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->All firms purchase factors to make products to sell, whether they are perfectly competitive firms, oligopolistic firms, or whatever.
->The demand for factors is a derived demand; that is, it is derived from and directly related to the demand for the product that the resources go to produce.
I. MRP = TR /Quantity (of the factor)
II. MRP = MR x MPP*).
*Marginal Physical Product (MPP) = The change in output that results from changing the variable input by one unit, holding all other inputs fixed.
I. MRP = TR /Quantity (of the factor
II. MRP = MR x MPP).
->graph on slide 8
->The data in columns (1) and (5) in 1 are plotted to derive
->the MRP curve. ( to view the previous slide click here: Calculating Marginal Revenue Product (MRP) II)
The MRP curve shows the various quantities of the factor the firm is willing to buy at different prices, which is what a demand curve shows.
->The MRP curve is the firm’s factor demand curve.
->A firm wants to know the VMP of a factor because it helps in deciding how many units of the factor to hire.
->For labor, you want to know what the worker will do for you and what you will have to pay the worker. The VMP of a factor is a dollar measure of how much an additional unit of the factor will do for you.
->MRP = MR x MPP VMP = P x MPP.
->The MRP (factor demand) curve for a firm that is a price searcher (monopolist, monopolistic competitor, oligopolist lies below the VMP curve because for these firms, P > MR.
->MFC is calculated in column 4. Notice that the firm is a factor price taker because it can buy a quantity of factor X at a given price ($5, as shown in column 2).
->The data from columns (1) and (4) are plotted to derive the MFC curve, which is the firm’s factor supply curve.
->The firm continues to purchase a factor as long as the factor’s MRP exceeds its MFC.
->In the exhibit, the firm
->Specifies the combination of factors that minimizes costs. This requires that the following condition be met:
-> MPP1/ P1 = MPP2/ P2= . . . = MPPN/ PN, where the numbers stand for the different factors (land, labor, capital, entrepreneurship).
When a perfectly competitive firm employs one worker, it produces 20 units of output, and when it employs two workers, it produces 39 units of output. The firm sells its product for $10 per unit. What is the marginal revenue product connected with hiring the second worker?
MRP = MR x MPP. For a perfectly competitive firm, MR = P, so MR is $10. MPP in this case is 19 units. It follows that MRP $190.
What is the difference between marginal revenue product (MRP) and value marginal product (VMP)?
There is no difference between MRP and VMP if the firm is perfectly competitive. In this situation, P = MR, and because MRP = MR x MPP and VMP = P x MPP, the two are the same. If the firm is a price searcher— monopolist, monopolistic competitor, or oligopolist—P > MR; therefore, VMP > MRP.
What is the distinguishing characteristic of a factor price taker?
A factor price taker can buy all it wants of a factor at the equilibrium price, and it will not cause factor price to rise. For example, if firm X is a factor price taker in the labor market, it can buy all the labor it wants at the equilibrium wage, and it will not cause this wage to rise.
How much labor should a firm purchase?
A firm should buy that quantity at which MRP of labor = MFC of labor.
Labor is a factor of special interest because, at one time or another, most people find themselves in the labor market. An understanding of the labor market requires and understanding of the demand for labor, then the supply of labor, and finally the two together.
-> It is always the case that MRP = MR x MPP.
->For a perfectly competitive firm, where P = MR*, it follows that:
-> MRP = P x MPP. If P changes, MRP will change.
* An assumption in this case.
->For example, if product price rises, MRP rises, and the firm’s MRP curve (factor demand curve) shifts rightward.
-> If product price falls, MRP falls, and the firm’s MRP curve (factor demand curve) shifts leftward.
->It is always the case that MRP = MR x MPP.
-> If MPP rises (reflected in a shift in the MPP curve), MRP rises and the firm’s MRP curve shifts rightward.
-> If MPP falls, MRP falls and the firm’s MRP curve shifts leftward.
-> Two firms, A and B, make up the buying side of the market for labor.
->At a wage rate of W1, firm A purchases 100 units of labor and firm B purchases 150
->Together, they purchase 250 units, as illustrated in (c). Product price is P1.
->The wage rate rises to W2, and the amount of labor purchased by both firms initially falls to 180 units, as shown in (c).
->Higher wage rates translate into higher costs, a fall in product supply (in the market demand/supply – not shown), and a rise in product price from P1 to P2.
Finally, an increased price raises MRP and each firm has a new MRP curve. The horizontal “addition” of the new MRP curves shows they purchase 210 units of labor.
Connecting the units of labor purchased by both firms at W1 and W2 gives
the market demand curve.
