Factor Markets 1

Question 1

What are factor markets

Answer 1

Markets in which the services of the FOP (labour, land, capital and entrepreneurship) are bought and sold.

Question 2

Introduction to the theory

Answer 2

Firms aim to minimise costs or maximise profits by choosing labour (L) and capital (K) such that the marginal rate of technical substitution equals MRTS(L,K) = w/r where w is wage and r is the rental rate of capital. This ensures efficient input use.

Question 3

Demand for labour

Answer 3

Labour demand is derived demand that depends on the demand for the final good. The firms hiring decision is based on comparing the benefit of an additional worker to the cost (wage).

Question 4

Marginal product of labour (MPL)

Answer 4

The extra output from hiring one more worker

Question 5

Marginal revenue (MR)

Answer 5

The extra revenue from selling one more unit of output

Question 6

Marginal revenue product of labour (MRPL)

Answer 6

MPL x MR, representing additional revenue from one more worker

Question 7

Demand for labour under perfect and imperfect competition

Answer 7

Under PC, MR=P, so MRPL = MPL x P = VMPL (Value of Marginal Product of Labour). Under IPC, MR < P, hence MRPL < VMPL. This creates an inverse relationship between MRPL and the quantity of labour hired

Question 8

Hiring rule

Answer 8

Firms hire workers until MRPL = w. If MRPL > w, hire more workers; if MRPL < w, hire fewer. this ensures profit maximisation

Question 9

Shifts in labour demand

Answer 9

Any factor that changes the MPL or MR will shift the labour demand curve e.g.
-Change in productivity or technology- higher shifts demand right
-Change in capital- complementary capital increases MPL, shifts demand right
-Change in output price- lower price reduces MRPL, shifts demand left

Question 10

Industry about demand and wage feedback

Answer 10

At industry level, if there is a feedback effect lower wages can lead to lower prices making demand steeper. In the SR, capital is fixed but in the LR both labour and capital can adjust, making the LR labour demand more elastic (flatter)

Question 11

What is the feedback effect

Answer 11

A situation where an initial change in one variable causes a response in another variable which then loops back to reinforce or alter the original change. Its a circular causal relationship