AP Economics

Mr. Bernstein

Module 69: Factor Markets: Introduction and Factor

Demand

December 18, 2014

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AP EconomicsMr. Bernstein

Factors of Production• AKA “resources” or “inputs”• Land

• Resources provided by nature

• Labor• Work done by humans

• Capital• Physical Capital such as tools, buildings, machinery, etc.• Human Capital – improvement in labor due to education, training…

may be the most important factor in modern econ.

• Entrepreneurship• Talent for bringing together resources for innovative production

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AP EconomicsMr. Bernstein

Factor Prices• Factor prices allocate resources among

producers• The demand for a factor of production is a

derived demand (derived from the output being producted)

• Factor Distribution of Income: Payments to labor are most of economy’s total income (71% )

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AP EconomicsMr. Bernstein

Marginal Productivity and Factor Demand• MP = Marginal Product of one additional unit

• ie MPL is additional output from hiring one more worker

• VMP = Value of Marginal Product• ie VMPL is additional value from hiring one more worker; =

MPL x P

• VMP curve is the demand curve for a factor• If a unit of labor costs W, the Profit-Maximizing Rule

is to hire worker if VMPL >= W• Law of Demand applies in factor markets

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AP EconomicsMr. Bernstein

What Causes Shifts in Factor Demand Curves?• Change in price of goods

• If price of product rises, VMP also rises• Example: NFL players worth more if league’s TV package rises• Example: Airline pilot is worth less as ticket prices fall• Labor demand is derived from product demand

• Change in supply of other factors• Factors are often paired (ie labor and capital) so increase in

supply of one increases VMP of the other

• Change in technology• Advances in technology increase VMP