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CHAPTER 11
The Demand for Factors of Production
1
Part Three: Microeconomics of Factor Markets
Slides prepared by Bruno Fullone,
George Brown College ©2010 McGraw-Hill Ryerson Ltd.
Chapter 11
2
In this chapter you will learn:
11.1 How factor prices are determined
11.2 What determines the demand for
a factor
11.3 What determines the elasticity of
factor demand
11.4 How a firm arrives at the optimal
combination of factors to use in the
production process
3 LO 11.1
11.1 Factor Pricing and Demand
Reasons to study how factor prices are
determined:
• Money-Income Determination
• Resource Allocation
• Cost Minimization
• Policy Issues
4 LO 11.1
Marginal Productivity Theory of Factor
Demand
•Factor demand is a derived
demand
•Depends on:
•Productivity of factor
•Price of the good it helps to
produce
5 LO 11.1
Marginal Productivity Theory of Factor
Demand
•Marginal Revenue Product (MRP)
-Productivity
•Marginal Product (MP) eventually diminishes
•Illustrated ….
LO 11.1 6
Units of
a factor
Total
product
Marginal
product, MP
]
]
]
0
1
2
3
4
5
6
7
0
7
13
18
22
25
27
28
7
6
5
4
3
2
1
]
]
] ]
Table 11-1 The Demand for Labour
Diminishing MP
7
LO 11.1
Marginal Productivity Theory of Factor
Demand Marginal Revenue Product (MRP)
Productivity Marginal Product (MP) eventually
diminishes
quantityfactor in changeunit one
revenue in total change
product
revenue
Marginal
Product Price • Marginal Revenue Product (MRP)
LO 11.1 8
Units of
a factor
Total
product
Marginal
product, MP
]
]
]
0
1
2
3
4
5
6
7
0
7
13
18
22
25
27
28
7
6
5
4
3
2
1
]
]
] ]
The Demand for Labour Product
price
$2
2
2
2
2
2
2
2
Total
revenue
$ 0
14
26
36
44
50
54
56
Marginal revenue
product, MRP
$ 14
12
12
10
8
6
4
2
] ] ] ] ] ] ]
9 LO 11.1
Marginal Productivity Theory of Factor
Demand
Rule for employing factors
MRP = MFC
Marginal
Factor = change in total (factor) cost
Cost unit change in factor quantity
MRP is a factor demand schedule
– consider the case of pure competition
(product price is constant)
LO 11.1
10
Units of
a factor
Total
product
Marginal
product, MP Product
price
Total
revenue
Marginal revenue
product, MRP
] ] ] ] ] ]
] ] ] ] ] ]
0
1
2
3
4
5
6
7
0
7
13
18
22
25
27
28
7
6
5
4
3
2
1
$2
2
2
2
2
2
2
2
$ 0
14
26
36
44
50
54
56
$ 14
12
10
8
6
4
2
0 1 2 3 4 5 6 7 8
14
12
10
8
6
4
2 Fa
cto
r p
rice
(wa
ge
rate
)
Quantity of Labour
The Perfectly Competitive Seller’s Demand Curve
D = MRP Figure 11-1
LO 11.1 11
The Imperfectly Competitive Seller’s
Demand Curve
0 1 2 3 4 5 6 7 8
18
16
14
12
10
8
6
4
2
0
- 2
D = MRP
(imperfect
competition)
D = MRP
(perfect
competition)
The MRP curve of
imperfect competitive
producer (decreasing
price) is less elastic
than that of perfectly
competitive producer
(constant price)
Facto
r p
rice
(wag
e r
ate
)
Quantity of factor demanded
Figure 11 - 2
12 LO 11.1
Marginal Productivity Theory of Factor
Demand
•Market Demand for a Factor
•Sum of the individual demand (MRP)
curves for all firms hiring that factor
13 LO 11.2
11.2 Determinants of Factor Demand
•Changes in Product Demand
•Changes in Productivity
•Quantities of Other Factors
•Technological Progress
•Quality of the Variable Factor
LO 11.2 14
Determinants of Factor Demand
• Changes in the Prices of Other Factors
– Substitute Factors of Production
• Substitution Effect
• Output Effect
• Net Effect
– Complementary Factors of Production
LO 11.3 15
11.3 Elasticity of Factor Demand
• Efd = % change in factor quantity
% change in factor price
• What determines the elasticity of factor
demand?
