#AP Microeconomics: Unit 5 - Factor Markets Study Guide 🚀

This unit makes up 10-13% of the AP Micro exam, so it's crucial to master these concepts! Let's dive in and make sure you're ready.

#Introduction to Factor Markets

#The Flip Side 🔄

Remember the circular flow model? In the product market, households buy goods and services from firms. Well, in factor markets, it's the other way around! Firms are the demanders, buying factors of production (labor, land, capital, and entrepreneurship) from households. It's like looking in a mirror – everything is reversed! 🪞

Key Concept

This is a crucial shift in perspective. Always ask: "Who is demanding? What are they demanding?" This will help you stay oriented in factor market analysis.

#Derived Demand 💡

The demand for factors of production is derived demand. This means that the demand for labor (or any factor) depends on the demand for the final product it helps produce. If the demand for smartphones increases, so will the demand for workers who make them. 💥

Quick Fact

Think of it this way: No one wants to buy a robot unless they want the thing the robot makes!

#Marginal Revenue Product (MRP) and Marginal Resource Cost (MRC)

Firms decide how many workers to hire by comparing the marginal revenue product (MRP) (the additional revenue from hiring one more worker) and the marginal resource cost (MRC) (the cost of hiring one more worker). Firms will hire as long as MRP ≥ MRC.

Memory Aid

MRP: Money Really Produced by one more worker. MRC: Money Required to Compensate one more worker.

#Changes in Factor Demand and Factor Supply

#Supply and Demand, but Flipped! 🔀

Just like product markets, factor markets have supply and demand curves. But remember, firms are the demanders, and households are the suppliers.

Quick Fact

Think of it like this: Firms demand labor, and people supply their labor.

#Determinants of Factor Demand (R.O.D.)

These factors shift the labor demand curve:

Resource Productivity: If workers become more productive, demand for labor increases.
Price of Other Resources: If the price of capital (like machines) decreases, firms may use more capital and less labor.
Product Demand: If demand for the final product increases, demand for labor to produce it also increases.

Memory Aid

Remember R.O.D.: Resource productivity, Other resource prices, Demand for the product.

#Determinants of Factor Supply (P.I.N.)

These factors shift the labor supply curve:

Personal Values/Leisure: If people value leisure more, they'll supply less labor.
Intervention by Government: Policies like occupational licensing or minimum wage can affect labor supply.
Number of Qualified Workers: An increase in the number of qualified workers increases labor supply.

Memory Aid

Remember P.I.N.: Personal values, Intervention by government, Number of workers.

Determinants of Labor Demand (DL)	Determinants of Labor Supply (SL)
R.O.D	P.I.N
1. Productivity of the Resource	1. Personal values/leisure
2. Price of Other resources	2. Intervention by government
3. Product Demand	3. Number of qualified workers

#Profit-Maximizing Behavior in Perfectly Competitive Factor Markets

#Wage Takers 🧑‍💼

In a perfectly competitive labor market, many firms compete for workers, and workers are wage-takers. No single firm or worker can influence the market wage. The market wage is determined by the intersection of market supply and demand for labor.

Quick Fact

Think of it like a big job fair where everyone has to accept the going rate for their skills.

#MRP = MRC Rule

Firms in a perfectly competitive labor market hire workers up to the point where MRP = MRC. Since the wage is constant for the individual firm, the MRC = Wage = Supply of labor is perfectly elastic. The firm's demand curve for labor is its MRP curve.

Exam Tip

Remember that the MRC curve for a perfectly competitive firm is horizontal (perfectly elastic) at the market wage rate. This is a key difference from monopsony.

#Cost Minimization

Firms also seek to minimize costs by choosing the optimal combination of resources. For example, they will hire workers and buy capital until the marginal product per dollar spent is equal for all resources.

Memory Aid

Think of it this way: Firms want the most bang for their buck, whether it's from workers or machines.

#Monopsonistic Markets

#Wage Makers 👑

A monopsony is a market with only one buyer of labor. This gives the firm wage-making power. In a monopsony, the firm's labor supply curve is the market labor supply curve. The firm must increase wages to hire more workers, so the MRC curve is above the labor supply curve.

Common Mistake

Many students confuse monopsony with monopoly. Remember, monopsony is about one buyer of labor, while monopoly is about one seller of a product.

#Monopsony Graph

The monopsonist hires where MRP = MRC, but pays workers the wage on the labor supply curve at that quantity. This results in a lower wage and less employment than in a perfectly competitive market.

