The document discusses factors of production and factor markets. It covers the demand for inputs, using the example of a farmer hiring workers. It discusses marginal product and how the value of marginal product determines the demand for labor. It also discusses the supply of labor and how equilibrium is reached in the labor market.
The document discusses factors of production and factor markets. It covers the demand for inputs, using the example of a farmer hiring workers. It discusses marginal product and how the value of marginal product determines the demand for labor. It also discusses the supply of labor and how equilibrium is reached in the labor market.
The document discusses factors of production and factor markets. It covers the demand for inputs, using the example of a farmer hiring workers. It discusses marginal product and how the value of marginal product determines the demand for labor. It also discusses the supply of labor and how equilibrium is reached in the labor market.
The document discusses factors of production and factor markets. It covers the demand for inputs, using the example of a farmer hiring workers. It discusses marginal product and how the value of marginal product determines the demand for labor. It also discusses the supply of labor and how equilibrium is reached in the labor market.
IRFANI FITHRIA Factors of Production and Factor Markets • Factors of production: the inputs used to produce goods and services. – Labor – Land – Capital → the equipment and structures used to produce goods and services. • Prices and quantities of these inputs are determined by supply & demand in factor markets. Demand for Inputs: A Derived Demand derived demand The 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 provided by that firm. Two Assumptions 1. All markets are competitive. The typical firm is a price taker – in the market for the product it produces – in the labor market 2. Firms care only about maximizing profits. – Each firm’s supply of output and demand for inputs are derived from this goal. Our Example: Farmer Jack • Farmer Jack sells wheat in a perfectly competitive market. • He hires workers in a perfectly competitive labor market. • When deciding how many workers to hire, Farmer Jack maximizes profits by thinking at the margin: – If the benefit from hiring another worker exceeds the cost, Jack will hire that worker. • Cost of hiring another worker : the wage—the price of labor.
• Benefit of hiring another worker →Jack can produce and sell
more wheat, increasing his revenue.
• The size of this benefit depends on Jack’s production function:
the relationship between the quantity of inputs used to make a good and the quantity of output of that good. Farmer Jack’s Production Function L Q (bushels (no. of of wheat 3,000 workers) per week) 0 0 2,500
0 0 1 2 3 4 5 No. of workers Marginal Product of Labor (MPL)
• Marginal product of labor: the increase in the amount of
output from an additional unit of labor • where ∆Q = change in output ∆L = change in labor The Value of the Marginal Product • Problem: – Cost of hiring another worker (wage) is measured in dollars – Benefit of hiring another worker (MPL) is measured in units of output • Solution: convert MPL to dollars • Value of the marginal product: the marginal product of an input times the price of the output VMPL = value of the marginal product of labor = P x MPL P = $5/bushel. Computing MPL and VMPL Find MPL and VMPL, fill them in L Q the blank spaces of (no. of (bushels MPL VMPL the table. workers) of wheat) Then graph a curve with VMPL on the 0 0 vertical axis, L on 1 1000 horizontal axis. 2 1800 3 2400 4 2800 5 3000
5,000 Farmer Jack’s VMPL curve is downward 4,000 sloping due to diminishing marginal 3,000 product. 2,000
1,000
0 0 1 2 3 4 5 L (number of workers) W VMPL and Labor Demand For any competitive, profit- maximizing firm: – To maximize profits, hire W1 workers up to the point where VMPL = W. – The VMPL curve is the VMPL labor demand curve. L L1 Factors that Shift the Labor Demand Curve • Changes in the output price, P • Technological change (affects MPL) • The supply of other factors (affects MPL) • Example: If firm gets more equipment (capital), then workers will be more productive; MPL and VMPL rise, labor demand shifts upward. The Connection Between Input Demand & Output Supply
• In general: MC = W/MPL • Notice: – To produce additional output, hire more labor. – As L rises, MPL falls – causing W/MPL to rise – causing MC to rise. • Hence, diminishing marginal product and increasing marginal cost are two sides of the same coin. • The competitive firm’s rule for demanding labor →P x MPL = W • Divide both sides by MPL → P = W/MPL • Substitute MC = W/MPL from previous slide: P = MC • This is the competitive firm’s rule for supplying output. • Hence, input demand and output supply are two sides of the same coin. Labor Supply
• Trade-off between work and leisure:
The more time you spend working, the less time you have for leisure. • The opportunity cost of leisure is the wage. W The Labor Supply S1 Curve W2 An increase in W is an increase in the opp. W1 cost of leisure. People respond by taking less leisure and by working more. L L1 L2 Factors that Shift the Labor Supply Curve
• Changes in tastes or attitudes regarding the labor–leisure trade-
off • Opportunities for workers in other labor markets • Immigration W Equilibrium in the S Labor Market The wage adjusts to balance supply and W1 demand for labor. The wage always equals VMPL. D L L1 From the previous slides : – Equilibrium wages equal the value of workers’ marginal products. – Differences in equilibrium wages result from differences in • worker characteristics: education, experience, talent, effort • job characteristics: extent to which a job is pleasant and safe – Some earnings differences due to discrimination. Land and Capital
• With land and capital, must distinguish between:
– Purchase price: the price a person pays to own that factor indefinitely – Rental price: the price a person pays to use that factor for a limited period of time • The wage is the rental price of labor • The determination of the rental prices – Analogous to the determination of wages How the Rental Price of Land Is Determined The market ▪ Firms increase the for land P quantity of land to rent S until the value of the marginal product (VMP) of land equals the land’s rental price. P
• The rental price of
land adjusts to balance supply and D = VMP demand for land. Q Q
23 How the Rental Price of Capital Is Determined The market • Firms increase the P for capital quantity of capital to S rent until the value of the marginal product (VMP) of capital equals the capital’s rental price. P • The rental price of capital adjusts to balance supply and D = VMP demand for capital. Q Q Rental and Purchase Prices
• Buying a unit of capital or land
– Yields a stream of rental income. • The rental income in any period – Equals the value of the marginal product (VMP) • Hence, the equilibrium purchase price of a factor – Depends on both the current VMP and the VMP expected to prevail in future periods. Poverty
• Poverty line : an absolute level of income set by the govt for
each family size below which a family is deemed to be in poverty • Poverty rate: the percentage of the population whose family income falls below the poverty line POVERTY VS INEQUALITY
• Poverty and inequality are not the same thing
• Poverty is when people don't have very much • While inequality is when some people have more than others Problems Measuring Inequality
• Data on income distribution & poverty rate
– Incomplete picture of inequality – Household annual income 1. Doesn’t account for in-kind transfers • Transfers to the poor in the form of goods and services rather than cash Problems Measuring Inequality
• Data on income distribution & poverty rate
2. Normal life cycle pattern • Causes inequality in the distribution of annual income • May not represent true inequality in living standards • Life cycle: regular pattern of income variation over a person’s life • People can borrow and save to offset life-cycle changes in income (e.g., saving for retirement). • Data on income distribution & poverty rate 3. Transitory vs. permanent income • Transitory changes - need not affect standard of living • A family’s ability to buy goods and services depends largely on its permanent income • Permanent income: a person’s normal income • Economic mobility – Many people move among income classes – Some reflects transitory variation in income – Some reflects more persistent changes in income – Many of those below the poverty line are there only temporarily The Political Philosophy of Redistributing Income • Utilitarianism → argues that govt should choose policies to maximize society’s total utility → Redistributing income from rich to poor increases utility of the poor more than it reduces utility of the rich Rawlasian
→ Maximin criterion: govt should aim to maximize the well-
being of society’s worst-off person
Libertarianism
→ argues that govt should punish crimes and enforce voluntary
agreements but not redistribute income Policies to Reduce Poverty 1. Minimum-Wage Laws 2. Welfare 3. In-Kind Transfers 1. Minimum-Wage Laws • Arguments for: – Helps the poor without any cost to government – Little impact on employment if demand for unskilled labor is relatively inelastic. • Arguments against: – In the long run, demand for unskilled labor is likely elastic, so minimum wage causes substantial unemployment among the unskilled. – Those helped by minimum wage are more likely to be teens from middle-income families than low-income adult workers. 2. Welfare program :government programs that supplement the incomes of the needy 3. Negative Income Tax
• Negative income tax:
– Tax system that collects revenue from high-income households and gives transfers to low-income households 4. In-Kind Transfers In-Kind Transfer : goods or services provided to the needy
