9.1Input Demand: Labor and Land Markets

Input demand is said to be a Derived demand because it is dependent on the demand for the outputs those inputs are used to produce.

Inputs are demanded by a firm if, and only if, households demand the good or service produced by that firm

this means that firms will layoff employees when the demand for its product falls and will hire fewer workers when the price of labor (wages) increases.

9.2Inputs: Complementary and Substitutable

The productivity of an input is the amount of output produced per unit of that input.Labor Productivity: Q/L (output per hour of labor)

Inputs can be complementary or substitutable. This means that a firm’s input demands are tightly linked together.

• Complements: as the firm hires more workers, it will need to employ more machinery (computers, etc.) for labor to use.

• Substitutes: as labor becomes more costly firms will automate by buying machinery that can do what labor does.

9.3Marginal Product and Marginal Revenue Product

Faced with a capacity constraint in the short-run, a firm that decides to increase output will eventually encounter diminishing marginal product.

• Marginal product of labor (MPL) is the additional output produced by one additional unit of labor.

• Marginal Revenue Product of Labor (MRPL) is the additional revenue a firm earns by employing one additional unit of labor, holding all else constant.

Suppose Px is the price of output MRPL = Px * MPL

9.4Marginal Revenue Product Per Hour of Labor in Sandwich Production (One Grill)

(1)TOTAL LABOR

UNITS (EMPLOYEES)

(2)TOTAL

PRODUCT (SANDWICHES

PER HOUR)

(3)MARGINAL

PRODUCT OF LABOR (MPL)

(SANDWICHES PER HOUR)

(4)PRICE (PX)

(VALUE ADDED PER SANDWICH)a

(5)MARGINAL REVENUEPRODUCT (MPL X PX)

(PER HOUR)

0 0

1 10 10 $ .50 $ 5.00

2 25 15 .50 7.50

3 35 10 .50 5.00

4 40 5 .50 2.50

5 42 2 .50 1.00

6 42 0 .50 0

aThe “price” is essentially profit per sandwich; see discussion in text.

9.5Marginal Revenue Product Per Hour of Labor in Sandwich Production (One Grill)

When output price is constant, the behavior of MRPL depends only on the behavior of MPL.

MRPL = Px*MPL

A competitive firm using only one variable input will use that input as long as its marginal revenue product exceeds its unit cost.

If the firm uses only labor, then it will hire labor as long as MRPL is greater than the going wage, W*.

Suppose W = $2.50

9.6In General

Labor labor

W

Labor Market

S

D

When a firm uses only one variable factor of production, that factor’s marginal revenue product curve is the firm’s demand curve for that factor in the short run.

Representative Firm

Profit-max rule: hireL* where MRPL = W

L*

MRPL

9.7Comparing Marginal Revenue and Marginal Cost to Maximize Profits

We have 2 profit-maximizing rules: The output rule: choose q* where MR = MCThe input rule: choose L* where MRPL = W

These two rules should be consistent: the L* from the input rule should be capable of producing the q* units from the output rule.

• Assuming that labor is the only variable input, if society values a good more than it costs firms to hire the workers to produce that good, the good will be produced.

• Firms weigh the value of outputs as reflected in output price against the value of inputs as reflected in marginal costs.

9.8Many Labor Markets

If labor markets are competitive, the wages in those markets are determined by the interaction of supply and demand.Firms will hire workers only as long as the value of their product exceeds the relevant market wage. This is true in all competitive labor markets.

• Examples:

9.9Land Markets

• Unlike labor and capital, the total supply of land is strictly fixed (perfectly inelastic).

9.10Land Markets: Demand Determined Price

• The price of a good that is in fixed supply is demand determined.

• Because land is fixed in supply, its price is determined exclusively by what households and firms are willing to pay for it.

The return to any factor of production in fixed supply is called pure rent.

• Unlike labor and capital, the total supply of land is strictly fixed (perfectly inelastic).

9.11Land in a Given Use Versus Land of a Given Quality

• The supply of land in a given use may not be perfectly inelastic or fixed.

• The supply of land of a given quality at a given location is truly fixed in supply.

9.12Rent and the Value of OutputProduced on Land

• A firm will pay for and use land as long as the revenue earned from selling the output produced on that land is sufficient to cover the price of the land.

• The firm will use land (A) up to the point at which:

MRPA = PA

Where MRPA is defined as Px*MPA

9.13The Firm’s Profit-Maximization Condition in Input Markets

• Profit-maximizing conditions for the perfectly competitive firm with 3 types of variable inputs: are

where L is labor, K is capital, A is land (acres), X is output, and PX is the price of that output.

PL = MRPL = Px*MPL

PA = MRPA = Px*MPA

PK = MRPK = Px*MPK

9.14The Firm’s Profit-Maximization Condition in Input Markets

• Profit-maximizing condition for the perfectly competitive firm, written another way is:

• 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.

xA

A

k

k

L

L

PP

MP

P

MP

P

MP 1

9.15Input Demand Curves

The Firm’s demand for inputs increases if• product demand increases (Px )

• productivity of labor (or any input) increases (MPL )

MRPL=PX*MPL

9.16Impact of Technological Change

• Technological change refers to the introduction of new methods of production or new products intended to increase the productivity of existing inputs or to raise marginal products.

• Technological change can, and does, have a powerful influence on factor demands.

• When we aggregate up all the firms’ higher demand curves for labor, we see the entire demand curve for labor shift right, pushing up wages.