Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- Factor markets are markets for labour, capital and land. Households sell factor services; firms buy them. This is the reverse of a product market.
- Factor prices: labour → wage; capital → interest; land → rent. They act as incentives and signal scarcity.
- Labour demand is a derived demand: it comes from the demand for the product the workers make.
- A firm’s hiring decision depends on the factor’s productivity (MP), the output price (or MR) and the cost of the factor (MRC).
- Market labour demand slopes down; market labour supply slopes up. A change in the wage moves along the curves.
Key relationships
| Measure | Formula | Notes |
|---|---|---|
| Marginal product (MP) | ΔTP ÷ ΔL | In units of output; falls with diminishing returns |
| Marginal revenue product (MRP) | ΔTR ÷ ΔL = MP × MR | In dollars; the firm’s demand for labour |
| MRP for a price taker in the output market | MP × P (value of the marginal product) | MR = P |
| MRP for a firm with market power | MP × MR, less than MP × P | Price cut on earlier units lowers MR |
| Marginal resource cost (MRC) | ΔTC ÷ ΔL | Also called marginal factor cost (MFC) |
| MRC for a wage taker | = wage | Horizontal line on a graph |
| Curve | Slope | Reason |
|---|---|---|
| Labour demand | negative | MRP falls as workers are added, so a lower wage makes more workers worth hiring |
| Labour supply | positive | higher wage raises the opportunity cost of leisure and draws workers from other jobs |
Assumptions and scope
- Other inputs (capital, land) are fixed while the firm varies labour.
- “Other things constant”: only the wage changes when we move along a curve. Shifts are Topic 5.2.
Mistakes to avoid
- Calling households the buyers in a factor market.
- Giving MP (units of output) when the question asks for MRP (dollars).
- Multiplying total product by price instead of marginal product.
- Using MP × P for a firm that must cut its price to sell more.
- Including fixed cost in MRC.
- Saying a wage change shifts labour demand or supply.
Quick self-check
- A worker adds 6 units of output, and each unit sells for $15 in a competitive market. What is the worker’s MRP? (6 × $15 = $90)
- Hiring a 6th worker raises total revenue from $400 to $470. What is the MRP of the 6th worker? ($470 − $400 = $70)
- A firm hires at a market wage of $80 a day. What is its MRC? ($80 for every worker)
- Why is the demand for bakers a derived demand? (Bakeries want bakers only because people buy bread.)
Next: practice questions.