Lecture Notes: Chapter 17 – Markets for Factors of Production
Based on Microeconomics: Canada in the Global Environment (11th Edition)
Introduction
In addition to buying goods and services, firms must also acquire inputs or factors of
production—land, labour, capital, and natural resources. These inputs are traded in factor
markets, which are essential for determining how income is distributed in an economy. This
chapter explores how factor markets function, how the value of marginal product (VMP)
guides the demand for inputs, how wages and employment are determined, how labour unions
influence outcomes, and how rental rates for capital and land are established. Graphs, examples,
and real-world applications illustrate these concepts.
1. The Anatomy of Factor Markets
1.1 What Are Factor Markets?
Factor markets are where firms buy the inputs they need for production, and households provide
those inputs in exchange for income.
Factor Seller (Supplier) Buyer (Demand) Payment Type
Labour Households Firms Wages/salaries
Capital Savers/investors Firms Interest/rent
Land Landowners Firms Rent
Natural Resources Owners Firms Royalties or prices
The price of each factor (e.g., wage, rent, or interest) is determined by supply and demand, just
like in product markets.
1.2 Derived Demand
The demand for a factor of production is derived from the demand for the goods and services
it helps produce.
Example:
If demand for pizza increases, pizza restaurants demand more workers (chefs, servers),
increasing the demand for labour.
, 2. Value of Marginal Product (VMP) and Factor Demand
2.1 Marginal Product of Labour (MP)
The marginal product of labour (MP) is the additional output produced by hiring one more
unit of labour.
Due to the law of diminishing returns, MP eventually declines as more workers are added
(holding capital fixed).
2.2 Value of Marginal Product (VMP)
VMP tells us the revenue generated by hiring one more worker.
Firm’s Hiring Rule:
A profit-maximizing firm hires workers until:
If VMP > wage, hiring more workers increases profit.
If VMP < wage, the firm should reduce employment.
Graph Description – Labour Demand Curve
X-axis: Quantity of labour
Y-axis: Wage rate (or VMP)
Downward-sloping curve: Reflects diminishing marginal product as more labour is
hired
VMP curve = labour demand curve
Example:
A bakery sells cakes for $10 each. The fifth worker adds 20 cakes/week →
Based on Microeconomics: Canada in the Global Environment (11th Edition)
Introduction
In addition to buying goods and services, firms must also acquire inputs or factors of
production—land, labour, capital, and natural resources. These inputs are traded in factor
markets, which are essential for determining how income is distributed in an economy. This
chapter explores how factor markets function, how the value of marginal product (VMP)
guides the demand for inputs, how wages and employment are determined, how labour unions
influence outcomes, and how rental rates for capital and land are established. Graphs, examples,
and real-world applications illustrate these concepts.
1. The Anatomy of Factor Markets
1.1 What Are Factor Markets?
Factor markets are where firms buy the inputs they need for production, and households provide
those inputs in exchange for income.
Factor Seller (Supplier) Buyer (Demand) Payment Type
Labour Households Firms Wages/salaries
Capital Savers/investors Firms Interest/rent
Land Landowners Firms Rent
Natural Resources Owners Firms Royalties or prices
The price of each factor (e.g., wage, rent, or interest) is determined by supply and demand, just
like in product markets.
1.2 Derived Demand
The demand for a factor of production is derived from the demand for the goods and services
it helps produce.
Example:
If demand for pizza increases, pizza restaurants demand more workers (chefs, servers),
increasing the demand for labour.
, 2. Value of Marginal Product (VMP) and Factor Demand
2.1 Marginal Product of Labour (MP)
The marginal product of labour (MP) is the additional output produced by hiring one more
unit of labour.
Due to the law of diminishing returns, MP eventually declines as more workers are added
(holding capital fixed).
2.2 Value of Marginal Product (VMP)
VMP tells us the revenue generated by hiring one more worker.
Firm’s Hiring Rule:
A profit-maximizing firm hires workers until:
If VMP > wage, hiring more workers increases profit.
If VMP < wage, the firm should reduce employment.
Graph Description – Labour Demand Curve
X-axis: Quantity of labour
Y-axis: Wage rate (or VMP)
Downward-sloping curve: Reflects diminishing marginal product as more labour is
hired
VMP curve = labour demand curve
Example:
A bakery sells cakes for $10 each. The fifth worker adds 20 cakes/week →