Exam Tip

Be sure to label your monopsony graphs carefully, showing the MRC curve above the supply curve, and the wage and quantity chosen by the monopsonist.

#Real-World Examples

Think of a small town with one major employer, like a large factory or a mine. That employer has monopsony power because workers have limited options for employment.

Memory Aid

Monopsony: Mono (one) Pson (buyer). Think of a single employer in a town.

#Final Exam Focus 🎯

#High-Priority Topics

Derived Demand: Understand how product demand impacts factor demand.
MRP and MRC: Know how firms use these to make hiring decisions.
Perfectly Competitive Labor Markets: Be able to graph and analyze equilibrium.
Monopsony: Understand the differences from perfect competition and its impact on wages and employment.

#Common Question Types

Multiple Choice: Expect questions on the determinants of factor supply and demand, and the characteristics of different labor market structures.
Free Response: Be prepared to draw and explain graphs for perfectly competitive labor markets and monopsonies. Be able to analyze the impact of policy changes on these markets.

#Last-Minute Tips

Time Management: Don't spend too long on any one question. If you're stuck, move on and come back later.
Graphing: Practice drawing and labeling graphs accurately. This is key for FRQs.
Key Terms: Make sure you understand the definitions of all key terms. This is essential for both MCQs and FRQs.

#Practice Questions

Practice Question

#Multiple Choice Questions

Which of the following would cause an increase in the demand for labor in the fast-food industry? (A) A decrease in the price of burgers (B) An increase in the number of teenagers seeking part-time work (C) An increase in the price of fries (D) A decrease in the productivity of workers (E) An increase in the minimum wage
In a perfectly competitive labor market, a firm will hire workers up to the point where: (A) Marginal revenue equals marginal cost (B) Marginal revenue product equals the wage rate (C) Average revenue product equals the wage rate (D) Total revenue equals total cost (E) Average total cost is minimized
A monopsonist in the labor market will: (A) Hire more workers and pay a higher wage than a firm in a perfectly competitive labor market (B) Hire more workers and pay a lower wage than a firm in a perfectly competitive labor market (C) Hire fewer workers and pay a higher wage than a firm in a perfectly competitive labor market (D) Hire fewer workers and pay a lower wage than a firm in a perfectly competitive labor market (E) Hire the same number of workers and pay the same wage as a firm in a perfectly competitive labor market

#Free Response Question

Assume a perfectly competitive labor market for nurses. The market wage is $50 per hour. A local hospital is a wage taker in this market.$

(a) Draw a correctly labeled graph for the labor market, including the market supply and demand curves. Show the equilibrium wage and quantity of nurses.

(b) Draw a correctly labeled graph for the hospital, including the marginal revenue product (MRP) curve and marginal resource cost (MRC) curve. Show the wage and quantity of nurses hired by the hospital.

(c) Suppose the local government imposes a minimum wage of60 per hour. Show on your graphs the effect of the minimum wage on the market and the hospital. Explain the effect on the quantity of nurses hired by the hospital.

(d) Suppose the hospital is the only employer of nurses in the area. Redraw the hospital graph as a monopsony. Show the wage and quantity of nurses hired by the monopsonist.

#Scoring Guidelines

(a) (3 points) * One point for correctly labeled axes (Quantity of Labor on the x-axis, Wage on the y-axis) * One point for correctly drawn and labeled market supply and demand curves * One point for showing the equilibrium wage and quantity at the intersection of supply and demand

(b) (3 points) * One point for correctly labeled axes (Quantity of Labor on the x-axis, Wage on the y-axis) * One point for a correctly drawn and labeled MRP curve (downward sloping) and a horizontal MRC curve at the market wage of $50 * One point for showing the quantity of nurses hired where MRP=MRC$

(c) (4 points) * One point for showing the minimum wage above the equilibrium wage on the market graph * One point for showing the new quantity supplied and demanded in the market graph * One point for showing the new horizontal MRC at the minimum wage of60 * One point for explaining that the hospital will hire fewer nurses at the minimum wage where MRP=new MRC

(d) (3 points) * One point for correctly labeled axes (Quantity of Labor on the x-axis, Wage on the y-axis) * One point for correctly drawn and labeled MRP, upward sloping labor supply, and MRC curves (MRC above supply curve) * One point for showing the quantity of nurses hired where MRP=MRC and the wage paid on the supply curve at that quantity