Lecture Economics (6/e): Chapter 27 - Stephen L. Slavin
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Chapter 27
Demand in the Factor Market
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
271
Chapter Objectives
•
•
•
•
•
•
Derived demand
Productivity
Marginal revenue product
Changes in resource demand
The substitution and output effects
Optimum resource mix for the firm
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
272
Derived Demand
• Derived demand is the demand for resources
• There are four resources: land, labor, capital,
and entrepreneurial ability
• The demand for these resources is derived from
the demand for the final products
– The demand for land on which to grow corn is
derived from the demand for corn
– The demand for labor with which to produce cars is
derived from the demand for cars
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
273
Productivity
• Productivity is output per unit of input
– Productivity is measured by what is produced
– Inputs measure the four economic resources
• The more productive a resource is, the more it
will be in demand
– This is reflected in in both their prices and their
rents
• Sally can get higher wages than John because she is more
productive
• An acre of land that produces more cotton than another
acre of land will command a higher rent
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
274
Prices of Substitute Goods
• A given good or service can usually be
produced in many different ways
• Every country or organization uses the
cheapest production method
– When wages rise, many companies seek to substitute
machinery for relatively expensive labor
– If land becomes more expensive, farmers would
work each acre more intensively, substituting labor
and capital for more expensive land
• The demand for a resource is its marginal
revenue product schedule (MRP)
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
275
Marginal Revenue Product
(MRP)
• How much of a resource is purchased
depend on three things
– The price of that resource
– The productivity of that resource
– The selling price of the final product that the
resource helps to produce
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
276
Hypothetical Output of Labor Hired by
a Firm
Units of Labor Output Marginal Physical Product
1 15 15
2 29 14
3 41 12
4 51 10
5 58 7
6 62 4
7 63 1
8 63 0
9 62 1
10 60 2
Note: The marginal physical product we are computing here is identical to
computing marginal output in diminishing returns
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
277
Hypothetical Output of Labor Hired by
a Firm
Units of Labor Output Marginal Physical Product
1 15 15
2 29 14
3 41 12
4 51 10
5 58 7
6 62 4
7 63 1
8 63 0
9 62 1
10 60 2
Note: No business firm would hire more than seven workers under these
circumstances, even if the wage rate was a penny an hour.
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
278
Hypothetical Marginal Revenue Product
Schedule
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Land Output Product Price Product Product*
1 20 20
2 38 18
3 53 15
4 65 12
5 73 8
6 78 5
7 80 2
8 80 0
9 79 1
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
279
Hypothetical Marginal Revenue Product
Schedule
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Land Output Product Price Product Product*
1 20 20 $10
2 38 18 10
3 53 15 10
4 65 12 10
5 73 8 10
6 78 5 10
7 80 2 10
8 80 0 10
9 79 1 10
This is a perfect competitor because the firm can sell its entire output at the same
price of $10
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2710
Hypothetical Marginal Revenue Product
Schedule
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Land Output Product Price Product Product*
1 20 20 $10 $200 $200
2 38 18 10
380 180 3 53 15 10
530 150 4 65 12
10 650 120 5 73
8 10 730 80 6
78 5 10 780 50 7
80 2 10 800 20
8 80 0 10 800 0
9 79 1 10 790
*You should use the Total Revenue Product column to calculate the Marginal
10
Revenue Product (MRP) because this method works for both the perfect
competitor and the imperfect competitor
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2711
Hypothetical Marginal Revenue Product
Schedule
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Land Output Product Price Product Product*
1 20 20 $10 $200 $200
2 38 18 10
380 180 3 53 15 10
530 150 4 65 12
10 650 120 5 73
8 10 730 80 6
78 5 10 780 50 7
80 2 10 800 20
8 80 0 10 800 0
9 79 1 10 790
10
How many units of land would you hire if you needed to pay $200 rent per unit?
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2712
Hypothetical Marginal Revenue Product
Schedule
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Land Output Product Price Product Product*
1 20 20 $10 $200 $200
2 38 18 10
380 180 3 53 15 10
530 150 4 65 12
10 650 120 5 73
8 10 730 80 6
78 5 10 780 50 7
80 2 10 800 20
8 80 0 10 800 0
9 79 1 10 790
10
How many units of land would you hire if you needed to pay $200 rent per unit?
You would hire just one unit of land because only the first unit is worth $200
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2713
Hypothetical Marginal Revenue Product
Schedule
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Land Output Product Price Product Product*
1 20 20 $10 $200 $200
2 38 18 10
380 180 3 53 15 10
530 150 4 65 12
10 650 120 5 73
8 10 730 80 6
78 5 10 780 50 7
80 2 10 800 20
8 80 0 10 800 0
9 79 1 10 790
10
How many units of land would you hire if you needed to pay $150 rent per unit?
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2714
Hypothetical Marginal Revenue Product
Schedule
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Land Output Product Price Product Product*
1 20 20 $10 $200 $200
2 38 18 10
380 180 3 53 15 10
530 150 4 65 12
10 650 120 5 73
8 10 730 80 6
78 5 10 780 50 7
80 2 10 800 20
8 80 0 10 800 0
9 79 1 10 790
10
How many units of land would you hire if you needed to pay $150 rent per unit?
