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This chapter talks about the basic theory for the analysis of factor markets. The three most important factors of production are labor, land, and capital.
We are also going to analyze factor demand by looking at how a competitive profit maximizing firm decides how much of any factor to buy. The labor is considered the most important factor of production. Later, we will learn about the labor market apply directly to the markets for the other factors of production.


Words to keep in mind:
capital
the equipment and structures used to produce goods and services
diminishing marginal product
the property whereby the marginal product of an input declines as the quantity of the input increases
factors of production
the inputs used to produce goods and services
marginal product of labor
the increase in the amount of output from an additional unit of labor
production function
the relationship between the quantity of inputs used to make a good and the quantity of output of that good
value of the marginal product
the marginal product of an input times the price of the output



The Demand For Labor
  • The Competitive Profit Maximizing Firm

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A typical firm makes their worker do a lot of work as they can.
Then the firm sells the product, pays, and keeps profit. We can
say that the firm is competitive and profit maximizing. The basic
tools of supply and demand apply to goods and labor services.
The supply demand for apples determine the price of product.
And it also shows how to determine the wage of workers.






The Production Function and the Marginal Product of Labor

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Ex. of a short run production function

In order to make the hiring decision, the firm should keep in mind of how the size of work force affects the output. We use the term production function to describe the relationship between the quantity of inputs used to make a good and the quantity of output of that good. One of the most key idea to understand how firms decide what quantity of labor to hire is knowing the marginal product of labor. Marginal product of labor is the increase in the amount of output from an additional unit of labor. As the number of workers increase, the marginal product of labor declines. We call this a diminishing marginal product. The property whereby the marginal product of an input declines as the quantity of the input increases. As the workers increases, more workers have to work with fewer workspace. Therefore, more workers contribute less to the production.






The Value of the Marginal Product and the Demand for Labor

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Value of the Marginal Product of Labor


The firm consider how much profit each worker would bring in when deciding the
number of workers to hire. In order to find the contribution to revenue, convert the
marginal product of labor into the value of the marginal product. The value of the
marginal product is the marginal product of an input times the price of the output.
As the number of workers rises, the value of the marginal product decreases. In
order to maximize the profit, the firm should hire the workers up to the point where
the value of the marginal product of labor equals the wage.





What causes the Labor Demand Curve to Shift?
There are three main things that cause the labor demand curve to shift.
  1. The Output Price: When output price changes, the value of the marginal product changes, thus, the labor demand curve shifts. The labor demand increases when the increase in the price raises the value of the marginal product of each worker. In the meanwhile, labor demand decreases when a decreases in the price reduces the value of the marginal product.
  2. Technological Change: The technological advance usually raises the marginal product of labor. It increases demand of labor and shifts its curve to the right. There is possibility for technological change to reduce labor demand, for example, invention of a cheap industrial robot.
  3. The Supply of Other Factors: A fall in the supply will reduce the marginal product of workers and the demand for workers.


The Supply Of Labor
  • The Trade off between Work and Leisure
What would you give up to get an hour of leisure? The labor supply curve shows how workers' decisions about the labor leisure trade off respond to a change in that opportunity cost. The upward slope labor supply curve means that an increase in the wage makes worker to work increase the quantity of labor product.

What Causes the Labor Supply Curve to Shift?
  1. Changes in Tastes: During the mid 1900s, women were looking for paid jobs to support their family. However, in the early 2000s, more than half of the women are looking for jobs. This simply shows the changes in tastes.
  2. Changes in Alternative Opportunities: There are many opportunities available in various markets. If the wage of certain area of workers abruptly rises, the workers will decide to switch occupations.
  3. Immigration: When the workers move from region to region, the supply of labor changes. When immigrants moves to United States to work, the supply of labor increases and their home country's supply of labor decreases.


Equilibrium in the Labor Market
Shifts in Labor Supply
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The price of labor depends on supply and demand. As the number of workers employed rises, the marginal product of a worker and value of the marginal product falls. When labor supply increases, the equilibrium wage falls. When the wage is low, firms hire more workers and employment rises.

Shifts in Labor Demand
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When the labor demand increases from D1 to D2, the equilibrium wage and employment rises due to an increase in the price.
The change in the wage reflects a change in the value of the marginal product of labor.

THE OTHER FACTORS OF PRODUCTION: LAND AND CAPITAL
Equilibrium in the Markets for Land and Capital
Economists use the term capital to refer to the stock of equipment and structures used for production. Capital is the equipment and structures used to produce goods and services. Labor, land, and capital each earn the value of their marginal contribution to the production process.


In this chapter, I have explained how labor, land, and capital work in the production. The factors of production is divided into labor, land, and capital. The supply of labor increase from the individual trade off between work and leisure. The price adjusts the balance between the supply and demand. And the demand reflects the value of the marginal product. We also learned that factors are compensated to its marginal contribution in the equilibrium.
Since the factors of production are all bonded together, the marginal product will depend on the quantities of factors available. Therefore, if one factor changes, then it will affect the earnings of all the other facts.


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