MPL = ∆Q/ ∆L

(Bushels per week)

Q

(Bushels per week)

L

(Number of workers)

Marginal ProfitWage

Value of the

Marginal product of

labour

Marginal Product of

LabourOutputLabour

0 Quantity of Apple Pickers

Quantity of Apples

Production function

100

180

1 43 5

240

280300

2

Figure 2: The Production Function Figure 2: The Production Function Figure 2: The Production Function Figure 2: The Production Function

• Diminishing Marginal Product of labour– As the number of workers increases, the

marginal product of labour 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

• Diminishing Marginal Product of labour– As the number of workers increases, the

marginal product of labour 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 The Production Function and the Marginal Product of LabourMarginal Product of Labour

The Production Function and the The Production Function and the Marginal Product of LabourMarginal Product of Labour

Diminishing marginal product refers to the property whereby the marginal product of an input declines as the quantity of the input increases.

Diminishing marginal product refers to the property whereby the marginal product of an input declines as the quantity of the input increases.

The Production Function and the The Production Function and the Marginal Product of LabourMarginal Product of Labour

The Production Function and the The Production Function and the Marginal Product of LabourMarginal Product of Labour

Table 1: How the Competitive Firm Decides Table 1: How the Competitive Firm Decides How Much Labour to Hire How Much Labour to Hire Table 1: How the Competitive Firm Decides Table 1: How the Competitive Firm Decides How Much Labour to Hire How Much Labour to Hire

-300500200203005

-100500400402804

100500600602403

300500800801802

$500$500$10001001001

00

∆Profit = VMPL - W$ 500

VMPL = P x MPL

MPL = ∆Q/ ∆L

(Bushels per week)

Q

(Bushels per week)

L

(Number of workers)

Marginal ProfitWage

Value of the

Marginal product of

labour

Marginal Product of

LabourOutputLabour

• 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 (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 is the marginal product of the input multiplied by the market price of the output.

VMPL = MPL P

• 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 The Value of the Marginal Product and the Demand for Labourand the Demand for Labour

The Value of the Marginal Product The Value of the Marginal Product and the Demand for Labourand the Demand for Labour

• To maximize profit, the competitive, profit-maximizing firm hires workers up to the point where the value of the marginal product of labour equals the wage.

VMPL = Wage

• The value-of-marginal-product curve is the labour demand curve for a competitive, profit-maximizing firm.

• To maximize profit, the competitive, profit-maximizing firm hires workers up to the point where the value of the marginal product of labour equals the wage.

VMPL = Wage

• The value-of-marginal-product curve is the labour demand curve for a competitive, profit-maximizing firm.

The Value of the Marginal Product The Value of the Marginal Product and the Demand for Labourand the Demand for Labour

The Value of the Marginal Product The Value of the Marginal Product and the Demand for Labourand the Demand for Labour

0 Quantity of Apple Pickers

Value of the

Marginal Product

Value of marginal product (demand curve for labour)

Market Wage

Profit Maximizing Quantity

Figure 3: The Value of the Marginal Product Figure 3: The Value of the Marginal Product of Labour of Labour Figure 3: The Value of the Marginal Product Figure 3: The Value of the Marginal Product of Labour of Labour

• The labour supply curve reflects how workers’ decisions about the labour-leisure tradeoff respond to changes in opportunity cost.

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

• The labour supply curve reflects how workers’ decisions about the labour-leisure tradeoff respond to changes in opportunity cost.

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

THE SUPPLY OF LABOURTHE SUPPLY OF LABOURTHE SUPPLY OF LABOURTHE SUPPLY OF LABOUR

• The wage adjusts to balance the supply and demand for labour.

• The wage equals the value of the marginal product of labour.

• Labour supply and labour demand determine the equilibrium wage.

• Shifts in the supply or demand curve for labour cause the equilibrium wage to change.

• The wage adjusts to balance the supply and demand for labour.

• The wage equals the value of the marginal product of labour.

