Factor Markets

The demand
for a factor is derived from the demand for what the factor produces.

Marginal revenue product (MRP)
 the
change in total revenue from employing an additional factor unit
 MRP = MR
x MPP
 The MRP curve will always
eventually
slope downward due to the law of diminishing marginal returns
 The
demand curve for a factor is that factor’s
MRP curve.
 The MRP curve tells the
employer how many workers to employ at different wage rates

Marginal factor cost (MFC)
 the
additional cost
from employing an additional factor unit
 For a
perfectly competitive employer, the MFC of
each worker is the same as the wage rate

To maximize profits, a producer employs
additional factor units up to the quantity where MRP = MFC 
Determinants of factor
demand:
 Product
price
 Factor
Productivity
 Prices
of reelated goods

Value of the marginal
product (VMP)
 the
value to society of the output produced by the marginal factor.
 VMP
equals the price of the product times the
MPP of the factor.
 VMP = P
x MPP

To minimize costs,
producers will attempt to
combine factors so that the ratio of MPP to factor price will be the
same for
all factors 
The elasticity of demand
for labor
measures the responsiveness of employers to a change in the wage rate. There are three determinants of the
elasticity of demand for labor:
 The
number of substitute factors
 The
price elasticity of demand for the product
that the labor produces
 The
percentage that labor costs make up of total
cost

The labor supply curve in
a particular labor
market will be upward sloping 
Determinants of labor
supply:
 Wage
rates in alternative labor markets
 Nonmoney
aspects of a job

Wage rates in different
labor
markets differ due to:
 Differences
in workers’ MRP
 Differences
in nonmoney aspects of jobs
 Rareness
of skills required
 Training
costs
 Relocation
costs
