Theory of Factor Pricing: Meaning

and Need | Microeconomics

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In this article we will discuss about:- 1. Meaning and Definitions of Factor
Pricing 2. Need for a Separate Factor Pricing 3. Perfect Competition
during Short Period 4. Imperfect Competition 5. Criticisms.

Contents:
1. Meaning and Definitions of Factor Pricing
2. Need for a Separate Factor Pricing
3. Factor Pricing under Perfect Competition during Short Period
4. Factor Pricing under Imperfect Competition
5. Criticisms of Factor Pricing

1. Meaning and Definitions of Factor Pricing:

The theory of factor pricing is also called theory of distribution. The
distribution may be either functional or personal. The personal
distribution is concerned with the distribution of national income among
various factors of production which is unequally distributed. On the other
hand, the functional distribution is concerned with the remuneration paid
to various factors of production in an act of production.
The factors of production, viz., land, labour, capital, entrepreneur and
organisation are paid in the form of rent, wages, interest, profit and
salary. Thus, the theory of functional distribution is called the theory of
factor pricing.
The various definitions of the theory of distribution have been
given as under:
(1) Professor Chapman has defined, “The economics of distribution
accounts for the sharing of wealth produced by a community among the
agents or the owners of the agents which have been active in its
production.”
(2) According to Professor Seligman, “All wealth that is created in society
finds its way to the final disposition of the individuals through certain
channels or sources of income. This process is known as distribution.”

2. Need for a Separate Factor Pricing:

In the distribution part of economic theory we study the determination of
reward for various factors of production. Why is the theory of demand
and supply not applicable for the determination of factor price, Professor
Alfred Marshall has emphasised that there is a need for a separate
theory of factor pricing because the characteristics of commodities and
factors of production are different.
The following are the arguments but forward for the need of a
separate theory of distribution or factor pricing:
(1) The demand for a factor of production is not a direct demand as is
found in case of a commodity. The demand for factors of production
depends on the demand for the goods and services in which they are
employed. While the demand for a commodity is a direct demand
because it directly satisfies the want of a consumer. Thus, there should
be a separate theory of factor pricing.
(2) The demand for a factor of production is a joint demand because two
or more than two factors are jointly demanded for an act of production.
(3) Some of the factors of production are human factors, namely, labour,
entrepreneur and organisation. They are not only affected by the
economic factors but are also affected by the non-economic factors. In
case of commodity pricing there is no involvement of human factor.
Thus, the characteristics of factors of production are different than those
of commodities. Hence, there should be a separate theory of distribution
for factor price determination.

3. Factor Pricing under Perfect Competition during Short

Period:
The firm will be making profit, earning normal profit and incurring losses.
These three situations are discussed under perfect competition with the
help of the diagrams. We assume that labour as a variable factor is
employed with keeping other factors constant.

The diagram shows that the factor price (wages) is determined by the
industry keeping in view the total demand for and supply of labour by the
industry. DD and SS are demand curve and supply curve of labour and
E is the point of intersection where OW wage rate is fixed or determined
and OQ is the demand and supply of labour as shown on the left portion
of the diagram. On the right portion of the diagram the firm employs OQ
of labour with given wage rate OW.
Wages and marginal revenue productivity (MRP) and average revenue
productivity (ARP) are shown on OY-axis while units of labour on OX-
axis. The AW=MW is the demand curve for the labour which is perfectly
horizontal to OX-axis. ARP and MRP are average revenue productivity
curve and marginal revenue productivity curve.
They are opposite to U- shaped curve. The point of equilibrium of a firm
will be at the point E where marginal factor cost or marginal wage (MFC
or MW) is equal to its marginal revenue productivity (MRP=MFC or MW)
and the MRP curve must cut the MFC or MW from the above.
The average profit of the firm is (ARP-AW) SE and the total profit is
equal to TWES. The firm is earning profit because the wages are less
than the marginal revenue productivity of labour. In other words, workers
are being exploited equivalent to the volume of profit TWES. Karl Marx
has propounded the surplus theory of value on this ground and wrote a
famous book Das Capital in 1869.

The wage rate is OW and demand for and supply of labour is OQ in the
industry while on the same wage rate firm employs OQ units of labour.
The point of equilibrium of the firm is at E where the MW is equal to its
MRP. The wage rate OW is higher than the ARP (AW>ARP) and the firm
is incurring losses. Average loss to firm is (AW-ARP) LE and the total
loss to firm is WTEL. In other words, labour is getting more than what he
contributes to the productivity (AW>ARP).

