Factor Markets: every key term you need (+ practice quiz)

More AP Microeconomics guides

• Supply and Demand
• Production, Cost, and the Perfect Competition Model
• Imperfect Competition
• Market Failure and the Role of Government

Factor Market

A market where firms buy productive resources — labor, land, and capital — from households.

Derived Demand

Demand for a factor comes from demand for the product it helps produce; more pizza demand means more demand for pizza cooks.

Marginal Product of Labor (MPL)

The additional output from hiring one more worker, holding other inputs constant.

Marginal Revenue Product (MRP)

The additional revenue from hiring one more unit of a factor: MRP = MPL × MR (which equals MPL × P for a competitive seller).

Marginal Factor Cost (MFC)

The additional cost of hiring one more unit of a factor; also called marginal resource cost (MRC).

Profit-Maximizing Hiring Rule

Hire units of a factor up to the point where MRP = MFC.

Firm's Labor Demand Curve

The downward-sloping portion of the MRP curve; it slopes down because of diminishing marginal returns.

Shifters of Labor Demand

Changes in output price (product demand), worker productivity or technology, and prices of other inputs shift the MRP curve.

Labor Supply

The number of workers willing to work at each wage; upward sloping because higher wages draw more people into the market.

Shifters of Labor Supply

Population and immigration, worker preferences, opportunities in other occupations, and required education or licensing.

Perfectly Competitive Labor Market

Many firms hire many identical workers; each firm is a wage taker facing a horizontal labor supply at the market wage, so MFC = wage.

Wage Taker

A firm too small to affect the market wage; it can hire any number of workers at the going wage.

Market vs. Firm Graphs (labor)

The market graph's supply and demand set the wage; the firm's horizontal MFC = S curve at that wage crosses its MRP to set employment.

Monopsony

A labor market with a single buyer of labor, such as the only hospital in a small town.

Monopsony MFC Above Supply

To hire an extra worker, a monopsonist must raise the wage of all workers, so marginal factor cost lies above the labor supply curve.

Monopsony Outcome

Hires where MRP = MFC but pays the lower wage from the supply curve: fewer workers and a lower wage than a competitive market.

Least-Cost Rule

To produce any output at minimum cost, equalize marginal product per dollar across inputs: MPL/PL = MPK/PK.

Profit-Maximizing Input Combination

Employ each input up to where its MRP equals its price: MRPL/PL = MRPK/PK = 1.

Rent (economic)

Payment for land; because the supply of land is perfectly inelastic, rent is determined entirely by demand.

Interest (factor payment)

The payment for the use of capital; firms invest when the expected rate of return exceeds the interest rate.

Wage Determination

In competitive markets, the equilibrium wage equals the marginal revenue product of the last worker hired.

Wage Differentials

Wages differ across jobs because of human capital, compensating differentials for unpleasant work, ability, and discrimination.

Compensating Differential

A wage premium paid to attract workers to dangerous, unpleasant, or otherwise undesirable jobs.

Minimum Wage in Competitive Markets

A binding minimum wage above equilibrium reduces employment and creates a labor surplus (unemployment).

Minimum Wage under Monopsony

A minimum wage set between the monopsony wage and the competitive wage can raise both wages and employment.

Union Effects

Unions raise wages by restricting labor supply, bargaining collectively, or increasing demand for union labor.

Bilateral Monopoly

A monopsonist employer facing a union (monopoly seller of labor); the wage lands between the two extremes through bargaining.

Change in Product Price and MRP

If the price of the firm's output rises, every worker's MRP rises, shifting labor demand rightward.

Diminishing Returns and Hiring

MRP falls as more workers are hired because MPL falls, so firms hire additional labor only at lower wages.

Substitute Inputs

If machines and workers are substitutes, cheaper machinery can reduce labor demand (substitution effect) or raise it via higher output (output effect).

Complementary Inputs

Inputs used together; cheaper capital that is complementary to labor raises labor's productivity and demand.

Supply Curve of Labor to a Firm (competitive)

Horizontal at the market wage: the firm can hire all it wants at that wage, so wage = MFC.

Human Capital Investment

Education and training raise a worker's marginal product, shifting their labor supply into higher-MRP occupations and raising earnings.

Immigration and Wages

An increase in labor supply from immigration lowers the equilibrium wage and raises employment in affected markets, ceteris paribus.