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AP Lesson Plan Introduction to Factor Demand

Learning Targets: 1. Define what factors of are 2. Describe how factor determine the efficient allocation of resources 3. Determine factor demand for land, labor and capital 4. Determine how to calculate the profit-maximizing hiring decision

Textbook Chapter: Chapter 20: Factor Markets and the Distribution of Income (pages 510-519)

1. WARM-UP: Draw a firm operating in monopolistic competition in long-run equilibrium

2. ASK: What is the most important you will encounter in your life? Various responses but focus on WAGES (price of labor)

3. There are two different types of markets in economics: Product markets and Factor markets a. Product markets: Where goods and services are sold to consumers b. Factor markets: Inputs or resources used to produce goods and services

4. broken into 4 categories: a. Land – resources that come from nature b. Labor – work done by humans c. Capital – tools that go into production i. Physical capital: tools, machines, factories ii. Human capital: skills and training of workers d. Entrepreneurship – talent for taking risk and bringing resources together

5. Land, labor and capital can be bought in sold in a FACTOR a. The prices for each are called FACTOR PRICES b. Factor prices are set by market forces of

6. EXAMPLE: Why Factor Prices Matter … a. ASK: What does it mean when someone says that the “hot new career” is nursing? There are lots of job openings in the field and that wages are attractive b. ASK: What will be the result at major colleges and universities? People will begin taking courses in nursing so they can enter the field c. In other words … the high price of labor helped allocate labor from some markets (history teachers) and into another market (nursing) d. No one had to order students into nursing, they chose to do it because of the wages e. What this story tells us is that demand in factor markets is DERIVED DEMAND i. Demand for the factor of production is driven by demand for the output ii. Demand for nurses is driven by the demand for nursing care

7. EXAMPLE: Coffee and cancer a. Presume that a study comes out that links coffee drinking to an increased likelihood of cancer b. ASK: What will that study do to the coffee market? (DRAW IT OUT) It will cause a decrease in demand for coffee (lower prices and lower quantity) c. ASK: What will then happen to the demand for coffee bean pickers? It will also decrease because we won’t need as many to produce the quantity of coffee demanded d. Demand for factors of production is DERIVED from the demand for the good in the product market

8. EXAMPLE: Deciding how much of a factor you need … the labor market a. Pretend that I run a lemonade stand and you need a job b. ASK: Why would I choose to hire you? i. The job you do adds to my TOTAL PRODUCT (i.e., output) ii. ASK: What do we call the amount that each additional worker adds to total product? Marginal product iii. SHOW: We can calculate the MPL of the lemonade stand by looking at the chart c. ASK: What else do I need to know to determine whether your output is helpful to me or not? Wages and how much the good can sell for i. MARGINAL REVENUE PRODUCT tells me how much additional revenue you will bring in for my firm 1. MRP = P * MP (Price X Marginal product) 2. SHOW: If I assume that each cup of lemonade sells for $2 then we can calculate MRP ii. ASK: How do I determine how much your labor will cost my lemonade stand? Look at the wages (W) that are being paid 1. Assume that wages are $8 per hour 2. ASK: At what point should I stop hiring workers? After the 5th worker iii. PAIRS: Determine a general rule for firms trying to decide whether to employ factors of production. MRP > MC (hire); MRP = MC (stop); MRP < MC (don’t hire)

9. BRAIN BREAK

10. EXAMPLE: George and Martha’s Vineyard a. Work in pairs to identify: MRP and optimum number of employees given a $200 wage rate b. ASK: How did you determine what the proper number of employees was? MRP > MC c. If we hired 4 workers then we would have i. MRP = $220 ii. W = $200 iii. We make a $20 profit from the third worker d. If we hired 6 workers then we would have: i. MRP = $180 ii. W = $200 iii. We would lose $20 from the 8th worker

11. Our decision would change based on what the wage rate was a. If the wage rate increases then we will hire fewer workers b. If the wage rate decreases then we will hire more workers c. ASK: What other line does the MRP line behave like (where the quantity decreases with an increase in price)? The demand curve because it shows the LAW OF DEMAND d. The MRP curve is the FACTOR DEMAND CURVE

12. Just like with other demand curves you need to distinguish between a shift and a movement along the curve a. ASK: What would a change in wages do to the factor demand curve for labor – shift it or move it? It would represent a MOVEMENT since a price change is a movement along the curve b. ASK: What would happen if there was a change in technology that increased workers’ productivity? It would shift it to the right because of an increased marginal product of labor

13. Factors that would shift the factor demand curve include: a. Changes in prices of goods i. ASK: What do you think an increase in the price of a good does to the MRP curve? It would shift it to the right for every given price ii. MRP of labor is higher at any given level of employment iii. Demand for labor would then SHIFT to the right iv. The opposite is true if the price of a good decreased 1. MRP would SHIFT to the left 2. MRP would be less at any given level of employment v. EXAMPLE: Lemonade stand 1. SHOW: MRP at $2 per cup vs. $4 per cup 2. We will hire 6 workers when the price rises b. Changes in supply of other factors i. ASK: What would happen to your productivity if you had more land on which to work? Presumably it would increase ii. ASK: What would happen to productivity if I provided you with a machine to juice lemons instead of having you do it by hand? Your productivity would increase iii. ASK: What do you think will happen to the factor demand for labor if the supply of other factors increases then? It will SHIFT to the right iv. Having more of each factor of production should increase productivity and the MRP in the same way as an increase in the product’s price c. Changes in technology i. In general, technological advances make workers more productive ii. The more productive a worker is the greater his MRP iii. When MRP increases then factor demand SHIFTS to the rights