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Lesson 42 ECO402

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Lesson 42 ECO402

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asmasardar340
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Micro Economics –ECO402 VU

LESSON 42
MARKETS FOR FACTOR INPUTS

COMPETITIVE FACTOR MARKETS


Characteristics
1) Large number of sellers of the factor of production
2) Large number of buyers of the factor of production
3) The buyers and sellers of the factor of production are price takers

DEMAND FOR A FACTOR INPUT WHEN ONLY ONE INPUT IS VARIABLE


Demand for factor inputs is a derived demand from factor cost and output demand.

Assume
• Two inputs: Capital (K) and Labor (L)
• Cost of K is r and the cost of labor is w
• K is fixed and L is variable

Problem: How much labor to hire?

MEASURING THE VALUE OF A WORKER’S OUTPUT


Marginal Revenue Product of Labor (MRPL) = (MPL)(MR)

Assume perfect competition in the product market


Then MR = P
Question
What will happen to the value of MRPL when more workers are hired?

MARGINAL REVENUE PRODUCT

Wages
($ per Competitive Output Market (P = MR)
hour)

MRPL = MPLx P
Monopolistic
Output MRPL = MPL x MR
Market
Hours of Work

Choosing the profit-maximizing amount of labor


• If MRPL > w (the marginal cost of hiring a worker): hire the worker
• If MRPL < w: hire less labor
• If MRPL = w: profit maximizing amount of labor

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Micro Economics –ECO402 VU

HIRING BY A FIRM IN THE LABOR MARKET (WITH CAPITAL FIXED)

In a competitive labor market, a


Price firm faces a perfectly elastic supply of labor
of and can hire as many workers as it wants at w*.
Labor
The profit maximizing firm will
hire L* units of labor at the point
where the marginal revenue product
of labor is equal to the wage rate.

w* S

Why not hire fewer


or more workers than L*.

MRPL = DL

L* Quantity of Labor

DEMAND FOR A FACTOR INPUT WHEN ONLY ONE INPUT IS VARIABLE


If the market supply of labor increased relative to demand (baby boomers or female entry), a
surplus of labor would exist and the wage rate would fall.

Question: How would this impact the quantity demanded for labor?

A SHIFT IN THE SUPPLY OF LABOR

Price of
Labor

w1 S1

w2 S2

MRPL = DL

Quantity of Labor
L1 L2

COMPARING INPUT AND OUTPUT MARKETS


MRP L = ( MP L )( MR)
and at profit maximizing
number of workers MRP L = w
(MP L )( MR) = w
MR = w MP L
w MP L = MC of production

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Micro Economics –ECO402 VU

In both markets, input and output choices occur where MR = MC


• MR from the sale of the output
• MC from the purchase of the input
DEMAND FOR A FACTOR INPUT WHEN SEVERAL INPUTS ARE VARIABLE
Scenario:
Producing farm equipment with two variable inputs: labor and assembly-line machinery.
Assume the wage rate falls.

Question: How will the decrease in the wage rate impact the demand for labor?

FIRM’S DEMAND CURVE FOR LABOR (WITH VARIABLE CAPITAL)

When two or more inputs are


Wages variable, a firm’s demand for one
($ per input depends on the marginal
hour) revenue product of both inputs.
When the wage rate is $20, A
represents one point on the firm’s
demand for labor curve.
A When the wage rate falls to $15, the
20
MRP curve shifts, generating a new
C point C on the firm’s demand for
15 labor curve. Thus A and C are
B
on the demand for labor curve, but
D
10 B is not.
MRPL1
5 MRPL

0 40 80 120 160 Hours of Work

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