Ch09

© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
CHAPTERCHAPTER 99
Prepared by: FernandoPrepared by: Fernando
Quijano and Yvonn QuijanoQuijano and Yvonn Quijano
Input Demand:Input Demand:
The Labor and Land MarketsThe Labor and Land Markets

Firm Choices in Input MarketsFirm Choices in Input Markets

Demand for Inputs: A Derived DemandDemand for Inputs: A Derived Demand
• Derived demandDerived demand is demand for resourcesis demand for resources
(inputs) that is dependent on the demand(inputs) that is dependent on the demand
for the outputs those resources can befor the outputs those resources can be
used to produce.used to produce.
• Inputs are demanded by a firm if, and onlyInputs are demanded by a firm if, and only
if, households demand the good or serviceif, households demand the good or service
produced by that firm.produced by that firm.

Inputs: Complementary and SubstitutableInputs: Complementary and Substitutable
• TheThe productivity of an inputproductivity of an input is theis the
amount of output produced per unit of thatamount of output produced per unit of that
input.input.
• Inputs can beInputs can be complementarycomplementary oror
substitutable.substitutable. This means that a firm’sThis means that a firm’s
input demands are tightly linked together.input demands are tightly linked together.

Diminishing ReturnsDiminishing Returns
• Faced with a capacity constraint in theFaced with a capacity constraint in the
short-run, a firm that decides to increaseshort-run, a firm that decides to increase
output will eventually encounteroutput will eventually encounter
diminishing returns.diminishing returns.
• Marginal product of labor (MPMarginal product of labor (MPLL)) is theis the
additional output produced by oneadditional output produced by one
additional unit of labor.additional unit of labor.

Marginal Revenue ProductMarginal Revenue Product
• The marginal revenue product (MRP)The marginal revenue product (MRP) ofof
a variable input is the additional revenue aa variable input is the additional revenue a
firm earns by employing one additional unitfirm earns by employing one additional unit
of input,of input, ceteris paribusceteris paribus..
• MRPMRPLL equals the price of output,equals the price of output, PPXX, times, times
the marginal product of labor,the marginal product of labor, MPMPLL..

Marginal Revenue Product Per Hour ofMarginal Revenue Product Per Hour of
Labor in Sandwich Production (One Grill)Labor in Sandwich Production (One Grill)
(1)(1)
TOTALTOTAL
LABOR UNITSLABOR UNITS
(EMPLOYEES)(EMPLOYEES)
(2)(2)
TOTALTOTAL
PRODUCTPRODUCT
(SANDWICHES(SANDWICHES
PER HOUR)PER HOUR)
(3)(3)
MARGINALMARGINAL
PRODUCT OFPRODUCT OF
LABOR (LABOR (MPMPLL))
(SANDWICHES(SANDWICHES
PER HOUR)PER HOUR)
(4)(4)
PRICE (PRICE (PPXX))
(VALUE(VALUE
ADDED PERADDED PER
SANDWICH)SANDWICH)aa
(5)(5)
MARGINALMARGINAL
REVENUEREVENUE
PRODUCT (PRODUCT (MPMPLL XX PPXX))
(PER HOUR)(PER HOUR)
00 00 −− −− −−
11 1010 1010 $$.50.50 $$ 5.005.00
22 2525 1515 .50.50 7.507.50
33 3535 1010 .50.50 5.005.00
44 4040 55 .50.50 2.502.50
55 4242 22 .50.50 1.001.00
66 4242 00 .50.50 00
aa
The “price” is essentially profit per sandwich; see discussion in text.The “price” is essentially profit per sandwich; see discussion in text.

Marginal Revenue Product Per Hour ofMarginal Revenue Product Per Hour of
Labor in Sandwich Production (One Grill)Labor in Sandwich Production (One Grill)
• When output price isWhen output price is
constant, the behaviorconstant, the behavior
ofof MRPMRPLL depends onlydepends only
on the behavior ofon the behavior of MPMPLL..
• Under diminishingUnder diminishing
returns, bothreturns, both MPMPLL andand
MRPMRPLL eventuallyeventually
decline.decline.
MRPL = PX  MPL

A Firm Using One Variable Factor ofA Firm Using One Variable Factor of
Production: LaborProduction: Labor
• A competitive firm using only one variableA competitive firm using only one variable
factor of production will use that factor asfactor of production will use that factor as
long as its marginal revenue productlong as its marginal revenue product
exceeds its unit cost.exceeds its unit cost.
• If the firm uses only labor, then it will hireIf the firm uses only labor, then it will hire
labor as long aslabor as long as MRPMRPLL is greater than theis greater than the
going wage,going wage, W*.W*.