->If the wage rate rises, firms will cut back on the labor they hire.
->How much they cut back depends on the elasticity of demand for labor, which is the percentage change in the quantity demanded of labor divided by the percentage change in the price of labor (the wage rate).
There are three main determinants of elasticity of demand for labor:
->The elasticity of demand for the product that labor produces
->The ratio of labor costs to total costs
->The number of substitute factors
The relationship between the elasticity of demand for the product and the elasticity of demand for labor is as follows:
->The higher the elasticity of demand for the product, the higher the elasticity of demand for the labor that produces the product.
->The lower the elasticity of demand for the product, the lower the elasticity of demand for the labor that produces the product.
The relationship between the ratio of labor cost to total cost and the elasticity of demand for labor is as follows:
->The higher the ratio of labor cost to total cost, the higher the elasticity of demand for labor (i.e., the greater the cutback in labor for any given wage increase).
->The lower the ratio of labor cost to total cost, the lower the elasticity of demand for labor (i.e., the less the cutback in labor for any given wage increase).
->The more substitutes there are for labor, the higher the elasticity of demand will be for it.
->The fewer substitutes for labor, the lower the elasticity of demand for labor.
A direct relationship exists between the wage rate and the quantity of labor supplied.
Changes in the wage rate change the quantity supplied of labor units; that is, they cause a movement along a given supply curve.
->The forces of supply and demand bring about the equilibrium wage rate and quantity of labor. ->At the equilibrium wage rate, the quantity demanded of labor equals the quantity supplied. ->At any other wage rate, there is either a surplus or a shortage of labor.
->To discover why wage rates differ, we must determine what conditions are necessary for everyone to receive the same pay. Assume the following conditions:
1.The demand for every type of labor is the same. (Throughout our analysis, any wage differentials caused by demand are short-run differentials.)
2.There are no special non-pecuniary aspects to any job.
3.All labor is ultimately homogeneous and can be trained for different types of employment at no cost.
4.All labor is mobile at zero cost.
->Given the four necessary conditions, there will be no wage rate differences across labor markets.
->We start with a wage rate of $30 in labor market ->A and a wage rate of $10 in labor market B.
Soon some individuals in B relocate to A.
->This increases the supply in one market (A), driving down the wage rate, and decreases the supply in the other market (B), driving up the wage rate.
->Equilibrium comes when the same wage rate is paid in both labor markets.
->This outcome critically depends on the necessary conditions holding.
1. If a firm is a factor price taker, marginal factor cost is constant and equal to factor price, MFC = P. Suppose the factor price taker hires labor. For the firm, MFC = W, where W is the wage rate.
2. Firms hire the factor quantity at which MRP = MFC.
3. Taking points 1 and 2 together, a factor price taker pays labor a wage equal to its marginal revenue product: W = MRP. That is, because MFC = W (point 1) and MRP = MFC (point 2), it follows that W = MRP.
4. If a firm is perfectly competitive, MRP = VMP.
5. If a firm is both perfectly competitive (a product price taker) and a factor price taker, it pays labor a wage equal to its value marginal product: W = VMP.
6. That is, because W = MRP (point 3) and MRP = VMP (point 4), it follows that W = VMP.
The demand for labor is a derived demand.
What could cause the firm’s demand curve for
labor to shift rightward?
->The MRP curve is the firm’s factor demand curve. MRP = P x MPP for a perfectly competitive firm; so if either the price of the product that labor produces rises or the MPP of labor rises (reflected in a shift in the MPP curve), the factor demand curve shifts rightward.
Suppose the coefficient of elasticity of demand for labor is 3. What does this mean?
It means that for every 1 percent change in the wage rate, the quantity demanded of labor changes by 3 times this percentage. For example, if wage rates rise 10 percent, then the quantity demanded of labor falls 30 percent.
Why are wage rates higher in one
competitive labor market than in another? In
short, why do wage rates differ?
The short answer is because supply-and-demand conditions differ among markets. But this answer raises the question why do supply- and-demand conditions differ?
Workers in labor market X do the same work as
workers in labor market Y, but they earn $10
less per hour. Why?
We can’t answer this question specifically without more information. We know that under four conditions, wage rates would not differ: (1) The demand for every type of labor is the same; (2) there are no special nonpecuniary aspects to any job; (3) all labor is ultimately homogeneous and can costlessly be trained for different types of employment; and (4) all labor is mobile at zero cost. For wage rates to differ, one or more of these conditions is not being met. For example, perhaps labor is not mobile at zero cost.
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