No Bull Economics Lessons

Macroeconomics & Microeconomics Concepts You Must Know

5.1 Perfectly Competitive Labor Market (Micro)

Factor Markets Review Terms

  • Firms are sellers in a product market and buyers in a factor (resource) market.
  • The demand for any resource is derived from the demand for the products that the resource can produce.  Thus, resource demand depends upon the price of the good or service that the resource produces and upon the resource’s productivity in producing the good or service
  • The demand curve for a resource is downward sloping because the marginal physical product (MPP) of additional inputs of a resource will decrease because of the law of diminishing marginal returns.  In some textbooks, marginal physical product is called marginal product.
  • The resource demand curve for a firm selling in an imperfectly competitive market will be steeper than the resource demand curve for a firm selling in a perfectly competitive market.  The steeper slope results from both a decrease in the marginal physical product and a a decrease in the product price required to permit the firm to sell a larger output.
  • A firm will continue to hire factors of production as long as its marginal revenue product (MRP) exceeds its marginal resource cost (MRC).  A firm will not hire resources once their MRC exceeds their MRP.
  • A firm maximizes profits where a factor’s marginal revenue product equals a factor’s marginal resource cost.  A firm maximized profit where MRP=MRC.
  • In a perfectly competitive labor market, a firm will hire workers until the last worker’s wage (MRC) equals the marginal revenue product of the last worker hired.
  • When a combination of resources is employed in producing a good or service, the profit maximizing rule is: 

         MRPa/MRCa =MRPb/MRCb = 1   

     or   MRPa/Pa= MRPb/Pb = 1

  • When a firm produces the profit-maximizing level of output, it must utilize a least cost combination of resources. The rule for a least-cost combination of resource is:

        MPPa/MRCa = MPPb/MRCb

        or  MPa/Pa = MPb/Pb

  • However, a least-cost combination of resources is not necessarily a profit-maximizing combination since the least-cost rule requires that the marginal  physical product per dollar expenditure on each resource be proportionate at any number greater than zero; the profit-maximizing rule requires that the marginal revenue product of each resource employed by equal to its marginal resource cost and, therefore, their rations must be equal to 1.
  • For a firm facing a perfectly competitive resource market, resource supply is perfectly elastic and equal to marginal resource cost at a market-determined price (wage) for the resource.  Under Monopsony or imperfect conditions of employment, both resource supply and marginal resource cost are positively sloped curve with the marginal resource cost being a value greater than the price (wage) for all units beyond the first unit of the resource employed.
  • Given a downward-sloping marginal revenue product curve and the differences existing between supply and marginal resource cost in perfect competition and monopsony, a monopsonistic employer will pay a lower price (wage) and hire fewer units of a resource than a perfect competitor
  • Economic rent is any payment to the supplier of a resource that is great than the minimum amount required to employ the desired quantity of the resource to be supplied.
  • The equilibrium real interest rate influences the level of investment and helps allocate financial and physical capital to specific firms and industries.
  • Profits are the return to entrepreneurs for assuming risk and for organizing and directing economic resources.
  • Profits allocate resources according to the demands of consumers.

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