The firm employs OQ units of labour at given wage rate of OW and the
point of equilibrium of the firm is at point E where the
AW=ARP=MW=MRP. The firm is earning normal profit and it is the
optimum firm that the optimum utilisation of resources is attained.
In the long run the firm will earn normal profit only because there is
perfect competition in both the markets.
The point of equilibrium of the firm will be at that point where the
AW=ARP=MW=MRP in the long run as shown in the diagram:

Thus, we can say that the wage rate will always be equal to marginal
revenue productivity (AW=ARP=MW=MRP) in the long run but during
short period there may be variations and it may result into profit, loss and
normal profit.

4. Factor Pricing under Imperfect Competition:

The theory of marginal productivity is based on the assumption of perfect
competition. But perfect competition is a market structure which is
unrealistic and imaginary. In imperfect competition the reward paid to a
factor of production will be less than its marginal revenue productivity
(W<MRP).
The equilibrium of a firm under imperfect competition can be
explained with the help of the following diagram:
The diagram shows wage rate and productivity on OY-axis while units of
labour on OX-axis. ARP and MRP are average revenue productivity
curve and marginal revenue productivity while AW and MW are average
wages and marginal wages of workers. The point of equilibrium is E
where the MW equals to MRP (MW=MRP). The average profit (ARP-
AW) is LT and the total profit is SWTL. The firm is earning profit. But
workers are exploited by the firm because they are paid reward less than
their marginal revenue productivity.

5. Criticism of Factors Pricing:

The marginal productivity theory of distribution has been criticised
on the following grounds:
(i) All Units of a Factor are not Homogeneous:
The theory assumes that all the units of a factor of production are
homogeneous or identical. But in actual practice we see that all the units
are not identical in efficiency. For example, labour can be categorised
into skilled, semi-skilled and unskilled. Hence, they are not perfect
substitutes.
(ii) Perfect Competition is Unrealistic:
The theory is based on the assumption that there is perfect competition
in factor market and commodity market. But in actual practice we find
imperfect competition. Hence, perfect competition is an unrealistic and
imaginary market.
(iii) Unrealistic Assumption of Full Employment:
The theory is based on the assumption that there is full employment and
no single factor of production is unemployed. But in actual practice there
is less than full employment situation whether the country is developed
one because a certain percentage of people are found unemployed.
(iv) Marginal Productivity is not Measurable:
The theory assumes that the marginal productivity of a factor can be
measured by knowing the addition to the total production by employing
an additional unit of the factor keeping other factors of production
constant. The marginal productivity of entrepreneur cannot be measured
because it is not divisible.
(v) Imperfect Mobility of Factors of Production:
The theory is based on the assumption that all the factors of production
have perfect mobility. They will move from low rate of reward to high rate
of reward industry and there will be regional and occupational mobility of
labour. But in practice we see that factors of production are not only
affected by the economic factors but they are also affected by the non-
economic factors as well.
Labour, entrepreneur and organisation are human factors. They are
affected by the non-economic factors, namely, environment, language,
caste, religion, distance, etc. Hence, perfect mobility of factors is a
mismanage.
(vi) Maximisation of Profit is not the Sole Object:
The theory assumes that each producer or firm aims at maximisation of
profit. It is not correct because there is a cut-throat competition in the
market and non-price competition is the practice prevailing in domestic
and international markets. Firm tries to earn satisfactory level of profit
and maintain its existence in the market.
(vii) One Sided Theory:
The theory deals with the demand side of factors of production while
determining the factor prices. Professor Milton Friedmann and
Samuelson have criticised the theory on the ground that it has not taken
into consideration the supply side which is equally important for the
determination of price of factors of production.
(viii) Long Run Explanation:
The theory explains the factor price determination during long run and it
has failed to explain the short run determination of factor pricing.
Professor J.M. Keynes has rightly pointed out that in the long run we all
are dead and there is no economic problem. In such a situation the
theory does not have utility and applicability.
(ix) Not Applicable to Entrepreneur:
The remuneration of entrepreneur cannot be determined because he is
the only factor of production whose number neither can be increased nor
can be reduced. In such a situation marginal productivity cannot be
measured and consequently his remuneration cannot be determined.
(x) Neglects Technological Progress:
The theory of distribution has ignored the role of technological progress
increasing the productivity and production. The use of latest technology
and innovation have also influenced the productivity of labour and capital
as pointed out by Professor J.R. Hicks and consequently the relative
share of factors in national income has increased.
(xi) No Explanation of Inequalities of Income:
The theory does not explain the inequalities of incomes prevailing in
various countries. If the marginal productivity of various factors of
production is taken into consideration then we will see that the causes of
such inequalities cannot be justified on the ground that there are several
factors leading to such inequalities of income and wealth. The theory is
based on the static phenomenon and fails to explain the dynamic aspect
of economy which is more important and realistic.

