Unit 5:

Factor Markets

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Topic 5.1-
Introduction to Factor
Markets

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So far we’ve been discussing the product market.
This unit is about the resource (factor) market.

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The Four Factors of Production
1. Land -All natural resources that are used to produce
goods and services.
2. Labor -Any effort a person devotes to a task for
which that person is paid.
3. Capital -
Physical Capital- Any human-made resource that is used
to create other goods and services.
Human Capital- Any skills or knowledge gained by a
worker through education and experience.
4. Entrepreneurship - Ambitious leaders that
combine the other factors of production to create goods
and services.
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Factor Prices (Factor Factor Payments)
Payments made for the use of the factors of
production.
1. Land is paid Rent
2. Labor is paid Wage
3. Capital is paid Interest
4. Entrepreneurs are paid Profit
In the product market, individuals pay businesses
for goods and services.
In the factor market, businesses pay individuals
for the use of resources.
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The Labor Market

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Labor Demand and Supply
What is Demand for Labor?
• Demand is the different quantities of workers that
businesses are willing and able to hire at different
wages.
• There is an INVERSE relationship between wage and
quantity of labor demanded.
What is Supply for Labor?
• Supply is the different quantities of individuals that
are willing and able to sell their labor at different
wages.
• There is a DIRECT (or positive) relationship between
wage and quantity of labor supplied.
Workers have trade-off between work and leisure
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Who demands labor?
•FIRMS demand labor.
•Demand for labor shows the quantities of
workers that firms will hire at different wage
rates.

Wage
•As wage falls, Qd increases.
•As wage increases, Qd falls.

DL

Quantity of Workers
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Where do you get the Market Demand?
McDonalds Burger King Other Firms Market
Wage QLDem Wage QLDem Wage QLDem Wage QLDem

$12 1 $12 0 $12 9 $12 10

$8 $8 $8 $8
D D D D
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Q 2 Q 25 Q 30 Q
Who supplies labor?
•Individuals supply labor.
•Supply of labor is the number of workers that
are willing to work at different wage rates.
•Higher wages give workers incentives to leave
other industries or give up leisure activities.
Labor Supply

Wage

- As wage increases, Qs
increases.
- As wage decreases, Qs
decreases
Quantity of Workers
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Equilibrium
Wage (the price of labor) is set by the market.
EX: Supply and Demand for Carpenters

Wage Labor
Supply

$30hr

Labor
Demand
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Quantity of Workers 11
Minimum Wage
Minimum Wage- A minimum amount
employers are allowed to pay their
workers
It’s a wage floor

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Assume the government was interested in
increasing the federal minimum wage to
$15 an hour
What would be the purpose of this policy?
Do you believe that a $15 minimum wage
would successfully accomplish its goal?
Why or why not?
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Wage Fast Food Cooks

$15
The government wants to
$8 “help” workers because the
equilibrium wage is too low
$6

D
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5 6 7 8 9 10 11 12 Q of Labor 14
Wage Fast Food Cooks

$15
Minimum wage is a
$8 “WAGE FLOOR.”
Where?
$6

D
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5 6 7 8 9 10 11 12 Q of Labor 15
Minimum Wage
Wage

$15
Above
$8 Equilibrium!
$6

D
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Minimum Wage
Wage
Surplus of workers
(Unemployment) S

$15
What’s the result?
$8 Q demanded falls.
Q supplied increases.
$6

D
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5 6 7 8 9 10 11 12 Q of Labor 17
Identify the number of workers that lost
their job and the number unemployed
Wage
Supply

$20

$10 30 Fired
50 Unemployed

Demand

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Is increasing minimum wage
good or bad?
GOOD IDEA-
We don’t want poor people living in the street, so
we should make sure they have enough to live on.

BAD IDEA-
Increasing minimum wage too much leads to
more unemployment and higher prices.
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2008 AP Exam

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2012 AP Exam

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2012 AP Exam

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Marginal Resource Cost (MRC)
The additional cost of an additional resource
(worker).
In perfectly competitive labor markets the MRC
equals the wage set by the market and is constant.
Ex: The MRC of an unskilled worker is $8.75.
Another way to calculate MRC is:

Change in
Marginal
Total Cost
Resource = Change in
Cost Inputs
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The MRP of a resource equals
the Demand.

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Marginal Revenue Product
The additional revenue generated by an
additional worker (resource).
In perfectly competitive product markets the
MRP equals the marginal product of the resource
times the price of the product.
Ex: If the Marginal Product of the 3rd worker is 5 and
the price of the good is constant at $20 the MRP is…….
$100
Another way to calculate MRP is:
Change in
Marginal
Total Revenue
Revenue = Change in
Product Inputs
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What are other reasons for differences in wage?
Labor Market Imperfections-
•Insufficient/misleading job information-
•This prevents workers from seeking better
employment.
•Geographical Immobility-
•Many people are reluctant or too poor to move so
they accept a lower wage
•Unions
•Collective bargaining and threats to strike often
lead to higher than equilibrium wages
•Wage Discrimination-
•Some people get paid differently for doing the same
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job based on race or gender (illegal).
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