5.1 Introduction to Factor Markets
Factor demand is derived from product demand: firms hire based on marginal revenue product, MRP = marginal product × marginal revenue (price, if competitive).
In factor markets the roles flip: firms are the buyers of labor, land, and capital, and households are the sellers. Demand for any factor is derived demand, a firm wants workers only because consumers want the output those workers produce.
Marginal revenue product (MRP) is the extra revenue from hiring one more unit of a factor: MRP = marginal product × marginal revenue. When the firm sells its output in a perfectly competitive market, MR equals the product price, so MRP = MP × P. MRP falls as hiring rises because of diminishing marginal returns.
That downward-sloping MRP curve is the firm's demand curve for the factor. Market factor demand and factor supply then set the equilibrium wage (for labor) or rental rate (for capital), just like price in a product market.
Key terms for 5.1
Drag the curves above, or open the full Factor Markets sandbox. Then draw it yourself for a graded check or watch the step-by-step walkthrough. Teaching this? Put this graph on your own class page, free.
Computing MRP as the change in total revenue per extra unit of OUTPUT, that's marginal revenue. MRP is the change in total revenue per extra unit of the FACTOR (ΔTR ÷ Δlabor).
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