• Labour supply and labour demand determine the equilibrium wage.

• Shifts in the supply or demand curve for labour cause the equilibrium wage to change.

EQUILIBRIUM IN THE LABOUR EQUILIBRIUM IN THE LABOUR MARKETMARKET

EQUILIBRIUM IN THE LABOUR EQUILIBRIUM IN THE LABOUR MARKETMARKET

0 Quantity of Labour

Wage (price of

labour)

Equilibrium wage, W

Demand

Supply

Equilibrium employment, L

Figure 4: Equilibrium in the Labour Market Figure 4: Equilibrium in the Labour Market Figure 4: Equilibrium in the Labour Market Figure 4: Equilibrium in the Labour Market

0 Quantity of Labour

Wage (price of

labour)

Demand

Supply, S1

W1

L1

1. An increase in labour supply…

S2

3. … and raises employment.

2. … reduces the wage …

W2

L2

Figure 5: Shifts in Labour Supply Figure 5: Shifts in Labour Supply Figure 5: Shifts in Labour Supply Figure 5: Shifts in Labour Supply

• An increase in the supply of labour :– Results in a surplus of labour.– 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.

• An increase in the supply of labour :– Results in a surplus of labour.– 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.

Shifts in Labour SupplyShifts in Labour SupplyShifts in Labour SupplyShifts in Labour Supply

• Output Price• Technological Change• Supply of Other factors

• Output Price• Technological Change• Supply of Other factors

What Causes the Labour Demand What Causes the Labour Demand Curve to ShiftCurve to Shift

What Causes the Labour Demand What Causes the Labour Demand Curve to ShiftCurve to Shift

0 Quantity of Labour

Wage (price of

labour)

Demand, D1

Supply

W1

L1

1. An increase in labour demand…

3. … and raises employment.

D2

L2

W2

2. … increases the wage …

Figure 6: Shifts in Labour Demand Figure 6: Shifts in Labour Demand Figure 6: Shifts in Labour Demand Figure 6: Shifts in Labour Demand

• An increase in the demand for labour :– 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.

• An increase in the demand for labour :– 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.

Shifts in Labour DemandShifts in Labour DemandShifts in Labour DemandShifts in Labour Demand

• 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.

• 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.

OTHER FACTORS OF PRODUCTION: OTHER FACTORS OF PRODUCTION: LAND AND CAPITALLAND AND CAPITAL

OTHER FACTORS OF PRODUCTION: OTHER FACTORS OF PRODUCTION: LAND AND CAPITALLAND 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.

• Each factor’s rental price must equal the value of its marginal product.

• 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.

• Each factor’s rental price must equal the value of its marginal product.

Equilibrium in the Markets for Equilibrium in the Markets for Land and CapitalLand and Capital

Equilibrium in the Markets for Equilibrium in the Markets for Land and CapitalLand and Capital

Quantity of Land

Rental Price of

Land

(a) The Market for land (b) The Market for Capital

Rental Price of CapitalSupply

0 0

Demand

P

Q Quantity of Capital

Supply

Demand

P

Q

Figure 7: Shifts in Labour Demand Figure 7: Shifts in Labour Demand Figure 7: Shifts in Labour Demand Figure 7: Shifts in Labour Demand

• Factors of production are used together.– The marginal product of any one factor

depends on the quantities of all factors that are available.

• A change in the supply of one factor alters the earnings of all the factors.

• 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.

• Factors of production are used together.– The marginal product of any one factor

depends on the quantities of all factors that are available.

• A change in the supply of one factor alters the earnings of all the factors.

• 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.

Linkages among the Factors of Linkages among the Factors of ProductionProduction

Linkages among the Factors of Linkages among the Factors of ProductionProduction

KeywordsKeywordsKeywordsKeywords

• Factors of production• Production function• Marginal product of labour• Diminishing marginal product• Value of marginal product• Capital• Land

• Factors of production• Production function• Marginal product of labour• Diminishing marginal product• Value of marginal product• Capital• Land

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