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.

$\frac{dTR}{dQ}\approx \frac{\Delta TR}{\Delta Q}$

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).

$\\ 1. MPK= \frac{\partial F}{\partial K} \\\ \\ 2. MPL= \frac{\partial F}{\partial L}$

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.

$\\ 1. MRP_L= MR \cdot MPL \\\ \\ 2. MRP_K= MR \cdot MPK$

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.

$\\ 1. MFC_L= \frac{\partial TC}{ \partial L } \approx \frac{\Delta TC}{\Delta L}\\\ \\ 2. MFC_K= \frac{\partial TC}{ \partial K } \approx \frac{\Delta TC}{\Delta K}$

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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