Summary
Factor Markets
- 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, price-taking firm will keep employing more units of a factor until the factor’s price is equal to the value of the marginal product—the marginal product of the factor multiplied by the price of the output it produces. The value of the marginal product curve is therefore the price-taking 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 the prices of goods, changes in the supply of other factors, and technological changes.
Marginal Productivity Theory
- 4. According to the marginal productivity theory of income distribution, each factor is paid the value of the marginal product of the last unit of that factor employed in the factor market as a whole—its equilibrium value of the marginal product.
- 5. 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.
The Market for Labor
- 6. 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.
- 7. 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.
- 8. When a firm is not a price-taker in a factor market, the firm will consider the marginal revenue product when determining how much of a factor to hire. This concept is equivalent to the value of the marginal product in a perfectly competitive market.
- 9. A monopsonist is the single buyer of a factor. A market in which there is a monopsonist is a monopsony.