Factors of Pricing in Perfectly

Competitive Markets (With
Diagram)
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ADVERTISEMENTS:

The mechanism of determination of factor prices does not differ

fundamentally from that of prices of commodities.

Factor prices are determined in markets under the forces of demand

and supply. The difference lies in the determinants of the demand and
supply of productive resources.
In the nineteenth century economists classified factor inputs into four
groups land, labour, capital and entrepreneurship.

ADVERTISEMENTS:

The prices of these factors were called rent, wage, interest and profit
respectively, and each one was examined by a separate body of theory.
Since, however, there are many common factors underlying the
determination of the price of inputs, a general framework can be
developed for analyzing the price mechanism of any productive
resource.

Thus, the theory to bedeveloped in will be presented in general terms,

so that it is applicable to all factors of production. Given that labour is
the most important input, we will usually speak of ‘the demand for
labour’ or, ‘the supply of labour’. But the reader should interpret such
expressions as implying ‘the demand for a productive factor’ and ‘the
supply of a productive factor’.

We will first examine the determination of factor prices in perfectly

competitive product and input markets. Subsequently we will relax the
assumption of perfectly competitive market and we will discuss factor
pricing in markets with various degrees of imperfection.

A. Factor pricing in perfectly competitive markets:

ADVERTISEMENTS:

In this part we will develop the so-called marginal productivity theory

of distribution. It takes its name from the fact that, in perfectly
competitive product and input markets, factors are paid the value of
their marginal physical product. The price of a factor, w, is determined
by its total demand and supply schedules. The total demand is the sum
(aggregate) of the demands of individual firms for the productive
factor. Similarly, the total supply of a factor is the sum of the supplies
by the individual owners of the factor.
We will develop the demand for labour by a single firm. The aggregate
demand will then be derived from the summation of the individual
demands. The same approach will be adopted for the market supply.
We will first derive the supply of labour by an individual consumer.
The aggregate supply of labour will then be derived from the
summation of the individual supply curves.

1. The Demand for Labour in Perfectly Competitive Markets:

We will examine the demand for labour in two cases:
ADVERTISEMENTS:

(i) When labour is the only variable factor of production.

(ii) When there are several variable factors.

(i) Demand of a firm for a single variable factor

The following assumptions underlie our analysis:

(a) A single commodity X is produced in a perfectly competitive
market. Hence Px is given for all firms in the market.
(b) The goal of the firm is profit maximisation.

(c) There is a single variable factor, labour, whose market is perfectly

competitive. Hence the price of labour services, is given for all firms.
This implies that the supply of labour to the individual firm is perfectly
elastic. It can be denoted by a straight line through w parallel to the
horizontal axis (figure 21.1). At the going market wage rate the firm
can employ (hire) any amount of labour it wants.
(d) Technology is given. The relevant production function is shown in
figure 21.2. The slope of the production function is the marginal
physical product of labour

ADVERTISEMENTS:

dX /dL = MPPL

The MPPL declines at higher levels of employment, given the law of

variable proportions. If we multiply the MPPL at each level of
employment by the given price of the output, Px, we obtain the value-
of-marginal-product curve VMPL (figure 21.3). This curve shows the
value of the output produced by an additional unit of labour employed.

ADVERTISEMENTS:

The firm, being a profit maximiser, will hire a factor as long as it adds
more to total revenue than to total cost. Thus a firm will hire a
resource up to the point at which the last unit contributes as much to
total cost as to total revenue, because total profit cannot be further
increased. In other words the condition of equilibrium of a profit
maximiser in the labour market is
In figure 21.4 the equilibrium of the firm denoted by e. At the market
wage rate w the firm will maximize its profit hiring l* units of labour.
This is so because to the left of I* each unit of labour costs less than
the value of its product (VMPL > w), hence the profit of the firm will be
increased by hiring more workers. Conversely to the right of l* the
VMPL < and hence profits are reduced. It follows that profits are at a
maximum when VMPL = w.

ADVERTISEMENTS:

If the market wage is raised to w1, the firm will reduce its demand for
labour to l1, (figure 21.5) in order to maximise its profit (at et in figure
21.5 w1 = VMPL). Similarly, if the wage falls to w2, the firm will
maximise its profit by increasing its employment to l2.

It follows from the above analysis that the demand curve of a firm for
a single variable factor is its value-of-marginal-product curve.

