Economy's Factors of Production

• Land

• resources that are God-given from nature
• Labor

• work done by human beings
• Capital

• Physical capital: consists of manufactured productive resources like equipment, buildings or tools

• Human capital: skills and knowledge a worker gets from education

• Entrepreneurship

• often referred to as the "4th Factor of Production," they combine the three resources to make innovative profits by taking risk

Derived Demand

• Definition

• demand from a factor is dericed fomr firm's output.
• Examples

• If the demand for flight increase, then the demand for airline pilots will also increase

• After Hurricane Katrina, the demand for houses increased, thus increasing the demand for construction workers.

• Graph Total Product vs. Marginal Product

• Total product shows the total quantity of output produced, which will eventually increase at a decreasing rate

• Marginal product of labor will decrease as you hire more workers due to diminishing marginal returns   Value of the Marginal Product

• Meaning

• The value of the marginal product of a factor is the value of the additional output generated by employing one more unit of that factor.

VMPL = Value of the Marginal Product of Labor

MRP = Marginal Revenue Product

• Formula

• VMPL = P * MPL

• MRP = P * MPL

• Hiring decision rule

• Hire the extra worker if VMPL >W

• VMPL = W at the profit-maximizing level of employment

• Example

• If the 5th worker produces 7 radios in the one day which sell for \$10 each and his daily wage rate equals \$10, should you hire the worker?

• VMPL = P * MPL = 10 * 7 = 70 < W = 100

• Curve • This curve shows how the value of marginal product of labor depends on the number of workers employed.

• It slopes downward because of diminishing returns to labor in production

• To maximize profit, you should choose the level of employment at which the value of the marginal product of labor is equal to the market wage rate

Shifts of the Factor Demand Curve

• Changes in the price of goods

• If the price of wheat, increases, what happens to the VMPL of wheat? • Change in supply of other factors

• If the workers decrease their productivity due to a loos of land, what happens to the VMPL? • Changes in Technology

• The usual impact of technological process will shift the MPL (and thus VMPL) to the right Factor Market Example Assume that Samantha's Shirt Company sells shirts at \$15 and pays a wage of \$85 a day. Assume labor is the only output.

• Draw a correctly labeled graph of SSC's current supply curve for unskilled labor

• Put QL on the x-axis, and W on the y-axis

• Perfectively competitive labor market • What is SSC's profit maximizing level?

QL Q MPL P MRP/VMPL W
0 0
1 30 30 15 450 85
2 50 20 15 300 85
3 60 10 15 150 85
4 65 5 15 75 85
5 68 3 15 45 85
6 70 2 15 30 85
• When QL = 3, MRP/VMPL > W

• When QL = 4, MRP/VMPL < W

• Answer: Produce 60 shirts and hire 3 workers

• Suppose SSC loses technology that decrease the productivity of its unskilled workers. How will the new technology affect the quantity of unskilled labor SSC hires?

• The MRP decreases, because MPL has decreased.

• The quantity of Labor will decrease

• How will the new technology affect the wage paid to SSC's unskilled workers

• Wage is unaffected because wage is perfectly elastic or constant Another Factor Market Example Sus & Jib is a profit-maximizing pin-making firm that can sell pins at a price of \$20 each. Sus & Jib can hire workers at a market wage of \$120 per day per worker

• In what market structure does this company sell its products?

• perfect competition because price is the same and no differentiation.
• In what market structure do the laborers work in?

• perfect competition because wage rate is constant
• Calculate the value of the marginal product of labor of the third worker

• MRP = (45 - 30) * 30 = 15 * 20 = 300
• What is the profit-maximizing output level?

QL Q MPL P MRP/VMPL W
0 0
1 10 10 20 200 120
2 30 20 20 400 120
3 45 15 20 300 120
4 55 10 20 200 120
5 58 3 20 60 120
6 59 1 20 30 120
• Profit-maximizing output level is 55-58 pins with 4-5 workers