You would hire 3 units of land
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2715
Hypothetical Marginal Revenue Product
Schedule
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Land Output Product Price Product Product*
1 20 20 $10 $200 $200
2 38 18 10
380 180 3 53 15 10
530 150 4 65 12
10 650 120 5 73
8 10 730 80 6
78 5 10 780 50 7
80 2 10 800 20
8 80 0 10 800 0
9 79 1 10 790
How many units of land would you hire if its price were $90. Assume the land is
10
indivisible.
You would hire 4 units because the fifth unit is only worth $80
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2716
Hypothetical Marginal Revenue Product
Schedule
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Land Output Product Price Product Product*
1 20 20 $10 $200 $200
2 38 18 10
380 180 3 53 15 10
530 150 4 65 12
10 650 120 5 73
8 10 730 80 6
78 5 10 780 50 7
80 2 10 800 20
8 80 0 10 800 0
9 79 1 10 790
10
In case you haven’t yet realized it the MRP schedule is the firm’s
demand schedule for land
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2717
The Marginal Revenue Product (MRP)
Curve
MRP
If the rent is $120 how many units
of land are demanded?
200
180
160
140
Rent
120
100
80
60
40
20
1
2
3
4
5
6
Units of land
7
8
9
Four units
This curve represents the firm’s demand for land. It slopes downward to the
right. The lower the rent the greater the quantity of land demanded. The higher
the rent the lower the quantity of land demanded
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2718
The Marginal Revenue Product (MRP)
Curve
MRP
If the rent is $120 how many units
of land are demanded?
200
180
160
140
Rent
120
100
80
60
How much rent is collected?
Total Rent is (4 X $120) = $480
40
20
1
2
3
4
5
6
Units of land
7
8
9
Four units
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2719
The Marginal Revenue Product (MRP)
Curve
The producer’s surplus is the
triangular area above the rent line.
This is the difference between how
much this land is worth to the firm
and how much it actually had to
pay in rent
MRP
200
180
160
140
Rent
120
100
How much the firm actually paid in
rent is shown in the rectangular area
below the triangle
80
60
40
20
1
2
3
4
5
6
Units of land
7
8
9
Four units
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2720
Hypothetical MRP Schedule of the Imperfect
Competitor
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Labor Output Product Price Product Product
1 18 18 $12 $216 $216
2 34 16 11 374 258
3 48 14 10 480 106
4 59 11 9 531 51
5 68 9 8 544 13
6 74 6 7 518
26 7 77 3 6 462
56 8 78 1 5 390
72
How do we know this firm is an imperfect competitor?
The firm has to lower price to sell more.
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2721
Hypothetical MRP Schedule of the Imperfect
Competitor
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Labor Output Product Price Product Product
1 18 18 $12 $216 $216
2 34 16 11 374 258
3 48 14 10 480 106
4 59 11 9 531 51
5 68 9 8 544 13
6 74 6 7 518
26 7 77 3 6 462
56 8 78 1 5 390
72
How many workers would the firm hire if the wage rate were $150?
Two workers would be hired. You would not hire the third worker because you
would be paying $150 for something worth only $106.
The wage bill would be (2 X $150) = $300
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2722
Hypothetical MRP Schedule of the Imperfect
Competitor
(1) (2) (3) (4) (5) (6)
Units Marginal Total Marginal
of Physical Revenue Revenue
Labor Output Product Price Product Product
1 18 18 $12 $216 $216
2 34 16 11 374 258
3 48 14 10 480 106
4 59 11 9 531 51
5 68 9 8 544 13
6 74 6 7 518
26 7 77 3 6 462
56 8 78 1 5 390
72
How many workers would the firm hire if the wage rate were $51?
Four workers would be hired. You would not hire the fifth worker because you
would be paying $51 for something worth only $13 .
The wage bill would be (4 X $51) = $204
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2723
The Marginal Revenue Product Curve of the
Perfect and Imperfect Competitors
MRP
220
200
180
The MRP curve of the imperfect
competitor declines more steeply
than that of the perfect competitor
because the imperfect competitor
must lower price to sell additional
output
160
140
120
100
MRP
(perfect
competitor)
80
60
40
20
MRP
(imperfect
competitor)
0
Ð20
Ð40
Ð60
Ð80
0
1
2
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
3
4
5
Units of labor
6
7
8
9
2724
A Shift in the Marginal Revenue
Product Curve
Four things can cause a shift
from MRP1 to MRP2
Changes in demand for the final
product
Productivity changes
MRP
70
60
50
40
30
Changes in the price of other resources
Complementary factors
MRP2
20
10
MRP1
1
2
3
4
5
6
Units of capital
7
8
9
Remember, the MRP schedule is a firm’s demand schedule. Therefore a shift in
the MRP schedule is the same as a shift in the demand schedule
Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved.
2725
