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# ch17 - Demand and Supply in Factor Markets Factor Prices...

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C Chapter 17 Demand and Supply in Factor Markets Factor Prices and Incomes Firms hire the services of factors of production (labour, capital, land, entrepreneurship) to produce output. Demand and supply in factor markets determine factor prices ( PF ) (wages, interest, rent) and quantities ( QF ). o Factor income = PF x QF The demand curve is D and the supply curve is S . The equilibrium price is PF and the quantity is QF . The blue rectangle shows the income of this factor of production— price multiplied by quantity. An increase in demand increases the price, quantity and income of a factor of production. A decrease in demand decreases the price, quantity and income of a factor of production. A decrease in supply raises the price, decreases the quantity, and has an ambiguous effect on income, depending on the elasticity of demand for the factor.

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Labour Markets The demand for a factor of production is a derived demand . Firms hire the quantities of factors of production that maximize their profit. To achieve this objective, they hire an additional unit of a factor of production if the additional revenue brought in exceeds the additional cost. The revenue brought in by one additional unit of a factor of production is the marginal revenue product of that factor. The cost of hiring an additional unit of a factor of production is the factor price. The price of a unit of labour is the wage rate. To calculate the marginal revenue product of a factor (say labour), we need to know the change in total product that results from a one-unit increase in the quantity of labour employed, (the marginal product), and the extra revenue that this output produces, (the marginal revenue). Quantity of labour (L) (workers) Total product (TP) (car washes per hour) Marginal product (MP = TP/ L) (washes per worker) Marginal revenue product (MRP = MR x MP) (dollars per worker) A 0 0 5 20 B 1 5 4 16 C 2 9 3 12 D 3 12 2 8 E 4 14 1 4 F 5 15 The table above calculates marginal revenue product at Max’s Wash ‘n’ Wax.
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ch17 - Demand and Supply in Factor Markets Factor Prices...

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