Market for Inputs in Production Principles of Microeconomics Module 6 Factors of Production • Factors of production: the inputs used to produce goods and services. • Production Function: Relationship between quantity of inputs (or factors of production) and total output Q = f(Land, Labor, Capital) Determining Production Example: Q = 100 K + 25 L If the firm increases capital (K) it will increase production (Q) If the firm increases labor (L) it will increase production (Q) • Demand for factors of production comes from the firm • Supply of factors of production comes from the household Demand for Factors of Production • Firms demand inputs to produce goods and services • But their demand is based on the demand of other people for the good they are producing • If many people want to buy their good – need lots of inputs to produce a large quantity to meet the demand • If demand is low – they don’t need to produce as much àDerived Demand for factors of production • Firm’s demand for inputs is derived from consumers’ demand for their product Demand for Labor • Marginal Physical Product of Labor (MPL) explains why some people earn more than others • Some workers are more productive: • Experience • Education/Training • Access to latest production technology Demand for Labor Marginal Product of Labor Suppose we have a small company making toasters. The price of each toaster is $10. Assume each worker is paid $100 per day Wage per Value of MPL Labor Output MPL worker Marginal Profit (MPL * Price) (daily) 0 0 1 50 2 90 3 120 4 140 5 150 7 150 Marginal Product of Labor Suppose we have a small company making toasters. The price of each toaster is $10. Assume each worker is paid $100 per day Wage per Value of MPL Labor Output MPL worker Marginal Profit (MPL * Price) (daily) 0 0 1 50 50 2 90 40 3 120 30 4 140 20 5 150 10 6 150 0 Marginal Product of Labor Suppose we have a small company making toasters. The price of each toaster is $10. Assume each worker is paid $100 per day Wage per Value of MPL Labor Output MPL worker Marginal Profit (MPL * Price) (daily) 0 0 1 50 50 $500 2 90 40 $400 3 120 30 $300 4 140 20 $200 5 150 10 $100 6 150 0 $0 Marginal Product of Labor Suppose we have a small company making toasters. The price of each toaster is $10. Assume each worker is paid $100 per day Wage per Value of MPL Labor Output MPL worker Marginal Profit (MPL * Price) (daily) 0 0 1 50 50 $500 $100 2 90 40 $400 $100 3 120 30 $300 $100 4 140 20 $200 $100 5 150 10 $100 $100 6 150 0 $0 $100 Marginal Product of Labor Suppose we have a small company making toasters. The price of each toaster is $10. Assume each worker is paid $100 per day Wage per Value of MPL Labor Output MPL worker Marginal Profit (MPL * Price) (daily) 0 0 1 50 50 $500 $100 $400 2 90 40 $400 $100 $300 3 120 30 $300 $100 $200 4 140 20 $200 $100 $100 5 150 10 $100 $100 $0 6 150 0 $0 $100 -$100 Value of Marginal Product of Labor • Value of MPL à the value of the last unit produced by the additional worker • Also known as: Marginal Revenue Product (MRP) or Marginal Value Product • In competitive markets MRP = P * MPL because firms are price takers and the price also reflects marginal revenue Demand for Labor Value of MPL Wage of each worker = Value of output $500 they each produce $400 Wage = Value of MPL $300 $200 Value of MPL: Firm’s willingness to pay $100 for labor $0 Market Wage Rate $100 Demand by Firms 1 2 3 4 5 Quantity of Labor Diminishing Marginal Returns to Labor Output is increasing at a decreasing rate if firm increases only one input Each worker adds to production, but less and less Labor Output MPL 0 0 150 140 1 50 50 130 2 90 40 120 3 120 30 90 50 4 140 20 0 5 150 10 6 150 0 0 1 2 3 4 5 6 7 Shifts in Demand for Labor Value of MPL 1. Change in output price $500 • Price of good increases à $400 • Firm will produce more à • Demand more labor $300 $200 • Value of MPL goes up! $100 $0 D.2 D.1 1 2 3 4 5 Quantity of Labor Shifts in Demand for Labor 2. Technological Change • Tech progress à workers more productive à firm needs less labor 3. Supply/Cost of other factors • If other factors become scarce à firm can produce less overall à less demand for labor Supply of Labor • Marginal Factor Costs • Recall that the wage rate = $100 per worker Wage per worker Labor Cost for Labor Output (daily) the Firm 0 0 $0 1 50 $100 $100 2 90 $100 $200 3 120 $100 $300 4 140 $100 $400 5 150 $100 $500 6 150 $100 $600 Marginal Factor Costs • Recall that the wage rate = $100 per worker • When the wage does not change with the number of workers employed MFC = Wage Wage Labor Cost for Labor Output MFC (daily) the Firm 0 0 $0 1 50 $100 $100 $100 2 90 $100 $200 $100 3 120 $100 $300 $100 4 140 $100 $400 $100 5 150 $100 $500 $100 6 150 $100 $600 $100 Supply of Labor Wage $150 Supply by Households $125 $100 Marginal Factor Cost $75 = $50 Market Wage Rate $25 $0 1 2 3 4 5 Quantity of Labor Shifts in Supply of Labor • Change in number of workers/population • More workers interested in a job à more labor available • Influx of workers à shifts supply curve • Change in Preferences or Income: • More income: people prefer to take time off and go on vacation – S labor decreases • Prefer to buy more goods: need to work more for more income • Change in Price of Related Services (and goods): • Services that affect the “cost” of working: child care costs • Child care more expensive: may choose to not work • Change in Expectations: • Retirement age/pension • Life expectancy • Health Equilibrium for Labor Wage Supply by Households $150 $125 $100 $75 Equilibrium: $50 Value MPL = MFC $25 $0 Demand by Firms Quantity of Labor 1 2 3 4 5 6 7 8 9 10 Equilibrium in the Factors Market occurs when the Value of output produced by the last worker is equal to the cost of employing that worker (OR) where Value MPL = MFC Linkages among the Factors of Production • Factors of production are used together • Productivity of each factor depends on the quantities of the other factors available • Change in the supply of any one factor can change the earnings of all of the factors. • Change in the earnings of any factor can be found by measuring the impact of the event marginal product of that factor..