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
Firms hire workers to make products people buy.
$MRP = MP \times P = 5 \times 10$.
Hiring more would cost more than the worker adds.
The firm is a wage taker.
It restricts hiring to keep wages down.
MRP rises when the price rises.
Higher marginal product raises MRP.
Labor gives 2 units per dollar and capital gives 1.5 units per dollar.
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.
Check off the points you earned:
(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.
Check off the points you earned:
(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: