Chapter18+JDEM



Land. Labor. Capital. Entrepreneurship. These are all factors of production. What is their role in the market? They determine wages, they determine rent, they determine interest, they determine profit. And, like all other areas of economics, this is decided by laws of supply and demand- they are also governed by the idea of 'scarcity'. This chapter will focus on how firms make decisions regarding limited factors of production. To get a better idea, read the big questions below:

A) Like any other market decisions, firms base their decision to hire on the supply of labor, and demand for labor. Assuming that the firm is competitive, it is a price taker, meaning that it can only accept the market price of labor (it cannot determine its own price). When supply of labor is high, but demand for it is low, the firms that actually need to hire will be able to do so at lower prices. When supply of labor is low but demand for it is high, the firms will have to pay a higher price in order to hire workers.
 * How do firms decide to hire?**

B) However, a firm is not directly concerned about how many workers it has, or how much it pays them- it is concerned about how much PROFIT it makes. To determine how much profit it will gain/lose from each additional worker that it hires, the firm calculates the VALUE OF THE MARGINAL PRODUCT.

(L) (Number of workers) || Output (Q) (Bushels per week) || Marginal Product of Labor (MPL= changeQ/changeL) (bushels per week) || Value of the marginal product of labor (VMPL= P x MPL) || Wage (W) || Marginal Profit (ChangeProfit = VMPL- W) ||
 * Labor
 * 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 ||

In the table above, the first 2 columns show the 'production function'. Production function describes the relationship between the quantity of inputs used, to produce a quantity of outputs. In this case, it shows the number of workers hired and the corresponding bushels of apples they can pick. As shown by the next column- Marginal Product of Labor, for each additional worker that is hired, more apples are picked, but each new worker is less efficient than the last worker that was hired: it exhibits diminishing marginal product.

What the firm then does is convert the MPL into the actual value of that product ($$$). They do this by multiplying the price of the good produced and the number of good produced. For example, if the MPL of hiring a 2nd worker is 80, the VMPL of hiring the second worker is $800 (=80 x 10). Therefore, the VMPL is always a downward sloping curve. The more workers are hired, the smaller the VMPL becomes- a result of diminishing marginal product. A firm will stop hiring when the wage is equal to the VMPL. This only makes sense- when wage=VMPL, profit will be 0, since the firm is giving and receiving the same value of $.

For a profit maximizing firm, the VMPL curve is also its 'demand for labor' curve, since it determines how much the firm gives up in order to gain profit. We now know that the labor-demand curve represents the VMPL. However, there are external factors that can cause this curve to shift. The most obvious factor is a change in output price. Since VMPL is obtained by multiplying the marginal Q of output with the price of output, when price increases, VMPL increases (when price decreases, VMPL decreases). The second factor is 'technological change'. When new technology is created, that increases the productivity of a worker, this will increase their MPL- this will increase the marginal Q of output, increasing the VMPL, shifting it to the right. However, technology can also reduce a demand for labor, by providing replacements for workers. If a robot were created that could to the same amount of work as 50 people, you wouldnt keep 50 workers- you would fire them so you didnt have to pay wages, and then buy a robot to replace them. In this example, MPL decreases, thus VMPL decreases, shifting the labor-demand curve to the left.
 * What will change a company's demand for labor?**

Now we will focus on the decisions that workers make. The most basic principle that determines how much workers are willing to work is the tradeoff between work and leisure. One of the 10 principles of economics was that people face trade-offs. Another was that the cost of something is what you give up to get it. How much does a worker give up for an hour of leisure time? the amount he would have made, if he had gone to work.
 * What trade-off do workers face?**

Ex: Mr. Ski has the choice of staying at home to watch Star Wars or coming to school and teaching AP Econ. By staying at home he can watch Star Wars and not work. By coming to school he can earn $500. Therefore, his opportunity cost for a day of leisure is $500. He decides to come to school. The next week, Mr. Ski learns that teacher salaries have been cut- now he earns only $50 by coming to school. Ski decides he would rather spend the day with Yoda and Obi-Wan.

The higher the opportunity cost for leisure time, the less of it workers will take. Meaning, the more you get paid for coming to work, the more likely you are not to call in sick. This trade-off is reflected by an upward sloping labor-supply curve. The higher the wage is, the more workers are willing to work. The higher the wage is, the more supply of labor there is.

each increase in wage shows a corresponding increase in the Q of labor supplied.

The labor-supply curve (above) reflects the amount of people that want to work at a certain wage. However, like the labor-demand curve, there are factors that can cause this curve to shift.
 * What will change the labor market's supply of labor?**

One of these is 'change in taste'. In the Victorian age, when women were expected to stay at home and take care of the children (booo), they wouldnt respond to an increase in wages, even if the opportunity cost of "leisure" increased. However, now that attitudes toward work have changed, women are just as likely as men are to respond to an increase(or decrease) in wages. When a society's tastes/attitude towards work changes, this can shift the labor-supply curve in either direction.

The second factor is changes in alternative opportunities. The supply of labor in one market also depends on the opportunities available in other markets. If Ski had the opportunity to work in the 'professional movie watchers' market for the same salary as KIS, he might still decide to leave the KIS labor market and enter the movie watchers market. Decreasing wages in other markets can also increase the amount of labor in the current market. Thus, the labor-supply curve shifts either way.

The last factor that can affect the labor-supply curve is immigration. Movement of workers from one region to another is an obvious reason for changes in the labor-supply curve. However, an additional factor that comes along with immigration is the fact that many immigrants are willing to work, even when the opportunity cost of labor is relatively low. In general, immigration will cause the labor-supply curve of a market to shift to the left, because more people are willing to work for lower wages.

When talking about wages, in relation to supply and demand of labor, there are 2 properties that always remain true. 1. the wage adjusts to balance the supply and demand for labor 2. wage equals the VMPL (Values of the marginal product of labor) Therefore, any event that changes the labor-demand or labor-supply curves changes the equilibrium wage and the VMPL by the same amount, because these must always be equal. Below are examples of the 4 scenarios presented by changes in the labor-supply and labor-demand curves.
 * How is wage determined?**

A) Labor-Supply curve shifts to the right A large number of immigrants enter the apple-picking labor market. When they do, they increase the number of people who are willing to work for lower wages. This shift the Labor-supply curve to the right. Now, at the previous wage, the demand curve is less than the supply curve, meaning that supply of labor exceeds demand for labor. This puts downward pressure on the wage- wage decreases. When wage decreases, the Q of labor increases, because the number of workers that the firms can hire at VMPL=wage increases (when you pay your workers less, you can hire more of them) <--A.Labor-supply shifts right/ B.Labor-supply shifts left--> B) Labor-Supply curve shifts to the left All juniors decide that the video-game tester market offers better wages than the KIS-student market. These juniors leave the KIS market, causing the labor-supply curve to shift to the left (because the quantity of workers willing to work for a certain wage decreases). When they do this, they cause upward pressure on the wage, because supply of labor is less than demand of labor at the previous 'equilibrium wage'. To make supply=demand, the wage rises. When the wage increases, the Q of labor has to decrease, because VMPL must always equal price(=wage).

C) Labor-Demand curve shifts to the right When the price of apples increases, the demand for labor in the apple-picking market increases, because the VMPL has increased (since VMPL=MPL x price, when price increases VMPL increases). Since VMPL must equal wage, when VMPL increases wage increases. Wage is also the point where supply of labor is equal to demand for labor, so when wage increases the Q of labor also increases.

<--C.Labor-demand shift right/ D.labor-demand shift left-->

D) Labor-Demand curve shifts to the left When the price of apples decreased, the demand for labor in the apple-picking market decreases, because the VMPL has decreased. Since VMPL always equals wage, the wage decreases. Wage is also a measure of labor-demand= labor-supply, so when the wage increases, the Q of labor employed moves to a point on the new labor-demand curve that matched this wage. In conclusion, wage decreases and Q of labor decreases.

Land is the physical location that is involved in production. Labor is the work that goes into the production of a good. Capital is the equipment and structure used to produce goods and services. In this way, we can see that all factors of production are interchangeable with each other, in terms of supply and demand of inputs. All factors of production can be expressed on similar supply and demand graphs, and all factors of production strive for equilibrium in markets. In other words: substituting capital for the word 'labor' in a labor-supply graph will give you the 'capital-supply' graph. etc.. **
 * How are the factors of production related?

Conclusion: - labor-demand curve is determined by the VMPL, reflects how much a firm receives in return for hiring more workers. reflects the firm's willingness to hire. - labor-supply curve is determined by the opportunity cost of leisure. reflects how many people are willing to work for a certain wage. reflects the laborers' willingness to work. - wage adjusts to balance the supply and demand for labor. Wage always indicates the equilibrium point between labor-supply and labor-demand. - wage equals the VMPL. - Factors of production are interchangeable when referring to the supply/demand of an input.



1. Which of the following factors of production is considered to be the most important in terms of income? a. land b. labor c. profit d. capital ANSWER: b. labor

2. What does WAGE equal? a. MP b. L c. VMPL d. Price

3. Factors of production are... a. interchangeable when referring to the supply/demand of an input b. noninterchangeable when referring to the supply/demand of an input c. interchangeable when referring to the wage d. noninterchangeable when referring to the marginal cost

4. The factors of production are best defined as the a. output produced from raw materials. b. inputs used to produce goods and services. c. wages paid to the workforce. d. goods and services sold in the market.

5. The term “factor market“ applies to the market for a. labor. b. capital. c. land. d. All of the above are correct.

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glossary: - production function: the relationship between the input and the output of a product. - marginal product of labor: how much new product can be made with each new unit of labor employed. - diminishing marginal product: the property of decreasing marginal product, as quantity of labor employed increases. - value of the marginal product/marginal revenue product: the monetary value of the marginal product - opp cost of leisure: the potential gain (wages) that are given up in favor of leisure time. - wage: the price of labor. The amount that a firm pays a worker in return for the labor they supply. - real wage: the wage, once living expenses etc.. are subtracted. The actual amount of wage that the worker can use. - capital: the equipment and structures used to produce goods and services.