CH 09

CHAPTER 9
Input Demand:
The Labor and Land Markets
Prepared by: Fernando

Quijano and Yvonn Quijano
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Firm Choices in Input Markets
Demand for Inputs: A Derived Demand
Derived demand is demand for resources

(inputs) that is dependent on the demand
for the outputs those resources can be
used to produce.
Inputs are demanded by a firm if, and only

if, households demand the good or service
produced by that firm.
Inputs: Complementary and Substitutable
The productivity of an input is the

amount of output produced per unit of that
input.
Inputs can be complementary or

substitutable. This means that a firms
input demands are tightly linked together.
Diminishing Returns
Faced with a capacity constraint in the

short-run, a firm that decides to increase
output will eventually encounter
diminishing returns.
Marginal product of labor (MPL) is the

additional output produced by one
additional unit of labor.
Marginal Revenue Product
The marginal revenue product (MRP) of

a variable input is the additional revenue a
firm earns by employing one additional unit
of input, ceteris paribus.
MRPL equals the price of output, PX, times

the marginal product of labor, MPL.
Marginal Revenue Product Per Hour of
Labor in Sandwich Production (One Grill)
(3)
(2) MARGINAL (4) (5)
(1) TOTAL PRODUCT OF PRICE (PX) MARGINAL
TOTAL PRODUCT LABOR (MPL) (VALUE REVENUE
LABOR UNITS (SANDWICHES (SANDWICHES ADDED PER PRODUCT (MPL X PX)
(EMPLOYEES) PER HOUR) PER HOUR) SANDWICH)a (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
The price is essentially profit per sandwich; see discussion in text.
a
Marginal Revenue Product Per Hour of
Labor in Sandwich Production (One Grill)
MRPL = PX MPL
When output price is
constant, the behavior
of MRPL depends only
on the behavior of MPL.
Under diminishing
returns, both MPL and
MRPL eventually
decline.
A Firm Using One Variable Factor of
Production: Labor
A competitive firm using only one variable

factor of production will use that factor 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*.
Marginal Revenue Product and Factor Demand for
a Firm Using One Variable Input (Labor)
The hypothetical firm will demand 210 units of labor.

W* =MRPL = 10
Short-Run Demand Curve for a Factor
of Production
When a firm uses only

one variable factor of
production, that factors
marginal revenue product
curve is the firms
demand curve for that
factor in the short run.
Comparing Marginal Revenue and
Marginal Cost to Maximize Profits
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.
The Two Profit-Maximizing Conditions
The two profit-maximizing conditions are simply two views
of the same choice process.
The Trade-Off Facing Firms
A Firm Employing Two Variable Factors
of Production
Land, labor, and capital are used together

to produce outputs.
When an expanding firm adds to its stock

of capital, it raises the productivity of its
labor, and vice versa. Each factor
complements the other.
Substitution and Output Effects of a
Change in Factor Price
Two effects occur when the price of an

input changes:
Factor substitution effect:
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 an

input changes:
Output effect of a factor price
increase (decrease):
(decrease) When a firm
decreases (increases) its output in
response to a factor price increase
(decrease), this decreases
(increases) its demand for all factors.
Response of a Firm to an Increasing Wage Rate

UNIT COST IF UNIT COST IF
INPUT REQUIREMENTS PL = $1 PL = $2
PER UNIT OF OUTPUT PK = $1 PK = $1
TECHNOLOGY K L (PL x L) + (PK x K) (PL x L) + (PK x K)
A (capital
When PL = P10
Whenintensive)P 5 $15 $20
K = $1, the labor-intensive method of
B (labor intensive) 3
producing output is10less costly. $13 $23
The Substitution Effect of an Increase in Wages on a Firm

Producing 100 Units of Output
TO PRODUCE 100 UNITS OF OUTPUT
TOTAL TOTAL TOTAL
CAPITAL LABOR VARIABLE
DEMANDED DEMANDED COST
When PL = $1, PK = $1, 300 1,000 $1,300

firm uses technology B
When PL = $2, PK = $1, 1,000 500 $2,000

firm uses technology A
When the price of labor rises, labor becomes more

expensive relative to capital. The firm substitutes capital
for labor and switches from technique B to technique A.
Many 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.
Land Markets
Unlike labor and

capital, the total
supply of land is
strictly fixed (perfectly
inelastic.
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.
Land in a Given Use Versus Land of a
Given Quality
The supply of land in a The supply of land of a
given use may not be given quality at a given
perfectly inelastic or location is truly fixed in
fixed. supply.
Rent and the Value of Output
Produced 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
The Firms Profit-Maximization
Condition in Input Markets
Profit-maximizing condition for the

perfectly competitive firm is:
PL = MRPL = (MPL X PX)
PK = MRPK = (MPK X PX)
PA = MRPA = (MPA X PX)

where L is labor, K is capital, A is land (acres),
X is output, and PX is the price of that output.
The Firms Profit-Maximization
Condition in Input Markets
Profit-maximizing condition for the perfectly

competitive firm, written another way is:
M PL M PK M PA 1

PL PK PA PX
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 Curves
If product demand increases, product price will

rise and marginal revenue product will increase.
Input Demand Curves
If the productivity of labor increases, both marginal

product and marginal revenue product will increase.
Impact of Capital Accumulation on
Factor Demand
The production and use of capital enhances the

productivity of labor, and normally increases the
demand for labor and drives up wages.
Impact 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.

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CHAPTER 9

Prepared by: Fernando

Derived demand is demand for resources

Inputs are demanded by a firm if, and only

The productivity of an input is the

Inputs can be complementary or

Faced with a capacity constraint in the

Marginal product of labor (MPL) is the

The marginal revenue product (MRP) of

MRPL equals the price of output, PX, times

A competitive firm using only one variable

If the firm uses only labor, then it will hire

The hypothetical firm will demand 210 units of labor.

When a firm uses only

Assuming that labor is the only variable

Firms weigh the value of outputs as

Land, labor, and capital are used together

When an expanding firm adds to its stock

Two effects occur when the price of an

Two effects occur when the price of an

Response of a Firm to an Increasing Wage Rate

The Substitution Effect of an Increase in Wages on a Firm

When PL = $1, PK = $1, 300 1,000 $1,300

When PL = $2, PK = $1, 1,000 500 $2,000

When the price of labor rises, labor becomes more

If labor markets are competitive, the wages

Firms will hire workers only as long as the

Unlike labor and

The price of a good that is

Because land is fixed in

The return to any factor of production in fixed

A firm will pay for and use land as long as

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

Profit-maximizing condition for the

PK = MRPK = (MPK X PX)

PA = MRPA = (MPA X PX)

Profit-maximizing condition for the perfectly

If product demand increases, product price will

If the productivity of labor increases, both marginal

The production and use of capital enhances the

Technological change refers to the

Technological change can, and does, have

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