Marginal Revenue Product and Factor Demand forMarginal Revenue Product and Factor Demand for
a Firm Using One Variable Input (Labor)a Firm Using One Variable Input (Labor)
• The hypothetical firm will demand 210 units of labor.The hypothetical firm will demand 210 units of labor.
W* =MRPL = 10

Short-Run Demand Curve for a FactorShort-Run Demand Curve for a Factor
of Productionof Production
• When a firm uses onlyWhen a firm uses only
one variable factor ofone variable factor of
production, that factor’sproduction, that factor’s
marginal revenue productmarginal revenue product
curve is the firm’scurve is the firm’s
demand curve for thatdemand curve for that
factor in the short run.factor in the short run.

Comparing Marginal Revenue andComparing Marginal Revenue and
Marginal Cost to Maximize ProfitsMarginal Cost to Maximize Profits
• Assuming that labor is the only variableAssuming that labor is the only variable
input, if society values a good more than itinput, if society values a good more than it
costs firms to hire the workers to producecosts firms to hire the workers to produce
that good, the good will be produced.that good, the good will be produced.
• Firms weigh the value of outputs asFirms weigh the value of outputs as
reflected in output price against the valuereflected in output price against the value
of inputs as reflected in marginal costs.of inputs as reflected in marginal costs.

The Two Profit-Maximizing ConditionsThe Two Profit-Maximizing Conditions
• The two profit-maximizing conditions are simplyThe two profit-maximizing conditions are simply
two views of the same choice process.two views of the same choice process.

The Trade-Off Facing FirmsThe Trade-Off Facing Firms

A Firm Employing Two VariableA Firm Employing Two Variable
Factors of ProductionFactors of Production
• Land, labor, and capital are used togetherLand, labor, and capital are used together
to produce outputs.to produce outputs.
• When an expanding firm adds to its stockWhen an expanding firm adds to its stock
of capital, it raises the productivity of itsof capital, it raises the productivity of its
labor, and vice versa. Each factorlabor, and vice versa. Each factor
complements the other.complements the other.

Substitution and Output Effects of aSubstitution and Output Effects of a
Change in Factor PriceChange in Factor Price
• Two effects occur when the price of anTwo effects occur when the price of an
input changes:input changes:
• Factor substitution effectFactor substitution effect: The
tendency of firms to substitute away
from a factor whose price has risen
and toward a factor whose price has
fallen.

• Two effects occur when the price of anTwo effects occur when the price of an
input changes:input changes:
• Output effect of a factor priceeffect of a factor price
increase (decrease)increase (decrease): When a firm
decreases (increases) its output in
response to a factor price increase
(decrease), this decreases
(increases) its demand for all factors.

• WhenWhen PPLL == PPKK = $1, the labor-intensive method of= $1, the labor-intensive method of
producing output is less costly.producing output is less costly.
TECHNOLOGYTECHNOLOGY
INPUT REQUIREMENTSINPUT REQUIREMENTS
PER UNIT OF OUTPUTPER UNIT OF OUTPUT
UNIT COST IFUNIT COST IF
PPLL = $1= $1
PPKK = $1= $1
((PPLL xx LL) + () + (PPKK xx KK))
UNIT COST IFUNIT COST IF
PPLL = $2= $2
PPKK = $1= $1
((PPLL xx LL) + () + (PPKK xx KK))KK LL
AA (capital intensive)(capital intensive) 1010 55 $15$15 $20$20
BB (labor intensive)(labor intensive) 33 1010 $13$13 $23$23
Response of a Firm to an Increasing Wage RateResponse of a Firm to an Increasing Wage Rate

• When the price of labor rises, labor becomes moreWhen the price of labor rises, labor becomes more
expensive relative to capital. The firm substitutes capitalexpensive relative to capital. The firm substitutes capital
for labor and switches from techniquefor labor and switches from technique BB to techniqueto technique AA..
TO PRODUCE 100 UNITS OF OUTPUTTO PRODUCE 100 UNITS OF OUTPUT
TOTALTOTAL
CAPITALCAPITAL
DEMANDEDDEMANDED
TOTALTOTAL
LABORLABOR
DEMANDEDDEMANDED
TOTALTOTAL
VARIABLEVARIABLE
COSTCOST
WhenWhen PPLL = $1,= $1, PPKK = $1,= $1,
firm uses technologyfirm uses technology BB
300300 1,0001,000 $1,300$1,300
WhenWhen PPLL = $2,= $2, PPKK = $1,= $1,
firm uses technologyfirm uses technology AA
1,0001,000 500500 $2,000$2,000
The Substitution Effect of an Increase in Wages on a FirmThe Substitution Effect of an Increase in Wages on a Firm
Producing 100 Units of OutputProducing 100 Units of Output

