Factor Markets In General

So far in this book, we have analyzed a variety of markets—for wheat, cable TV service, household exterminators, gasoline, perfume, airline travel, and more. All of these markets had one thing in common: They were product markets, in which firms sell goods and services to households or other firms. Of course, products aren't made out of thin air, but rather from the economy's resources—labor, capital, land, and natural resources. These resources must be purchased from those who own them. Since resources are sometimes called factors of production, the markets in which they are traded are called factor markets.

In this and the next two chapters, we switch our focus from product markets to factor markets. Figure 1 illustrates what this switch entails.

Notice that in product markets, households demand the products, and firms supply them. In factor markets, these roles are typically reversed: Firms demand land, labor, and capital, and households, which own them, are the suppliers.

Why are factor markets important? First, because we cannot fully understand markets for goods and services unless we understand markets for the resources needed

CHAPTER OUTLINE

Factor Markets in General

Labor Markets in Particular

Defining a Labor Market Competitive Labor Markets Firms in Labor Markets

Demand for Labor by a Single Firm

Goals and Constraints The Firm's Employment Decision When Only Labor Is Variable The Firm's Employment Decision When Several Inputs Are Variable

The Market Demand for Labor

Shifts in the Market Labor Demand Curve

Labor Supply

Individual Labor Supply Market Labor Supply Shifts in the Market Labor Supply Curve

Short-Run versus Long-Run Labor Supply

Labor Market Equilibrium

What Happens When Things Change?

A Change in Labor Demand A Change in Labor Supply Labor Shortages and Surpluses

Using the Theory: Understanding the Market for College-Educated Labor

Product markets Markets in which firms sell goods and services to households or other firms.

Factor markets Markets in which resources—capital, land, labor, and natural resources— are sold to firms.

FIGURE 1

PRODUCT MARKETS AND FACTOR MARKETS

Demand for Goods and Services

Product Markets

Supply of Goods and Services

Supply of Resources

Demand for Resources

Factor Markets

In product markets, households demand goods and services, and firms supply them. In factor markets, the roles are reversed: Firms demand labor, capital, land, and natural resources, and households supply them.

to produce them. Indeed, separating these two types of markets as we've done, while useful for learning, is highly artificial, since the decision to produce more output implies a decision to employ more resources. For example, when Ford decides to produce more automobiles, it must use more labor, more machinery, or more land for its factories, and perhaps more of all three. It will also need greater quantities of inputs produced by other firms—steel, tires, windshields—and these firms, in turn, will have to obtain more labor, capital, land, and natural resources to produce them. You can see that products and the resources used to produce them are really two sides of the same coin. What you learn in these next few chapters will help you understand how these two sides of the economy—product markets and factor markets—fit together.

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