# Factor Markets

Business I · Microeconomics · https://tryals.app/learn/business-i/factor-markets

## Input Markets & Labour Demand

**Factor markets** for labour, capital, and land are the flip side of product markets: firms are **buyers** and households are **sellers**.

**Labour demand** relies on profit maximisation. A 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 due to diminishing marginal returns.

**Market wage determination** occurs where labour supply and demand intersect. In competitive labour markets, workers earn their marginal product.

## Monopsony & Wage Differentials

A **monopsonist** is a single buyer of labour. Because it faces an upward-sloping labour supply, hiring more workers requires raising wages for all current workers. Thus, marginal cost exceeds the wage:

$$MC_L > w$$

| | Competitive buyer | Monopsonist |
|---|---|---|
| **Faces** | Market wage (flat) | Upward supply |
| **Hires** | $VMP_L = w$ | $VMP_L = MC_L > w$ |
| **Result** | Efficient employment | Lower wage & jobs |

**Human capital** (skills/education) increases productivity. **Wage differentials** also stem from compensating differentials, discrimination, unions, and efficiency wages.

## Practice questions

4 of this lesson's 13 practice questions, with answers. The full set is in the app.

### 1. Match each factor-market concept to its definition.

**Answer:**

- $VMP_L = w$ → Competitive firm hires until marginal value equals wage
- Monopsony → Single buyer of labour pays below VMP
- Human capital → Education and training that increase productivity
- Compensating differential → Higher pay for unpleasant or dangerous work

**Why:** Four concepts governing wages, marginal productivity, market power, investment in skills, and non-pecuniary attributes.

Page: https://tryals.app/practice/business-i/factor-markets/match-each-factor-market-concept-to-its-definition

### 2. Labour demand is called a derived demand. What follows for a worker whose employer's product suddenly falls out of fashion?

A. Their wage is protected, since it reflects their own productivity
B. Their employer must retrain them, since demand for labour is fixed
C. Their wage can fall despite unchanged skill and effort
D. Nothing follows; product demand affects hours rather than wages

**Answer:** C. Their wage can fall despite unchanged skill and effort

**Why:** Firms hire up to where the wage equals the value of the last worker's output, and that value contains the product price, so a demand collapse cuts the wage with the worker's skill untouched. It is why 'my wage should reflect how hard I work' misdescribes the mechanism, and why industry choice matters as much as effort.

Page: https://tryals.app/practice/business-i/factor-markets/labour-demand-is-called-a-derived-demand-what-follows-for-a-worker

### 3. Sort these into reasons for wage differentials.

**Answer:**

- Human capital: Surgeon earns more than nurse (years of training), PhD holder earns more than bachelor holder
- Compensating differential: Night-shift workers earn a premium, Oil-rig worker earns above average (dangerous)

**Why:** Human capital: wages reward investment in skills. Compensating differential: wages compensate for undesirable job attributes.

Page: https://tryals.app/practice/business-i/factor-markets/sort-these-into-reasons-for-wage-differentials

### 4. In a competitive labour market, workers are paid their value of marginal product.

**Answer:** True

**Why:** Competition drives the wage to $VMP_L = w$. No firm pays more (would lose money); no firm pays less (workers would go to competitors).

Page: https://tryals.app/practice/business-i/factor-markets/in-a-competitive-labour-market-workers-are-paid-their-value-of