Factor Markets

The Markets for Inputs

Factor markets (labour, capital, land) are the flip side of product markets — firms are buyers and households are sellers.

Labour demand: a profit-maximising firm hires workers until the value of the last worker's output equals the wage:

$$VMP_L = P \times MP_L = w$$

The value of marginal product ($VMP_L$) curve is the firm's labour demand curve. It slopes downward because of diminishing marginal returns.

Market wage determination: labour supply and demand intersect to give the equilibrium wage. In competitive labour markets, workers earn their marginal product.

Monopsony: a single buyer of labour (like a company town). The monopsonist faces an upward-sloping labour supply — to hire more workers, it must raise the wage for ALL workers. This makes the marginal cost of labour exceed the wage:

$$MCL > w \qquad (\text{analogous to } MR < P \text{ in monopoly})$$

The monopsonist hires fewer workers and pays a lower wage than the competitive outcome — a mirror image of monopoly's restriction.

Human capital (Becker): education and training increase worker productivity, justifying higher wages. The decision to invest in education is a cost-benefit analysis:

$$\text{NPV of education} = \sum \frac{w_{\text{skilled}} - w_{\text{unskilled}}}{(1+r)^t} - \text{tuition and foregone wages}$$

Wage differentials arise from: human capital differences, compensating differentials (dangerous or unpleasant jobs pay more), discrimination, union bargaining power, and efficiency wages (firms pay above market to reduce turnover).

Competitive vs monopsony hiring

Tip: Monopsony is why a minimum wage can raise employment — a floor above the monopsony wage but below $VMP_L$ removes the incentive to restrict hiring, moving the market toward the competitive outcome.