Factor Markets and the Distribution of Income

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  • How factors of production—resources like land, labour, physical capital, and human capital—are traded in factor markets, determining the factor distribution of income

  • How the marginal productivity theory of income distribution is used to determine factor prices

  • About the sources of wage disparities and the role of discrimination

  • How labour supply arises from a worker’s decision about time allocation

THE VALUE OF A DEGREE

If you have doubts about completing college or university, consider this: factory workers with high school degrees earn much less than post-secondary grads. The present discounted value of the difference in lifetime earnings is more than $1 million.

DOES HIGHER EDUCATION PAY? Yes, it does: in the modern economy, employers are willing to pay a premium for workers with more education. And the size of that premium has increased over the last few decades. Back in 1980 male workers with a bachelor’s degree earned only 32% more than those who had only graduated from high school. By 2005, the premium for a male with a bachelor’s degree had risen to over 45%. Females with a bachelor’s degree earned 49% more than high school graduates earned in 1980, and this premium had risen to more than 60% in 2005. By 2011, the average employment income of university graduates was 104% higher than the average income of high school graduates and 51% higher than the average income of college graduates. If the gaps observed in 2011 were to persist over a 40-year period of employment, a university graduate would earn $1.4 million more than a high school graduate.1

Who decided that the wages of workers with advanced degrees would rise so much compared with those of high school grads? The answer, of course, is that nobody decided it. Wage rates are prices, the prices of different kinds of labour; and they are decided, like other prices, by supply and demand.

Still, there is a qualitative difference between the wage rate of high school grads and the price of used textbooks: the wage rate isn’t the price of a good, it’s the price of a factor of production. And although markets for factors of production are in many ways similar to those for goods, there are also some important differences.

In this chapter, we examine factor markets, the markets in which the factors of production such as labour, land, and capital are traded. Factor markets, like markets for goods and services, play a crucial role in the economy: they allocate productive resources to producers and help ensure that those resources are used efficiently.

This chapter begins by describing the major factors of production. Then we consider the demand for factors of production, which leads us to a crucial insight: the marginal productivity theory of income distribution. We then consider some challenges to the marginal productivity theory. Next, we examine the markets for capital and for land. The chapter concludes with a discussion of the supply of the most important factor, labour.