Transcript Chapter 18 Mankiw - Villanova University

Chapter 18
The Markets for the Factors
of Production
Objectives
1. Understand the firm’s demand for labor.
2. Learn why the equilibrium wage rate
is equal to the value of labor’s marginal
product.
3. Understand how land and capital are
valued in the factor markets.
4. Know why a change in the supply of one
factor changes the earnings of all other
inputs
The Market for the Factors of
Production
 Factors
of Production are the inputs used to
produce goods and services. (Chapter 2)
– What are the major factors of production?
– What determines how much each factor
of production is paid?
– What determines how much of each
factor of production will be purchased?
The Market for the Factors of
Production
The
demand for a
factor of production is
a Derived Demand.
A
firms demand for a
factor of production is
derived from its decision
to supply a good in
another market.
A Firm’s Demand For Labor
 Labor
is the most important factor of
production.
 Labor
markets, like other markets in the
economy, are governed by the forces of
supply and demand. (Fig 18-1)
 Most
labor services, rather than being final
goods ready to be enjoyed by consumers,
are inputs into the production of other
goods.
The Demand for Labor
Labor markets, like
other markets in the
economy, are governed
by the forces of supply
and demand.
The Versatility of Supply and Demand
Price of
Apples
The Market
for Apple
Wage
Pickers
of Apple
The Market
for Apples
Pickers
Supply
P
Supply
W
Demand
0
Q
Quantity of
Apples
Demand
0
L
Quantity of
Apples
Pickers
The Demand For
Labor
Most labor services, rather
than being final goods ready
to be enjoyed by consumers,
are inputs into the production
of other goods.
The Production Function and
The Marginal Product of Labor
The production function
illustrates the relationship
between the quantity of inputs
used and the quantity of output
of a good.
A Firm’s Demand For Labor:
The Competitive Profit-Maximizing Firm
A Competitive Firm (Chapter 14):
–is a price taker, for both the product
it sells (e.g. apples) and the input it
buys (e.g. apple pickers)
–has the goal to maximize profits
The
firm’s supply of apples and its
demand for workers are derived from
its primary goal of maximizing profits.
Labor
(Numbers of
Workers)
(L)
Output
(Bushels
per week)
(Q)
Marginal Value of the
Wage
Product Marginal Product
of Labor
of Labor
(MPL =
Q/ L)
(VMPL = P x MPL)
(W)
Marginal
Profit
( Profit = VMPL - W)
0
0
1
100
100
$1,000
$500
$500
2
180
80
800
500
300
3
240
60
600
500
100
4
280
40
400
500
-100
5
300
20
200
500
-300
The Production Function and The
Marginal Product of Labor
Quantity
of Apples
Production
function
300
280
240
180
100
0
1
2
3
4
5
Illustrates and
describes the
relationship
between the
quantity of
inputs used and
the quantity of
output from
production.
Quantity of
Apple Pickers
The Marginal Product of Labor
Marginal
Product of Labor: The
increase is the amount of output from
an additional unit of labor.
MPL = (Q2 - Q1) ÷ (L2 - L1)
Example
from Table 18-1:
MPL = (180 - 100) ÷ (2 - 1) = 80
– The second unit of labor adds 80
additional bushels of apples picked
The Diminishing Marginal Product of
Labor
As
the number of workers increases,
the marginal product of labor declines.
As
more and more workers are hired,
each additional worker contributes
less to the production.
– The production function (Fig 18-2) gets
flatter as the number of workers rises.
The Marginal Product of Labor: How
many workers to hire?
To maximize profits,
the firm considers
how much profit
each worker would
bring in. . .
Value of the
Marginal Product
Value of the Marginal Product...
… is the marginal product of the input
(MPL) multiplied by the market price of
the output:
VMPL = (MPL) x (PQ )
– VMPL is measured in dollars and
diminishes as the number of workers
rises because the market price of the
good (PQ) is constant.
Value of the Marginal Product
VMPL
Value of Marginal
Product Curve
Quantity of
Labor
“How Many Workers Do I Hire?”
VMPL
Value of Marginal
Product Curve
?
Quantity of
Labor
How many workers to hire?
To
maximize profit, the firm hires
workers up to the point where the
VMPL is equal to the cost of the labor,
i.e. market wage (Fig 18-3)
VMPL = WAGE
The
value-of-marginal-product curve is
the labor demand curve for a
competitive, profit-maximizing firm
“How Many Workers Do I Hire?”
VMPL & WAGE
Market
Wage
VMPL Curve
Quantity of
Labor
“How Many Workers Do I Hire?”
VMPL & WAGE
Market
Wage
VMPL Curve
Quantity of
Labor
“How Many Workers Do I Hire?”
VMPL & WAGE
Market
Wage
VMPL Curve
Profit-Max
Quantity
Quantity of
Labor
Important!!
Remember:
P
x MPL = W
P
= W  MPL
NOTE:
P = MC
W  MPL = MC
Therefore,
P = MC
Quick Quiz!
 Define
“marginal product
of labor” and the “value
of the marginal product of
labor.”
 Describe
how a
competitive, profitmaximizing firms decides
how many workers to
hire.
Labor-Market Equilibrium
Labor
supply and labor demand
together determine the equilibrium
wage, and shifts in the supply or
demand curve for labor cause the
equilibrium wage to change.
Profit
maximization by competitive
firms demanding labor, ensures that
the equilibrium wage always equals
the value of the marginal product.
Labor-Market Equilibrium: Shifts in
the Supply and Demand of Labor
The
wage adjusts to balance the
supply and demand for labor (Fig 18-4)
Shift
in Supply of Labor: may be
caused by increased number of
available labor (Fig 18-5)
Shift
in Demand for Labor: may be
caused by an increased demand for
the final product produced by labor.
“How Many Workers Do I Hire?”
VMPL & WAGE
S0
Market
Wage
VMPL Curve
Profit-Max
Quantity
Quantity of
Labor
What Causes the Labor Demand
Curve to Shift?
Output
Price
Technological
Supply
Change
of Other factors
The Labor Supply Curve
 The
labor supply curve reflects how
workers’ decisions about the laborleisure tradeoff respond to changes in
opportunity cost.
 An
upward-sloping labor supply curve
means that an increase in the wages
induces workers to increase the
quantity of labor they supply.
The Labor Supply Curve
Wage
(price of
labor)
0
Supply
Quantity of
Labor
What Causes the Labor Supply
Curve to Shift?
Changes
in Tastes
Changes
in Alternative
Opportunities
Immigration
Equilibrium in the Labor
Market
The
wage adjusts to balance the
supply and demand for labor.
The
wage equals the value of the
marginal product of labor.
Shifts in the Supply and Demand
of Labor
 Shifts
in Supply of Labor:
Result in a surplus of labor which
puts downward pressure on wages which
makes it profitable for firms to hire more
workers, which
results in diminishing marginal product,
which
lowers the value of the marginal product.
Gives a new equilibrium...
A Shift in Labor Supply
Figure 18-5
Wage
(price of
labor)
Supply, S1
S2
1. An increase
in supply...
W1
W2
2. …reduces
the wage...
0
L1
3. …and raises employment.
L2
Quantity
of labor
A Shift in Labor Demand
Figure 18-6
Wage
(price of
labor)
Supply
1. An increase
in labor
demand...
W2
W1
D2
2. …increases
the wage...
Demand, D1
0
3. …and raises employment.
L1
L2
Quantity
of labor
What causes productivity and wages to
vary so much over time? (Table 18-3)
Physical
Capital: when workers work
with a larger quantity of equipment and
structures, they produce more.
Human
Capital: when workers are more
educated, they produce more.
Technological
Knowledge: When
workers have access to more sophisticated
technologies, they produce more.
“How Many Workers Do I Hire?”
VMPL & WAGE
Market
Wage
VMPL Curve
Quantity of
Labor
Quick Quiz!
How
does the
immigration of workers
affect labor supply,
labor demand, the
marginal product of
labor, and the
equilibrium wage?
Other Factors of Production:
Land and Capital
Capital:
refers to the stock of
equipment and structures used for
production.
– The economy’s capital represents the
accumulation of goods produced in the
past that are being used in the present to
produce new goods and services.
Two Prices for Land & Capital
Purchase
Price:
–the price a person pays to own that
factor of production indefinitely.
Rental
Price:
–the price a person pays to use that
factor for a limited period of time.
Determining the Rental Price and
Quantity of Land and Capital
Rental
Price:
– The rental price of land and the rental
price of capital are determined by supply
and demand.
Quantity
Purchased:
– The firm increases the quantity hired until
the value of the factor’s marginal product
equals the factor price.
The Markets for Land and Capital
Supply
Rental
Price of
Land