Many Labor MarketsMany Labor Markets
• If labor markets are competitive, the wagesIf labor markets are competitive, the wages
in those markets are determined by thein those markets are determined by the
interaction of supply and demand.interaction of supply and demand.
• Firms will hire workers only as long as theFirms will hire workers only as long as the
value of their product exceeds the relevantvalue of their product exceeds the relevant
market wage. This is true in all competitivemarket wage. This is true in all competitive
labor markets.labor markets.

Land MarketsLand Markets
• Unlike labor andUnlike labor and
capital, the totalcapital, the total
supply of land issupply of land is
strictly fixed (perfectlystrictly fixed (perfectly
inelastic.inelastic.

Demand Determined PriceDemand Determined Price
• The price of a good that isThe price of a good that is
in fixed supply isin fixed supply is demanddemand
determineddetermined..
• Because land is fixed inBecause land is fixed in
supply, its price issupply, its price is
determined exclusively bydetermined exclusively by
what households and firmswhat households and firms
are willing to pay for it.are willing to pay for it.
• The return to any factor of production in fixedThe return to any factor of production in fixed
supply is calledsupply is called pure rentpure rent..

Land in a Given Use Versus Land of aLand in a Given Use Versus Land of a
Given QualityGiven Quality
• The supply of land in aThe supply of land in a
given usegiven use may not bemay not be
perfectly inelastic orperfectly inelastic or
fixed.fixed.
• The supply of land of aThe supply of land of a
given qualitygiven quality at a givenat a given
location is truly fixed inlocation is truly fixed in
supply.supply.

Rent and the Value of OutputRent and the Value of Output
Produced on LandProduced on Land
• A firm will pay for and use land as long asA firm will pay for and use land as long as
the revenue earned from selling the outputthe revenue earned from selling the output
produced on that land is sufficient to coverproduced on that land is sufficient to cover
the price of the land.the price of the land.
• The firm will use land (The firm will use land (AA) up to the point at) up to the point at
which:which:
MRPA = PA

The Firm’s Profit-MaximizationThe Firm’s Profit-Maximization
Condition in Input MarketsCondition in Input Markets
• Profit-maximizing condition for theProfit-maximizing condition for the
perfectly competitive firm is:perfectly competitive firm is:
PPLL = MRP= MRPLL = (= (MPMPLL XX PPXX))
PPKK == MRPMRPKK = (= (MPMPKK XX PPXX))
PPAA == MRPMRPAA = (= (MPMPAA XX PPXX))
wherewhere LL is labor,is labor, KK is capital,is capital, AA is land (acres),is land (acres),
XX is output, andis output, and PPXX is the price of that output.is the price of that output.

The Firm’s Profit-MaximizationThe Firm’s Profit-Maximization
Condition in Input MarketsCondition in Input Markets
• Profit-maximizing condition for the perfectlyProfit-maximizing condition for the perfectly
competitive firm, written another way is:competitive firm, written another way is:
M P
P
M P
P
M P
P P
L
L
K
K
A
A X
= = =
1
• In words, the marginal product of the last dollar
spent on labor must be equal to the marginal
product of the last dollar spent on capital, which
must be equal to the marginal product of the last
dollar spent on land, and so forth.

Input Demand CurvesInput Demand Curves
• If product demand increases, product price willIf product demand increases, product price will
rise and marginal revenue product will increase.rise and marginal revenue product will increase.

Input Demand CurvesInput Demand Curves
• If the productivity of labor increases, bothIf the productivity of labor increases, both
marginal product and marginal revenue productmarginal product and marginal revenue product
will increase.will increase.

Impact of Capital Accumulation onImpact of Capital Accumulation on
Factor DemandFactor Demand
• The production and use of capital enhances theThe production and use of capital enhances the
productivity of labor, and normally increases theproductivity of labor, and normally increases the
demand for labor and drives up wages.demand for labor and drives up wages.

Impact of Technological ChangeImpact of Technological Change
• Technological changeTechnological change refers to therefers to the
introduction of new methods of productionintroduction of new methods of production
or new products intended to increase theor new products intended to increase the
productivity of existing inputs or to raiseproductivity of existing inputs or to raise
marginal products.marginal products.
• Technological change can, and does, haveTechnological change can, and does, have
a powerful influence on factor demands.a powerful influence on factor demands.

Ch09

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