MODULE 3 SUMMARY SHEET

• Factors of Production and their rewards

  • Land-rent
  • Labour-wages
  • Capital-interest
  • Enterprise-profit
• Derived demand


  The demand for a factor of production which comes about due to the demand for the good or service that the factor of production is used to produce
• Derived demand


  • The demand for Econ teachers is a derived demand as there is an increase in demand for Econ courses
• Marginal Productivity Theory


  A firm will demand a factor of production, particularly labour and capital, up to the point where the marginal revenue product of the last unit of factor of production employed is equal to the cost of employment

  
• Assumptions of the Marginal Productivity Theory of Labour

  • Firms are wage takers
  • Perfect knowledge exists
  • Workers are equally skilled
  • Firms are profit maximisers
  • Factors of production are completely mobile - geographical mobility
• Limitations of the Marginal Productivity Theory


  • There exist imperfections in the labour market hence labour is not purely mobile
  • In the real world labour is not homogenous
  • It is difficult to measure the output of service workers
  • Due to informational asymmetries, perfect information does not exist
• Marginal Revenue Product (MRP)


  MRP= Marginal Product of the Factor * Marginal Revenue (Price of the good)
• According to the MRP theory, firms hire where MRP is equal to wage

  
• MRP may increase if

  MPP rises or if the price of the commodity increases
• The firm's MRP curve is referred to as the firm's demand curve for labour
• Marginal Revenue Product of Capital


  The firm will demand capital up to the point where the Marginal Revenue Product of Capital is equal to the price of capital
• Net Present Value (NPV)

  The difference between the present value (PV) of the investment and its cost (C)
• If the NPV is positive, then investment in capital is feasible and firms should invest. If the NPV is negative, then the investment is not profitable and the firm should not purchase the capital
• Least Cost Method


  The firm will select the combination of inputs that will minimize cost for a given level of output
• Determining the least cost method

  1. Produce a given level of output, the firm should buy inputs until it has equalized the marginal product per dollar spent on each input (profit maximizing rule- MRP of labour = Wage)

  2. When the marginal product to price ratio for each input variable is equal, the firm is producing at the minimum cost

  3. If the ratios are not equal, the firm should use more of the input with the higher ratio and less of the input with the lower ratio

  
• Determining the interest rate in the market for loanable funds


  1. The rate of interest is determined by the demand and supply of loanable funds

  2. The supply of loanable funds comes through savings and the demand for loanable funds comes through investment

  3. If there is excess supply of loanable funds, the interest rate will fall

  4. If there is excess demand for loanable funds, the interest rate will rise

  
• Determining wages in the labour market

  1. Wages are determined by the demand for and supply of labour

  2. If there is excess supply of labour in the market, then wages will fall

  3. If there is excess demand for labour, then wages will rise

  
• Factors affecting the supply of land, labour and capital


  • Land: Rental price
  • Labour: Wages, Income, Skills and Education, Mobility of labour, Discrimination
  • Capital (savings): Interest Rate, Expected future income
• Factors affecting the demand for land, labour and capital

  • Land: Price, Industry growth and the economy, Location
  • Labour: Wages, Industry growth and the economy, Advances in technology, Population mobility
  • Capital: Interest rate, Indebtedness
• Fixity of land and rent determination

  Land is said to be fixed in supply. Rental price for land is purely determined by the demand for land. If the demand is high, rental price is high if demand is low, rental price is also low
• Economic rent and transfer earnings

  Transfer earning is the minimum amount of income necessary to keep a factor in its current or encourage employment of a factor while economic rent is the amount in excess of transfer earnings
• Wage differentials


  The differences in wages paid to varied units of labour
• Factors that cause wage differentials

  • Levels of skills and training and education
  • Risk or hazardous work- compensating wage differentials
  • Differences in relative demand and supply in the labour market
  • Immobility of workers
  • Presence of trade unions

  
• Compensating wage differential


  The difference in wages offered to offset the desirability or undesirability of a job
• Reasons for compensating wage differentials

  • Risk and Hazardous Conditions
  • Education and Skill
  • Location
• Compensating wage differentials have an important allocative function for the economy by providing incentives for people to undertake less desirable work and for employers to reduce the undesirable nature of the work
• Reasons why some workers are more productive than others

  • Level of skills and education
  • The difference in wages (wage efficiency hypothesis)
  • The availability of technology
• Minimum wage


  The minimum amount of wage that can be paid to a unit of worker. Minimum wage is a price floor
• Efficiency wage hypothesis


  Worker productivity has a positive relationship with pay. If you pay a worker more, they will work harder and produce more output than if you paid them the wage dictated by supply and demand
• Labour mobility


  The ease with which laborers are able to move around within an economy and between different economies
• Labour immobility


  The difficulty of labour to move within the different areas of the economy
• Wage and employment determination in a perfectly competitive labour market

  1. Wages are determined in the industry by the demand and supply of labour

  2. Firms operating in a perfectly competitive labour market are wage takers and have to pay the wages determined by the industry

  3. The firm's demand curve represents the Marginal Revenue Product (MRP) curve

  4. The Marginal Factor Cost curve, in this case, may be referred to as the labour supply curve which is a horizontal line

  5. The firm will hire L1 workers and pay them W1 as the industry suggests

  6. Any intervention by trade unions to increase the wage rate will result in unemployment

  
• Wage and employment determination in a monopsony labour market


  1. Monopsony in the labour market exists when there is a single buyer of labour

  2. A single buyer faces a large number of workers who are un-organised and whose geographical mobility of labour is very much limited

  3. Monopsony may prevail when a big employer hires a proportionately very large number of a given type of labour or when various employers have an understanding not to compete for labour and thus act as one in hiring labour

  4. Non-organisation of labourers into unions is an essential condition for the existence of monopsony
• Monopsony


  A single buyer of labour
• Monopsony in the labour market

  • A single buyer faces a large number of workers who are un-organised and whose geographical mobility of labour is very much limited
  • A large single employer or various employers acting as one confronts a large number of workers who are unorganised (i.e., non-unionized) and who lack geographical mobility
• When workers are unionized


  Trade unions will represent labour and bargain for higher wages, which will increase labour supply and reduce unemployment

  
• Wages under perfectly competitive labour market

  Higher than under monopsony
• Size distribution of income

  How income is distributed to different segments of the population
• Functional distribution of income


  How income is distributed according to the owners of factors of production
• Income inequality


  The uneven distribution of income