# MIT - Principles of Microeconomics - Unit 6. Topics in Intermediate Microeconomics - Lec 18. Factor Markets

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PROFESSOR: OK, so what we're going to do today is the last in what I'd say are the core set of lectures. Our core set of lectures, we started with talking about the market.

We then moved on and talked about consumer theory and did a series of lectures on that. Now we're doing producer theory. This is the last in our series of lectures on producer theory and then basically we move on to topics.

So the remainder of the section we'll talk about things like international trade, uncertainty, equity and efficiency, asymmetric information in insurance markets.

We'll move on to in the last part of the course showing you how you can apply what we've learned in the basics to answer a bunch of interesting, real world questions. So this is the last of our core basics lectures.

What we're going to do here is fit in something that's fallen through the cracks, which is we've talked about firms and their decisions about how much to produce. And we've talked about the output side. But we haven't talked about the input side at all. How do firms decide what kind of the inputs to use and in what ratio to use et cetera.

We talked a bit about it. We talked about isoquants and isocosts and doing that tradeoff between inputs. We haven't really talked about the input markets themselves.

So firms go and they say, look I've done my isoquants and isocosts and I want 63 workers. Well they've then got to go to a market for labor and hire those workers and how does that actually work.

So today what we want to focus on is the demand side of input markets. That is, what's the actual market analysis by which a firm having maximized its profits and deciding how many workers it wants goes and actually finds those workers.

So we're going to do is talk about demand for factors. In particular today we'll focus on the demand for labor. Although the demand for capital, the analysis will be very similar. But today we're going to focus

on the demand for labor. And what we're going to do is begin by focusing on the demand for labor in a competitive factor market.

So we're going to begin by talking about competitive factor markets. What I mean by that is that a perfectly competitive factor market is one where, just as perfect competition and output markets means there's lots of sellers selling the same good, a perfectly competitive factor market means there's lots of sellers, in this case workers, selling an identical good. That is their labor.

So the notion is we're in a market where there's many, many workers firms could hire, all of whom are equally qualified for a job. So this is not, obviously, a high-tech market. This is some low-tech, construction, other sort of blue collar market, where there's lots of workers out there who could equally well be qualified for a job.

In fact what we're going to assume is that there's a perfectly flat labor supply curve. Let's assume a perfectly flat labor supply curve. Perfectly elastic labor supply just to make life easy. Obviously it's not true in reality. Let's assume we're looking at some market with perfectly elastic labor supply.

Now how do we think about what happens in factor markets in that world? Well once again let's start with the short run. So in the short run capital's fixed.

So a firm has said, look, I've done my short run profit maximization, my isoquants and isocosts. I've decided how many workers I want given a fixed level of capital. And that gives me some demand for labor.

We then moved on and talked about consumer theory and did a series of lectures on that. Now we're doing producer theory. This is the last in our series of lectures on producer theory and then basically we move on to topics.

So the remainder of the section we'll talk about things like international trade, uncertainty, equity and efficiency, asymmetric information in insurance markets.

We'll move on to in the last part of the course showing you how you can apply what we've learned in the basics to answer a bunch of interesting, real world questions. So this is the last of our core basics lectures.

What we're going to do here is fit in something that's fallen through the cracks, which is we've talked about firms and their decisions about how much to produce. And we've talked about the output side. But we haven't talked about the input side at all. How do firms decide what kind of the inputs to use and in what ratio to use et cetera.

We talked a bit about it. We talked about isoquants and isocosts and doing that tradeoff between inputs. We haven't really talked about the input markets themselves.

So firms go and they say, look I've done my isoquants and isocosts and I want 63 workers. Well they've then got to go to a market for labor and hire those workers and how does that actually work.

So today what we want to focus on is the demand side of input markets. That is, what's the actual market analysis by which a firm having maximized its profits and deciding how many workers it wants goes and actually finds those workers.

So we're going to do is talk about demand for factors. In particular today we'll focus on the demand for labor. Although the demand for capital, the analysis will be very similar. But today we're going to focus

on the demand for labor. And what we're going to do is begin by focusing on the demand for labor in a competitive factor market.

So we're going to begin by talking about competitive factor markets. What I mean by that is that a perfectly competitive factor market is one where, just as perfect competition and output markets means there's lots of sellers selling the same good, a perfectly competitive factor market means there's lots of sellers, in this case workers, selling an identical good. That is their labor.

So the notion is we're in a market where there's many, many workers firms could hire, all of whom are equally qualified for a job. So this is not, obviously, a high-tech market. This is some low-tech, construction, other sort of blue collar market, where there's lots of workers out there who could equally well be qualified for a job.

In fact what we're going to assume is that there's a perfectly flat labor supply curve. Let's assume a perfectly flat labor supply curve. Perfectly elastic labor supply just to make life easy. Obviously it's not true in reality. Let's assume we're looking at some market with perfectly elastic labor supply.

Now how do we think about what happens in factor markets in that world? Well once again let's start with the short run. So in the short run capital's fixed.

So a firm has said, look, I've done my short run profit maximization, my isoquants and isocosts. I've decided how many workers I want given a fixed level of capital. And that gives me some demand for labor.

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