LINKAGES AMONG THE FACTOR FOR PRODUCTION
We have seen that the price paid to any factor of production-labor, land, or capital=equals the value of the marginal product of that factor. The marginal product of any factor, in turn, depends on the quantity of that factor that is available. Because of diminishing marginal product, a’ factor in abundant supply has a low marginal product and thus a low price, and a factor in scarce supply has a high marginal product and a high price. As a result, when the supply of a factor falls, its equilibrium factor price rises.
When the supply of any factor changes, however, the effects are not limited to the market for that factor. In most situations, factors of production are used together in a way that makes the productivity of each factor dependent on the quantities of the other factors available for use in the production process.
As a result, a change in the supply of anyone factor alters the earnings of all the factors.
For example, suppose a hurricane destroys many of the ladders that workers use to pick apples from the orchards. What happens to the earnings of the various factors of production? Most obviously, the supply of ladders falls, and therefore, the equilibrium rental price of ladders rises. Those owners who were enough to avoid damage to their ladders now earn a higher return when they rent out their ladders to the firms that produce apples.
Yet the effects of this event do not stop at the ladder market. Because there are fewer ladders with which to work, the workers who pick apples have a smaller marginal product. Thus, the reduction in the supply of ladders reduces the demand for the labor of pickers, and this causes the equilibrium wage to fall.
This story shows a general lesson: An event that changes the supply of any factor of production can alter the earnings of all the factors. The change in earnings of any factor.