Summary

  1. Factor markets are markets for inputs that are used to produce outputs. One of the most important factor markets is the labor market. The marginal revenue product of labor is the marginal product of labor times the marginal revenue. In perfectly competitive factor markets, a firm employs the optimal amount of labor when the marginal revenue product of labor equals the wage. As the wage increases, the optimal amount of labor hired decreases, and the opposite is true when the wage decreases. Labor demand is an example of a derived demand, a demand for one product that results from the demand for another product. [Section 13.1]

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  2. Changes in the production function and the amount of capital a firm has can shift the marginal product of labor curve and, in turn, the labor demand curve. Likewise, changes in demand for the output good can shift the marginal revenue curve, shifting the labor demand curve. The market demand for labor is the horizontal sum of all firms’ labor demand curves. [Section 13.1]

  3. An individual’s labor supply involves a choice between consuming leisure and consuming the goods and services that can be bought with income from work. As a result, the relative price of leisure and consumption is the individual’s wage rate. The net effect of a wage change on labor supply is the sum of the substitution effect and the income effect. In general, the substitution effect dominates so that a higher wage encourages a person to work more. In principle, however, above a certain wage, the income effect can dominate so that the quantity of work a person is willing to supply falls as wages rise. This phenomenon can give rise to a backward-bending labor supply curve. [Section 13.2]

  4. The labor market reaches equilibrium when the wage equates the quantity of labor demanded by firms and the quantity of labor supplied by workers. In the long run, the firm is able to adjust its capital inputs, and consequentially, the labor demand curve is flatter than it is in the short run. [Sections 13.3 and 13.4]

  5. Intermediate goods are products that are made specifically to be used as factor inputs into the production of another good, and the supply of an intermediate good is like the supply of any other product. Meanwhile, the supply curve for unimproved land, land that is not designated for any specific use, is vertical because the supply is essentially fixed. [Section 13.5]

  6. Monopsony power exists when a buyer’s choice of how much to buy affects the market price of what it purchases. Marginal expenditure, the incremental expenditure from buying one more unit of a product, is equal to the price for buyers with no market power, but is always higher than the price for a monopsonist. The monopsonist buys the profit-maximizing amount of an input when the marginal revenue product of the input equals the marginal expenditure on it. In a monopsony, a smaller quantity of the input is purchased at a lower price than would be purchased in a competitive market. [Section 13.6]

  7. The concepts that applied to monopolists in previous chapters also apply to sellers with market power in factor markets. Labor unions are among the most well-known holders of market power in factor markets. If unions acted as standard profit-maximizing sellers, they would supply the amount of labor that would equate marginal revenue and marginal cost. Some economists, however, believe that unions instead maximize total wage earnings, in which case they supply labor until their marginal revenue equals zero. Either way, the union supplies a lower quantity of labor at a higher wage than would be obtained in a competitive market. [Section 13.7]

  8. A bilateral monopoly is the market structure that exists when there is major concentration of market power on both sides of the market, and the one-sided market power models don’t fit this situation well. [Section 13.8]