Marginal Revenue Product and the Demand for Factors

Having derived the MRP for different factors, we can now understand the demand for factors of production. Wejust sawthat a profit-maximizing firm would choose input ‘quantities such that the price of each input equaled tile MRP of that input. This means that from the MRP schedule for an input, we can immediately determine the relationship between the price of the: input and the quantity demanded of that input.

This relationship is what we call the demand curve. . Glance back at Table 12-3on pagf;!230. This table shows in the last column the MRP of labor for our corn farm. By the profit-maximizing condition, we know that at a wage of $60,000 the firm would choose
1 unit of labor; at a $30,000 wage, 2 units of labor would be sought; and so forth. The AUW schedule for each input gives the de- ‘ mand schedule of the firm for, that input.
We have used this result in Figure 12-3 to drawa labor demand curve,for our corn farm using the data shown in Table 12-3. We have in addition drawn a smooth curve through the individual points to show how the demand curve, would appear if fractional units of labor could be purchased.

Substitution Rule. A corollary of the least-cost rule is the substitution rule: If the price of one factor rises while other factor prices remain fixed, the firm will profit from substituting more of the other inputs for the more expensive factor. A rise in labor’s price, Ph will reduce MPJ PL. Firms will respond by reducing employment and increasing
land use .until equality of marginal products per dollar of input is restored-thus lowering the amount of needed L and increasing the demand for land acres. A rise in land’s price, PA, alone will, by the same logic, cause labor to be substituted for more expensive land. Like the least-cost rule, the substitution rule and the derived demand for factors apply to both perfect and imperfect competition in product markets.

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