Factor Markets
Unit III is similar to Unit II, in that factor markets are basically a special category of product markets. In this case, though, the "product" of our market is one of the four factors of production (Land, Labor, Capital, and Entrepreneurship, although we don't really have a "market" for Entrepreneurs).
Using the same principles we learned in the Product Markets, we're now going to analyze the markets for the various factors of production. With this insight, we can determine why the unit cost of labor is higher in one country than in another, or why some firms have to pay more than other firms for the same natural resource. The profit-maximizing rule in a product market is that MR=MC (that is, marginal revenue equals marginal cost). In a factor market, the profit-maximizing rule is MRP=MRC, that is, marginal revenue product equals marginal resource cost. If hiring an additional worker costs $4 and that additional worker produces an additional $3 worth of goods, you shouldn't hire that worker. (Unless you are running an elaborate tax dodge.) Taken together, the product markets and the factor markets combine to form the circular flow of economic activity, at right. |