the Market
for Land
P
Demand
Quantity of
Land
0
Q
The Markets for Land and Capital
Supply
Rental
Price of
Capital

the Market
for Capital
P
Demand
Quantity of
Capital
0
Q
Determining the Rental Price and
Quantity of Land and Capital
Labor, land, and
capital each earn the
value of their marginal
contribution to the
production process.
Determining the Purchase Price and
Quantity of Land and Capital
Equilibrium
Purchase Price:
–depends on both the current value of
the marginal product and the value
of the marginal product expected to
prevail in the future.
Land
and Capital are paid the value of
their marginal product.
Linkages Among the Factors of
Production
The factors of production not only
depend on the demand and supply of
the products they are used to produce,
but they are also dependent upon each
other.
Economic Interdependence
Economic Interdependence between
Factors of Production
An event that changes the supply of
any factor of production can alter the
earnings of all the factors.
The
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.
– Example: Case Study- Black Death
Quick Quiz!
 What
determines the
income of the owners of
land and capital?
 How
would an increase in
the quantity of capital
affect the incomes of
those who already own
capital? How would it
affect the incomes of
workers?
Summary
 The
three most important factors of
production are labor, land, and
capital.
 The
demand for factors, such as
labor, is a derived demand that comes
from firms that use the factors to
produce goods and services.
 Competitive,
profit-maximizing firms
hire each factor up to the point at
which the value of the marginal
product of the factor equals its price.
Summary
The supply of labor arises from
individuals’ tradeoff between work
and leisure.
An upward-sloping labor supply
curve means that people respond
to an increase in the wage by
enjoying less leisure and working
more hours.
Summary
 The
price paid to each factor adjusts
to balance the supply and demand
for that factor.
 Because
factor demand reflects the
value of the marginal product of that
factor, in equilibrium each factor is
compensated according to its
marginal contribution to the
production of goods and services.
Summary
Because
factors of production
are used together, the marginal
product of any one factor
depends on the quantities of all
factors that are available.
As
a result, a change in the
supply of one factor alters the
equilibrium earnings of all the
factors.