The factor market The Labour market Factor Markets

The factor market – The Labour market

• Factor Markets refers to the markets where services of the factors of production are bought and sold – Labor Markets – Capital Markets – The markets for raw materials – The market for management and entrepreneurial resources. • The demand for and supply of factors – Rent – Wages – Interest – Economic profit

• The demand for a factor is derived (Indirect) – There is demand for land because there is demand for rice. • The supply of factors of production – Depends on the system of property rights – The toil trouble involved in the work – (Depends on the leisure preference)

• In the free market (no government intervention and trade union pressure) the price of the factors of production are dependent on supply and demand. • Output determination commodity pricing • Income distribution factor pricing • Two types of income distribution – Functional distribution of income (Micro) – Personal distribution of income (Macro)

• Each factor is paid on the basis of the function performed by it. – Land owners – Rent – Workers – Wage – Suppliers of financial capital – interest – Entrepreneurs – profit. • Two main theories of factor price determination – Supply Demand Theory – The marginal productivity theory of factor demand

• When wages increase • Labor increases • When Rent Increases • More people give their property for rent

• This suggests that an individual firm pays a factor on the basis of its Marginal product • MR = MC • However, there are other factors. A rupee spent on labor cannot be spent on capital • Therefore firms have to choose their best option. • This it the law of EQUI-MARGINAL RETURN

• Commercial Rent – Payment for the use of property • Economic Rent – Is the reward for the uses of the services of the land. • The Supply of the land is perfectly inelastic because the quantity available is fixed and determined by nature. • Supply has no influence in the determining of rent. • Demand is the only determinant of rent • Perfectly inelastic – so as demand increases/decreases rent will increase/decrease. • Economic Rent offers no incentive system. • Since Land is a gift of nature , any payment received by the owner is called PURE or ECONOMIC RENT

• You give me Rs 2000 today and in a year I will give you Rs 500 as interest and the original Rs. 2000 – (500/2000)*100 = 25% – Bank interest is 8% – So my economic profit is (25 -8) = 17% • Banks sets Savings rates and Borrowing rates – and the bank keeps the difference as revenue. Rate of Interest = Interest *100 Principal

• Profit is a return on entrepreneurial ability or a reward for risk taking. • Economic role of profits – Profits as a signal to a resource owner • Profits are economics signals letting people know to enter markets or in cases of losses to leave markets. – Profits are motive for efficiency • Gives incentive to firms to reduce cost – Profits as reward • The prospect of earning rewards are the driving force behind development – Innovation • Profit is the prime mover of capitalistic economies.

• The wage rate refers to the earning per hour of labor. • The wage rate divide by the price index gives the “Real Wage Rate” • The level of real wages depends on the productivity of labor • Real wages are higher – The greater the amount of capital available (hedge fund managers) – The more technology available (scientists) – The availability of natural resources (oil)

• By adding each firms demand for labor we get the Market demand for labor • The market supply for labor depends on the – Size of the population – The proportion of the population in the labor force – The state of the economy – The level of real wages • Competitive equilibrium real wage rate is determined by the intersection of the market demand supply curves. – Then the firm hires labor until the MR = the wage rate

• Labor Unions try to increase wages in 3 ways • They try to increase the demand for labor by increasing productivity – By advertising union made products – By lobbying for the restriction of imports • Increase wage by restricting the supply of labor – High initiation fees – Long apprenticeships – Require that firms higher only union workers. • Increase wages by bargaining with employees – Threats of strikes – Go slow campaigns.

Minimum Wages

Minimum Wages • Group Discussion – What effect does minimum wages have on the economy? – Should Sri-Lanka have a minimum wage? If no, why not? If yes, explain and how much should it be set at?

CEO Salaries • • Cash/Base Salaries Bonuses Stock Options Stock Ownership