SECTION 13 REVIEW

Module 69

1. Just as there are markets for goods and services, there are markets for factors of production, including labor, land, and both physical capital and human capital. These markets determine the factor distribution of income.

2. A profit-maximizing firm hiring from a perfectly competitive factor market will keep employing more units of a factor until the factor’s price is equal to the marginal revenue product—the marginal product of the factor multiplied by the marginal revenue of the output it produces. The marginal revenue product curve is therefore the firm’s demand curve for a factor. Factor demand is often referred to as a derived demand because it is derived from the demand for the producer’s output.

3. The market demand curve for labor is the horizontal sum of the individual demand curves of firms in that market. It shifts for three main reasons: changes in output price, changes in the supply of other factors, and technological changes.

Module 70

4. When a perfectly competitive labor market is in equilibrium, the market wage is equal to the equilibrium marginal revenue product of labor, the additional revenue generated by the last worker hired in the labor market as a whole. The same principle applies to other factors of production: the rental rate of land or capital is equal to the equilibrium marginal revenue product. This insight leads to the marginal productivity theory of income distribution, according to which each factor is paid the marginal revenue product of the last unit of that factor employed in the factor market as a whole. The payment to a factor in excess of the minimum amount necessary to employ that factor is called economic rent.

Module 71

5. Labor supply is the result of decisions about time allocation, with each worker facing a trade-off between leisure and work. An increase in the hourly wage rate tends to increase work hours via the substitution effect but decrease work hours via the income effect. If the net result is that a worker increases the quantity of labor supplied in response to a higher wage, the individual labor supply curve slopes upward. If the net result is that a worker decreases work hours, the individual labor supply curve—unlike supply curves for goods and services—slopes downward.

6. The market labor supply curve is the horizontal sum of the individual labor supply curves of all workers in that market. It shifts for four main reasons: changes in preferences and social norms, changes in population, changes in opportunities, and changes in wealth.

7. When a firm is not a price-taker in a factor market due to imperfect competition, the firm will consider the marginal revenue product and the marginal factor cost when determining how much of a factor to employ. The marginal factor cost is equivalent to the wage (or the price of the factor) in a perfectly competitive market.

8. A monopsonist is the single buyer of a factor. A market in which there is a monopsonist is a monopsony.

Module 72

9. Firms will determine the optimal input combination using the cost-minimization rule: When a firm uses the cost-minimizing combination of inputs, the marginal product of labor divided by the wage rate is equal to the marginal product of capital divided by the rental rate.

Module 73

10. Large disparities in wages raise questions about the validity of the marginal productivity theory of income distribution. Many disparities can be explained by compensating differentials and by differences in talent, job experience, and human capital across workers. Market interference in the forms of unions and collective action by employers also creates wage disparities. The efficiency-wage model, which arises from a type of market failure, shows how wage disparities can result from employers’ attempts to increase worker performance. Free markets tend to diminish discrimination, but discrimination remains a real source of wage disparity. Discrimination is typically maintained either through problems in labor markets or (historically) through institutionalization in government policies.