16 LO 11.3
Determinants of Efd
•Ease of Factor Substitutability
•Elasticity of product Demand
•Ratio of Factor Cost to Total Cost
17 LO 11.4
11.4 Optimal Combinations of
Factors
The Least-Cost Rule:
)) C
C
L
L
(P capital of Price
)(MP capital of
product Marginal
(P labour of Price
)(MP labour of
product Marginal
LO 11.4 18
• The Profit Maximizing Rule:
Optimal Combinations of
Factors
1C
C
L
L
P
MRP
P
MRP
LO11.4 19
Q TP MP TR MRP
] ] ] ] ] ]
] ] ] ] ] ]
0
1
2
3
4
5
6
7
0
12
22
28
33
37
40
42
12
10
6
5
4
3
2
$ 0
24
44
56
66
74
80
84
24
20
12
10
8
6
4
Q TP MP TR MRP
] ] ] ] ] ]
] ] ] ] ] ]
0
1
2
3
4
5
6
7
0
13
22
28
32
35
37
38
13
9
6
4
3
2
1
$ 0
26
44
56
64
70
74
76
$ 26
18
12
8
6
4
2
Labour (price = $8) Capital (price = $12)
What is the least-cost combination of
labour and capital to use in producing 50
units of output?
Table 11-5
Least-Cost and Profit-Maximizing Combination
Will 50 units of output maximize the
firm’s profit?
]
]
] ]
LO11.4 20
Q TP MP TR MRP
] ] ] ] ] ]
] ] ] ] ] ]
0
1
2
3
4
5
6
7
0
12
22
28
33
37
40
42
12
10
6
5
4
3
2
$ 0
24
44
56
66
74
80
84
24
20
12
10
8
6
4
Q TP MP TR MRP
] ] ] ] ] ]
] ] ] ] ] ]
0
1
2
3
4
5
6
7
0
13
22
28
32
35
37
38
13
9
6
4
3
2
1
$ 0
26
44
56
64
70
74
76
$ 26
18
12
8
6
4
2
Labour (price = $8) Capital (price = $12)
What is the least-cost combination of
labour and capital to use in producing 50
units of output?
Table 11-5
Least-Cost and Profit-Maximizing Combination
Will 50 units of output maximize the
firm’s profit?
]
]
] ]
LO11.4 21
Q TP MP TR MRP
] ] ] ] ] ]
] ] ] ] ] ]
0
1
2
3
4
5
6
7
0
12
22
28
33
37
40
42
12
10
6
5
4
3
2
$ 0
24
44
56
66
74
80
84
24
20
12
10
8
6
4
Q TP MP TR MRP
] ] ] ] ] ]
] ] ] ] ] ]
0
1
2
3
4
5
6
7
0
13
22
28
32
35
37
38
13
9
6
4
3
2
1
$ 0
26
44
56
64
70
74
76
$ 26
18
12
8
6
4
2
Labour (price = $8) Capital (price = $12)
What is the least-cost combination of
labour and capital to use in producing 50
units of output?
Table 11-5
Least-Cost and Profit-Maximizing Combination
Will 50 units of output maximize the
firm’s profit?
]
]
] ]
22 LO 11.4
Marginal Productivity Theory of Income
Distribution
•Income gets distributed according to
contribution output
•Criticisms:
•Inequity
•Market imperfections
23
Chapter 11
The Last Word: Input Substitution: the
Case of ABMs • Input substitution
• Banks use ATMs instead of people
• Least-cost combination of resources
• ATMs debut about 38 years ago
• More than 50,000 ABMs in Canada
• 8,000 teller positions eliminated
• Former tellers find new jobs in other sectors
• Customer convenience
• Society wins
Chapter 11
24
Chapter 11 Summary
11.1 Factor Pricing and Demand
MRP (cases of perfect and imperfect competition)
11.2 Determinants of Factor Demand
Change in demand
Change in the productivity
Change in price (substitution and price effect)
11.3 Elasticity of Factor Demand
11.4 Optimal Combination of Factors
Least-cost rule and profit-maximization rule