Chapter 6Chapter 6

Factor Markets and Factor Markets and Income DistributionIncome Distribution

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BUSINESS FIRMS HOUSEHOLDS

SUPPLIER

BUYER

PRODUCT MARKETSFACTOR MARKETS

Determinants of Factor Determinants of Factor DemandDemand

The demand for productive The demand for productive resources.resources.

ProductivityProductivity - the most productive - the most productive resources have highest demand.resources have highest demand.

Prices of factor substitutes and Prices of factor substitutes and complementary resourcescomplementary resources affect the affect the demand for productive resources.demand for productive resources.

Demand for LaborDemand for Labor

The quantity demanded has inverse The quantity demanded has inverse relationship with wage rates.relationship with wage rates.

Marginal product of laborMarginal product of labor – is the additional – is the additional output produced by the employment of an output produced by the employment of an additional man-hour of labor.additional man-hour of labor.

Marginal revenue product of laborMarginal revenue product of labor – the – the additional revenue obtained by selling the additional revenue obtained by selling the marginal product of labor.marginal product of labor.

Marginal resource costMarginal resource cost – the payment of – the payment of additional man-hour-labor and other additional man-hour-labor and other productive resources like land and capital.productive resources like land and capital.

EMPLOYMENT DECISONSEMPLOYMENT DECISONS

MRP≥MRC, INCREASE LABORMRP≥MRC, INCREASE LABOR MRP≤MRC, DECREASE LABORMRP≤MRC, DECREASE LABOR MRP=MRC, NO ACTIONMRP=MRC, NO ACTION

SUPPLY IN THE FACTOR SUPPLY IN THE FACTOR MARKETMARKET

Increase in price means increase in Increase in price means increase in supply and vice versa applying the supply and vice versa applying the idea of ceteris paribus.idea of ceteris paribus.

SUPPLY OF LABORSUPPLY OF LABOR

LABOR MARKETLABOR MARKET

INCOME DISTRIBUTIONINCOME DISTRIBUTION

RousseauRousseau ProudhonProudhon Karl MarxKarl Marx

TYPES OF INCOME TYPES OF INCOME DISTRIBUTIONDISTRIBUTION

Personal Personal distributiondistribution

Functional Functional distributiondistribution

Causes of Income Causes of Income InequalityInequality

Intelligence and talents.Intelligence and talents. Education and training.Education and training. Unpleasant and risky jobs.Unpleasant and risky jobs. Ownership of productive factors.Ownership of productive factors. Luck and connectionsLuck and connections

Theories of Income DistributionTheories of Income Distribution

There are several theories of income There are several theories of income distribution based in the following:distribution based in the following:

Marginal productivityMarginal productivity NeedsNeeds Social usefulnessSocial usefulness EqualityEquality

Pricing of resourcesPricing of resources

--refers to payments of the factors refers to payments of the factors of production.of production.

Wages – The Price LaborWages – The Price Labor

Wage – the most important price of Wage – the most important price of productive resources.productive resources.

Real wagesReal wages – refer to the number of – refer to the number of goods and services that a worker can goods and services that a worker can buy with his money wage – his buy with his money wage – his nominal income. nominal income.

Determinants of wage ratesDeterminants of wage rates

Supply and demandSupply and demand Minimum wageMinimum wage Labor unionsLabor unions

Economic rentEconomic rent

In economics, rent is the payment for In economics, rent is the payment for the use of land and other natural the use of land and other natural resources which are completely fixed resources which are completely fixed in total supply.in total supply.

According to According to Adam SmithAdam Smith, rent was a , rent was a a monopoly price.a monopoly price.

R1

R2

R3

D1

D2

D3

Determination of land rent through demand and supply.

Interest RateInterest Rate

It is the payment for using the money It is the payment for using the money of other individuals.of other individuals.

UsuryUsury – the imposition of unreasonably – the imposition of unreasonably high interest rate on loans.high interest rate on loans.

Loan sharks or usurersLoan sharks or usurers – those who – those who charge extremely high interest rates.charge extremely high interest rates.

ProfitsProfits

Economic or Pure ProfitsEconomic or Pure Profits – earnings of firm – earnings of firm after deducting the cost of production, after deducting the cost of production, which includes explicit cost and implicit which includes explicit cost and implicit cost.cost.

Explicit costExplicit cost – actual expenditures if firm. – actual expenditures if firm. Implicit costImplicit cost – payments to productive – payments to productive

resources owned and self-employed by a resources owned and self-employed by a firm.firm.

Normal profitNormal profit – the minimum payment for – the minimum payment for the entrepreneur as a factor of production.the entrepreneur as a factor of production.