ARELLANO UNIVERSITY
Microeconomics
Chap. 6. Input Demand. The Labor
and Land Markets
Professor: Dr. Ronaldo A. Poblete, CFMP
Firm Choices in Input
Markets
Demand for Inputs: A
Derived Demand
Derived demand is demand for
resources (inputs) that is dependent
on the demand for the outputs those
resources can be used to produce.
Inputs are demanded by a firm if,
and only if, households demand the
good or service produced by that
firm.
Inputs: Complementary and
Substitutable
The productivity of an input is
the amount of output produced
per unit of that input.
Inputs can be complementary
or substitutable. This means
that a firm’s input demands are
tightly linked together.
Diminishing Returns
Faced with a capacity constraint
in the short-run, a firm that
decides to increase output will
eventually encounter diminishing
returns.
Marginal product of labor (MP )
L
is the additional output produced
by one additional unit of labor.
Marginal Revenue Product
The marginal revenue product
(MRP) of a variable input is the
additional revenue a firm earns
by employing one additional unit
of input, ceteris paribus.
MRP equals the price of output,
L
PX, times the marginal product of
Marginal Revenue Product Per Hour of Labor
in Sandwich Production (One Grill)
(3)
(2) MARGINAL (4) (5)
(1) TOTAL PRODUCT OF PRICE (PX) MARGINAL REVENUE
TOTAL LABOR PRODUCT LABOR (MPL) (VALUE PRODUCT (MPL X PX)
UNITS (SANDWICHES (SANDWICHES ADDED PER (PER HOUR)
(EMPLOYEES) PER HOUR) PER HOUR) SANDWICH)a
0 0 - - -
1 10 10 $.50 $ 5.00
2 25 15 .50 7.50
3 35 10 .50 5.00
4 40 5 .50 2.50
5 42 2 .50 1.00
6 42 0 .50 0
a
The “price” is essentially profit per sandwich; see discussion in text.
Marginal Revenue Product Per Hour of
Labor in Sandwich Production (One Grill)
MRPL = PX MPL
When output price is
constant, the behavior
of MRPL depends only
on the behavior of MPL.
Under diminishing
returns, both MPL and
MRPL eventually
decline.
A Firm Using One Variable
Factor of Production: Labor
A competitive firm using only one
variable factor of production will use
that factor as long as its marginal
revenue product exceeds its unit
cost.
If the firm uses only labor, then it will
hire labor as long as MRPL is greater
than the going wage, W*.
Marginal Revenue Product and Factor Demand
for a Firm Using One Variable Input (Labor)
The hypothetical firm will demand 210 units of labor.
W* =MRPL = 10
Short-Run Demand Curve for
a Factor of Production
When a firm uses
only one variable
factor of
production, that
factor’s marginal
revenue product
curve is the firm’s
demand curve for
that factor in the
short run.
Comparing Marginal Revenue and
Marginal Cost to Maximize Profits
Assuming that labor is the only
variable input, if society values a
good more than it costs firms to hire
the workers to produce that good,
the good will be produced.
Firms weigh the value of outputs as
reflected in output price against the
value of inputs as reflected in
marginal costs.
The Two Profit-Maximizing
Conditions
The two profit-maximizing conditions are simply two
views of the same choice process.
The Trade - Off Facing Firms
A Firm Employing Two Variable
Factors of Production
Land, labor, and capital are used
together to produce outputs.
When an expanding firm adds to
its stock of capital, it raises the
productivity of its labor, and vice
versa. Each factor complements
the other.
Substitution and Output Effects
of a Change in Factor Price
Two effects occur when the price of
an input changes:
• Factor substitution effect: The
tendency of firms to substitute
away from a factor whose price
has risen and toward a factor
whose price has fallen.
Substitution and Output Effects
of a Change in Factor Price
Two effects occur when the price of
an input changes:
• Output effect of a factor price
increase (decrease): When a firm
decreases (increases) its output in
response to a factor price increase
(decrease), this decreases
(increases) its demand for all
factors.
Substitution and Output Effects
of a Change in Factor Price
Response of a Firm to an Increasing Wage Rate
UNIT COST IF UNIT COST IF
INPUT REQUIREMENTS PL = $1 PL = $2
PER UNIT OF OUTPUT PK = $1 PK = $1
TECHNOLOGY (PL x L) + (PK x K) (PL x L) + (PK x K)
K L
A (capital intensive) 10 5 $15 $20
B (labor
intensive)
When PL = P3K = $1,
10 $13
the labor-intensive $23
method
of producing output is less costly.
Substitution and Output Effects
of a Change in Factor Price
The Substitution Effect of an Increase in Wages on a Firm
Producing 100 Units of Output
TO PRODUCE 100 UNITS OF OUTPUT
TOTAL TOTAL TOTAL
CAPITAL LABOR VARIABLE
DEMANDED DEMANDED COST
When PL = $1, PK = $1, 300 1,000 $1,300
firm uses technology B
When PL = $2, PK = $1, 1,000 500 $2,000
firm uses technology A
When the price of labor rises, labor becomes more
expensive relative to capital. The firm substitutes capital
for labor and switches from technique B to technique A.
Many Labor Markets
If labor markets are competitive, the
wages in those markets are
determined by the interaction of
supply and demand.
Firms will hire workers only as long
as the value of their product exceeds
the relevant market wage. This is
true in all competitive labor markets.
Land Markets
Unlike labor and
capital, the total
supply of land is
strictly fixed
(perfectly
inelastic.
Demand Determined Price
The price of a good that is
in fixed supply is demand
determined.
Because land is fixed in
supply, its price is
determined exclusively by
what households and firms
are willing to pay for it.
• The return to any factor of production in fixed supply is
called pure rent.
Land in a Given Use Versus
Land of a Given Quality
The supply of land in a • The supply of land of a given
given use may not be quality at a given location is truly
perfectly inelastic or fixed. fixed in supply.
Rent and the Value of Output
Produced on Land
A firm will pay for and use land as
long as the revenue earned from
selling the output produced on that
land is sufficient to cover the price of
the land.
The firm will use land (A) up to the
point at which:
MRPA = PA
The Firm’s Profit - Maximization
Condition in Input Markets
Profit - maximizing condition for the
perfectly competitive firm is:
PL = MRPL = (MPL X PX)
PK = MRPK = (MPK X PX)
PA = MRPA = (MPA X PX)
where L is labor, K is capital, A is land (acres), X is output,
and PX is the price of that output.
The Firm’s Profit-Maximization
Condition in Input Markets
Profit-maximizing condition for the
perfectly competitive firm, written another
way is:
M PL M PK M PA 1
PL PK PA PX
• In words, the marginal product of the last dollar spent on
labor must be equal to the marginal product of the last
dollar spent on capital, which must be equal to the
marginal product of the last dollar spent on land, and so
forth.
Input Demand Curves
If product demand increases, product price will
rise and marginal revenue product will increase.
Impact of Capital Accumulation on
Factor Demand
The production and use of capital enhances the
productivity of labor, and normally increases the demand
for labor and drives up wages.
Impact of Technological
Change
Technological change refers to the
introduction of new methods of
production or new products intended
to increase the productivity of existing
inputs or to raise marginal products.
Technological change can, and does,
have a powerful influence on factor
demands.
