Perfectly Competitive Factor Markets
Updated 10/3/2018 Jacob Reed
Factor markets are an important part of any Microeconomic Principles class. If you are preparing for an Advanced Placement (AP), IB, or college exam, reviewing these markets is essential. Below is a quick examination of the important aspects of perfectly competitive factor markets.
Note: The examples below use labor but these concepts apply to a firms use of capital and land as well.
When drawing a perfectly competitive factor market, there are generally two side by side graphs; one for the industry (the market) and one for the firm. The industry (or market) is a standard supply and demand curve. The equilibrium wage (price) in the market establishes the wage each firm will pay its workers. The supply of workers is derived from the number workers willing to work at each possible wage (equal to workers’ opportunity costs). The demand curve in a perfectly competitive labor market is derived from the demand for the product the workers produce and the productivity of the individual workers.
Since each firm can hire as many workers as it wants at the market wage, the labor supply curve for the firms is horizontal at the market wage. Also, the market wage equals the cost of hiring more workers so the supply curve equals the MRC.
As mentioned above, the firms demand curve is equal to the MRP (it is downward sloping) and a profit maximizing firm will hire the number of workers where the MRC=MRP.
For the firm, the demand curve will shift with changes in the firm’s worker productivity, demand for the firm’s products, and the price of the product (all three change the MRP). A firm’s supply curve shifts up or down with the market wage. See below for how to draw a perfectly competitive factor market with side by side graphs.
Note: The trick to identifying a perfectly competitive resource market if there is a chart instead of a graph is that there will only be one wage.
The graphs above show a decrease in the supply of labor. That causes the wage to increase, and with that the firm’s MRC (Supply) shifts upward. As a result, the firm hires fewer workers.
In this example, there was an increase in the marginal revenue product for just this firm’s workers. That could come in the form of better training for their workers, new technology only available to this firm, etc. As a result, the MRP shifts right and the firm hires more workers.
Multiple Choice Connections:
Competitive Labor Market
2012 Released AP Microeconomics Exam Questions: 13
2008 Released AP Microeconomics Exam Questions: 13, 43
Perfectly Competitive Firm
2012 Released AP Microeconomics Exam Questions: 26, 56, 58
2008 Released AP Microeconomics Exam Questions: 28, 42, 55, 57