AP Microeconomics

Unit 5

Factor Markets

8 practice questions · Free response

Notes

Derived demand

Demand for labor, land and capital is derived from the demand for the products they help make. If demand for cars rises, demand for autoworkers rises.

Marginal revenue product and marginal resource cost

  • Marginal product (MP) of labor: the extra output from one more worker.
  • Marginal revenue product (MRP) $= MP \times MR$. In a perfectly competitive product market, $MR = P$, so $MRP = MP \times P$.
  • Marginal resource cost (MRC) (or marginal factor cost): the extra cost of hiring one more worker.
  • Hiring rule: hire workers until MRP = MRC.
  • Labor demand shifts with product demand (and price), worker productivity (technology, training), and prices of other inputs.
  • Labor supply shifts with population, immigration, preferences, and alternative jobs.

Perfectly competitive labor markets

The firm is a wage taker: the wage is set by the market, so $MRC = W$ (horizontal labor supply to the firm). It hires until $MRP = W$.

Monopsony

  • A monopsony is a single buyer of labor (like a large employer in a small town). To hire more workers, it must raise the wage for everyone, so MRC is above the labor supply curve.
  • It hires where $MRP = MRC$ and pays the wage on the supply curve below that point: fewer workers and a lower wage than in a competitive market.
  • A minimum wage in a monopsony can raise both wages and employment (up to a point).

Least-cost rule

Firms use the combination of inputs where $\displaystyle \frac{MP_L}{P_L} = \frac{MP_K}{P_K}$ (the last dollar spent on each input adds the same output).

Practice

Demand for factors of production is called derived demand because:
A worker adds 5 units of output, and each unit sells for 10 dollars in a perfectly competitive market. What is the worker's MRP?
A profit-maximizing firm hires workers until:
In a perfectly competitive labor market, a firm's marginal resource cost equals:
A monopsony, compared with a competitive labor market, hires:
An increase in the price of the product a firm sells will:
A new training program makes workers more productive. Labor demand will:
A firm uses labor (MP = 20, price = 10 dollars) and capital (MP = 30, price = 20 dollars). To minimize cost, it should:

Free response

Write your answer first, then open the scoring guide.

Free-response question

A firm sells its product in a perfectly competitive market at 4 dollars each and hires workers in a perfectly competitive labor market at a wage of 40 dollars per day. Total output with 1, 2, 3, 4 and 5 workers is 20, 36, 48, 56 and 60 units.

(a) Calculate the marginal revenue product of the 3rd worker.

Show the answer and scoring guide

MP of the 3rd worker $= 48 - 36 = 12$. $MRP = 12 \times 4 = 48$ dollars.

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(b) How many workers should the firm hire? Explain.

Show the answer and scoring guide

MRPs: 80, 64, 48, 32, 16 dollars. Hire while MRP is at least the 40 dollar wage: 3 workers. The 4th worker's MRP (32 dollars) is less than the wage.

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(c) The product price rises to 6 dollars. How many workers will the firm hire now?

Show the answer and scoring guide

MRPs become 120, 96, 72, 48, 24 dollars. Hire 4 workers, since the 4th's MRP (48 dollars) is above the wage but the 5th's (24 dollars) is not.

Check off the points you earned: