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Module 37 krugman 1
Module 37
Factor Markets
What’s New in the Fourth Edition?
• Updated business cases
• Handouts to use in class
Module Objectives
• How are resources like land, labor, physical capital, and human capital traded in factor markets?
• How do factor markets determine the factor distribution of income?
The Economy’s Factors of Production
Creating Student Interest
• Ask students why they chose to go to college (perhaps have them list their top reason[s] on a sheet
of paper and collect them). Some answers will involve the utility gained from the educational
experience. Many of the reasons students cite will relate directly to the creation of human capital.
Go through some of the reasons and point this out. How and why do people invest in human capital?
Presenting the Material
• Begin by reviewing the four classes of factors of production: land, labor, physical capital, and human
capital. Emphasize that land refers to a resource provided by nature—and not merely to the
ground/soil. Land includes natural resources on top of the ground, such as water or trees, as well as
natural resources under the ground like oil and coal. Labor is the work of human beings, and must
be distinguished from human capital, which is the improvement in labor created by education and
knowledge. Finally, physical capital refers to goods used to produce other goods and services—such
as equipment and machines. To make sure students understand this distinction, ask them if a pickup
truck is considered capital. The answer is, “it depends.” If the truck is used recreationally for
enjoyment, it is a consumption good, not capital. If the truck is used by a construction company to
transport materials to building sites, it is considered capital.
• Remind students of the terms for the payments to factors of production. Rent is paid for land, wages
are paid to labor, and interest is paid for capital. It is useful to explain that interest is the payment
for capital; if you had to borrow from a bank to buy capital (e.g., to build a factory) you would have
to pay interest on the loan. A firm may have cash and not need to borrow to build a factory—but in
that case the firm gives up earning interest on the cash they choose to spend building a factory. The
interest in that case is the opportunity cost of investing in capital. Either way, interest is the price of
capital.
Module 37 krugman 2
Marginal Productivity and Factor Demand
Creating Student Interest
• Have students brainstorm about what influences how much a person earns. You may need to remind
them to consider characteristics of the market in which a person works as well as personal
characteristics.
• Have students imagine they own a business and are trying to decide if they should hire another
worker. Make a list of variables that should be considered. Students are likely to identify the wage
that must be paid, and will say something about the productivity or output of the worker. This
example should get them to think about hiring a worker in terms of marginal benefit and marginal
cost.
• Have students imagine it is 10 years later and they have a full-time job. Ask them why their employer
might give them a raise? Some students may correctly infer that raises are tied to performance, or
productivity. You can also discuss cost-of-living increases. This example should help students
understand the marginal productivity theory of income distribution, or the idea that factors of
production are paid a wage (or rental rate) that depends on the marginal product of the last unit hired.
• Now ask students what makes a worker more productive? Possible answers include training,
Presenting the Material
• The derivation of labor demand in this section assumes perfect competition, so be sure to remind
students of the key assumptions of a perfectly competitive market. Each firm will take the price of
the output and the wage of the worker as given. If a firm is hiring service workers and the going
wage rate is $9 per hour, then this is what they will pay. They cannot charge less and still attract
workers. They do not have to pay more than $9 if that is what others are paying.
Module Outline
Opening Example: The opening example compares the income-earning potential of people with
advanced degrees to those with only a high school degree.
I. The Economy’s Factors of Production
Module 37 krugman 3
A. A factor of production is any resource that is used by firms to produce a good or service,
including physical capital and human capital.
B. Factors of production are bought and sold in factor markets.
C. Factor prices play a key role in allocating resources among producers.
D. Demand for a factor is a derived demand: The demand for the factor is derived from the
demand for the firm’s output.
II. Marginal Productivity and Factor Demand
A. Most factor markets in the modern U.S. economy are perfectly competitive, meaning that
buyers and sellers of a given factor are price-takers.
B. An employer’s marginal cost of hiring an additional worker is simply the worker’s wage rate.
C. The marginal cost of hiring one additional worker must be weighed against the marginal
benefit of that additional worker.
Figure 37-2
I. Shifts in the factor demand curve occur as a result of:
Module 37 krugman 4
1. Changes in prices of goods: An increase in the price of the good shifts the VMPL curve
upward.
Case Studies in the Text
Economics in Action
The Factor Distribution of Income in the United States—This EIA presents the factor distribution of
income in the United States in 2013.
Ask students the following questions:
1. Why don’t wages measure the full return to labor? (Labor also receives compensation
2. Why is human capital the most important factor of production in a modern economy?
Web Resources
Module 37 krugman 5
Handout 37-1
Date_________ Name____________________________ Class________ Professor________________
In the following table calculate the marginal product of labor and the value of marginal product, given a
product price of $5.
Quantity of
labor
Quantity of
widgets
Marginal product
of labor
(ΔQ/ΔL)
Value of the
marginal product
(marginal product ×
product price)
0
0
—
—
1
38
2
72
3
102
4
128
5
150
6
168
7
182
8
192
1. If the equilibrium wage rate is $100, how many workers will the firm hire?
2. If the equilibrium wage rate is $80, how many workers will the firm hire?
3. If the equilibrium wage rate is $60, how many workers will the firm hire?
Module 37 krugman 6
Answers
Quantity of
labor
Quantity of
widgets
Marginal product
of labor
(ΔQ/ΔL)
Value of the
marginal product
(marginal product ×
product price)
0
0
—
—
1
38
2
72
3
102
4
128
5
150
6
168
7
182
8
192
1. If the equilibrium wage rate is $100, how many workers will the firm hire?
2. If the equilibrium wage rate is $80, how many workers will the firm hire?
3. If the equilibrium wage rate is $60, how many workers will the firm hire?
