Unit 5: Factor Markets

a. Define (using graphs where appropriate) key terms and concepts relating to factor markets. b. Explain (using graphs where appropriate) the relationship between factors of production, firms, and factor prices. c. Calculate (using data from a graph or table where appropriate) the marginal revenue product and marginal resource cost.

• Factors of production (labor, capital, and land) respond to factor prices (wages, interest, and rent), and employers’ (firms’) decision to hire is based on the productivity of the factors, output price, and cost of the factor.
• The quantity of labor demanded is negatively related to the wage rate, while the quantity of labor supplied is positively related to the wage rate in a given labor market, other things constant.
• Enduring understanding PRD-4: Factor prices provide incentives and convey information to firms and factors of production.

Explain (using graphs where appropriate) firms’ and factors’ responses to changes in incentives and constraints.

• Changes in the determinants of labor demand, such as the output price and the productivity of the worker, cause the labor demand curve to shift.
• Changes in the determinants of labor supply (such as immigration, education, working conditions, age distribution, availability of alternative options, preferences for leisure, and cultural expectations) cause the labor supply curve to shift.
• Enduring understanding PRD-4: Factor prices provide incentives and convey information to firms and factors of production.

a. Define (using graphs as appropriate) the characteristics of perfectly competitive factor markets. b. Explain (using graphs where appropriate) the profit-maximizing behavior of firms buying labor (with other inputs fixed) in perfectly competitive markets. c. Calculate (using data from a graph or table where appropriate) measures representing the profit-maximizing behavior of firms buying labor (with other inputs fixed) in perfectly competitive markets.

• In a perfectly competitive labor market, the wage is set by the market and each firm hires the quantity of workers, where the marginal factor (resource) cost (wage) equals the marginal revenue product of labor. A typical firm may be a perfect competitor in the labor market even if it is an imperfect competitor in its output markets.
• A typical firm hires labor in a perfectly competitive labor market as long as the marginal revenue product of labor is greater than the market wage.
• To minimize costs or maximize profits, firms allocate inputs such that the last dollar spent on each input yields the same amount of marginal product.
• Marginal revenue product of a factor of production is the change in total revenue divided by the change in that factor of production, which is also equal to the marginal physical product of that factor multiplied by the marginal revenue (MRP = MP × MR). Firms in a perfectly competitive output market will have marginal revenue product of labor that is equal to the value of the marginal product of labor (VMPL = MPL × P) because marginal revenue for each unit of output is equal to price.
• Enduring understanding PRD-4: Factor prices provide incentives and convey information to firms and factors of production.

a. Define (using graphs as appropriate) the characteristics of monopsonistic markets. b. Explain (using graphs where appropriate) the profit-maximizing behavior of firms buying labor (with other inputs fixed) in monopsonistic markets. c. Calculate (using data from a graph or table where appropriate) measures representing the profit-maximizing behavior of firms buying labor (with other inputs fixed) in monopsonistic markets.

• In a monopsonistic labor market, a typical firm hires additional labor as long as the marginal revenue product is greater than the marginal factor (resource) cost (the wage of a new unit of labor plus the wage increase given to all existing labor).
• When a typical firm hires additional workers in a monopsonistic labor market, the marginal factor (resource) cost is greater than the supply price of labor.
• Enduring understanding PRD-4: Factor prices provide incentives and convey information to firms and factors of production.