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Microeconomics: Factor Markets

Definition:

  • Factor markets: markets for the factors of production (example: labor and capital).
  • Markets are formed whenever consumers and producers meet to exchange goods or services.
Deriving factor demand:

  • the demand for goods or services in the product markets creates demand for the factors of production. 
    • An increase (decrease) in demand for good X leads the suppliers to increase their production thereby increasing (decreasing) the demand for the factors of production. 
Marginal revenue product:

  • The demand for the factor of production is formed by multiplying a firm's marginal revenue by its marginal product. 
    • Remember that by taking the derivative of the TR function with respect to Q we are able to find the MR.

  • Marginal product on the other hand is found by taking the derivative of the production function with respect to a factor of production (L or K for example).

  • Marginal revenue product (MRP): the change in total revenue when one more input is employed. It decreases as more similar inputs are employed due to the principle of diminishing marginal return.

  • Notice that the MRP is the factor demand; an increase in product prices, marginal revenue or marginal product increases (rightward shift) the factor demand.
Marginal-factor cost:

  • Marginal factor cost (MFC) is the extra cost a firm incurs when employing one additional unit of input such as a worker or machine.
    • In other words, the MFC is derived by taking the derivative of the TC function with respect to a specific input.

  • In a perfectly competitive factor market, the MCF is equal to the price of the input, i.e either wage rate for the labor market or rental rate in the capital market.


Reference: Mayer,David. AP Microeconomics Crash Course. Research & Education Association (2014). p 125-128.
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