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Flashcards in Factor Markets Deck (16)
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1

Factors

Labour

Capital

Land

Entrepreneurship

Factor prices and quantities are determined in the market by the equilibrium of supply and demand

2

Demand for Factors

A firms demand for a factor is a DERIVED DEMAND

The Demand for the factor occurs because the factor is used to produce a product rather than demand for the factor itself.

So the demand for CAPITAL is derived from the DEMAND for the product the capital produces

3

Marginal Product Definition

Marginal product is the change in total product (or output) that occurs with the addition of another unit of an input

The MP DECREASES as units of the factor INCREASE due to the LAS OF DIMINISHING RETURNS

4

Marginal Revenue Product (MRP) Definition

The change in TOTAL REVENUE resulting from the use of an additional unit of an input

In general, MRP = MR x MP

If the firm is a PRICE TAKER in the output market, then MR=P so that MRP=PxMP

5

MRP in Competitive Product Market

In general, MRP = MR x MP

If the firm is a PRICE TAKER in the output market, then MR=P so that MRP=PxMP

6

MRP in a Monopolist Product Market

As the units of inputs increase, MRP declines.

This is a result of the law of diminishing marginal returns since MP falls as the unit of inputs increase.

MRP curve is DOWNWARD sloping

7

Marginal Factor Cost (MFC)

The change in TOTAL COSTS resulting from the addition of one further unit of an input.

8

When should a firm stop adding units of factor?

It will be profitable for a firm to demand additional units of a factor up to the point at which the factors MRP is equal to its MFC

9

MRP For a competitive firm

MRP = MFC is the OPTIMIZING CONDITION.

(If MRP equals MFC at the 3rd unit of labour, then that is the optimal)



10

Demand for Labour

The labour demand curve and labour MRP curve are the same

A demand curve shows us how much would be demanded at each price level

If the wages INCREASE, the Q Demanded for labour will DECREASE

11

What are the variables that shift demand for Labour?

1. Price of Outputs

2. Prices of other Inputs

3. Technology

4. Productivity

12

Profit Maximizing Conditions for Input, and Output Markets

INPUT MARKETS

MRP = MFC

OUTPUT MARKETS

MR = MC

13

The Supply of Labour

The household chooses the number of hours per week of labour to supply.

Time is allocated between two activities

1. Market Activity - The supply of labour

2. Non-Market activity - Leisure (Recreation, education, etc.)

14

Leisure in the Supply of Labour

The price of leisure can be represented by its opportunity cost

The Opp cost of an hour of leisure is the foregone wages associated with that hour. Thus, we can use the wage rate as the price of leisure

15

When the WAGE RATE changes, the Q of Labour supplied changes. What TWO effects determines how it changes?

1. SUBSITUTION EFFECT

As the wage rate increases, individuals allocate more time to market activities and less to non market activities.

The price of the non market activities increases as the wage rate increases.

People substitute away from LEISURE since it becomes more expensive

2. INCOME EFFECT

As the wage rate increase, peoples incomes increase.

As income rise, consumers demand more of normal goods.

For most people, leisure is a normal good.

As incomes rise, income effect indicates that consumers will want more leisure and want to work less.


SO AS THE WAGE RATE INCREASES

- Quantity supplied of labour INCREASES from the substitution effect

- Quantity of labour DECREASES from the income effect

16

Low wages vs High wages

At LOW WAGE rates > Income Effect

At HIGH WAGE rates > Substitution Effect