As an illustration of the above discussion consider the following

numerical example.

ADVERTISEMENTS:
Assume a production process which involves a fixed amount of
machinery (e.g. ten machines) giving rise to a total fixed cost of £50,
and labour which is the only variable factor. The wage rate is £40 and
the price of the commodity produced is £10. The production function
is specified by the information of the first four columns of table 21.1.
Column 6 shows total revenue (= X . Px), column 10 includes total var-
iable cost (=L. w). Finally column 12 shows the profit of the firm (∏ =
R – TVC – FC).
The demand for labour which maximises the profit of the firm can be
determined either by using the total revenue and total cost curves, or
by using the VMPL schedule and the given wage rate, which defines the
supply of labour to the individual firm.
1. The Total Revenue-Total Cost Approach:
Profit is at a maximum when the difference between total revenue and
total cost is greatest. In our example this occurs when nine units of
labour are used. This solution, therefore, corresponds to the profit-
maximising position of the firm. The total revenue-total cost approach
is shown in figure 21.6. From this figure we see that the maximum
distance between the two curves occurs when the firm employs nine
units of labour. At this level of employment the slope of the total
revenue and the total cost curves are equal.
The slope of the revenue curve is the marginal revenue per additional
unit of labour, and the slope of the total cost curve is the wage rate,
which in perfectly competitive markets is equal to the marginal cost of
labour. Thus the condition for the equilibrium of the firm in the factor
market is

2. The VMPL approach:

In figure 21.7 we show the VMPL of our numerical example. The supply
of labour to the individual firm is the straight line S1 passing through
the given wage rate of S40. The two curves intersect at point e, which
defines the demand for labour (I = 9) at which the profit of the firm is
at a maximum.

The firm is in equilibrium by equating the VMPL to the market wage

rate. If the market wage rises, the equality of wt and VMPL occurs to
the left of e. Conversely if the wage rate falls to w2 the equality with the
VMPL curve occurs to the right of e. Thus the value-of-marginal-
product curve is the demand curve for labour of the individual firm.
(ii) Remand, of a Firm for Several Variable Factors:
When there are more than one variable factors of production the VMP
curve of an input is not its demand curve. This is so because the
various resources are used simultaneously in the production of goods
so that a change in the price of one factor leads to changes in the
employment (use) of the others. The latter, in turn, shifts the MPP
curve of the input whose price initially changed.

Assume that the wage rate falls. We will derive the new demand for
labour, using isoquant analysis. The change in the wage rate has in
general three effects: a substitution effect, an output effect, and a
profit-maximising effect. Let us examine these effects, using figure
21.8.

Suppose that initially the firm produces the profit-maximising output

with the combination of factors K1, L1, given the (initial) factor prices
w1 and r1 whose ratio defines the slope of the isocost line AB. Now let
us assume that the wage rate falls (w2) so that the new isocost line is
AB’ (the price of capital remains constant).
The firm, using the same expenditure, can now produce the higher
output denoted by the isoquant X2, using K2 and L2 amounts of capital
and labour respectively. This result is derived from the tangency of the
new isocost line AB’ with the highest isoquant, which, in our example,
is X2.
The movement from e1 to e2 can be split into two separate effects a
substitution effect and an output effect.
To understand these two effects we draw an isocost line parallel to the
new one (AB’) so that it reflects the new price ratio, but tangent to the
old isoquant X1. The tangency occurs at point a in figure 21.8. The
movement from e, to a constitutes the substitution effect the firm will
substitute the cheaper labour for the relatively more expensive capital,
even if it were to produce the original level of output X1.
Thus the employment of labour increases from L1 to L1. However, the
firm will not stay at a. Because, when the wage falls, the firm, with the
same total expenditure, can buy more of labour, more of capital, or
more of both. Consequently the firm can produce the higher output X2,
employing K2 of capital and L2 of labour. The increase of employment
from L1 to L2, corresponding to the movement from a to e2, is the
output effect.
Point e2 is not the final equilibrium of the firm. It would be if the firm
were to spend the same amount of money as initially. However,
keeping the total cost expenditure constant does not maximise the
profit of the firm. The firm will increase its expenditure and its output
in order to maximise its profit. To understand this let us assume that
the initial equilibrium of the firm is defined by point H in figure 21.9,
where the firm’s MC is equal to the price of X.

The fall in the wage rate shifts the MC curve downwards to the right,
and the profit-maximising output of the perfectly competitive firm
increases to X3. This requires an increase in expenditures equal to the
shaded area X1 HGX3. Thus in figure 21.8 the isocost line AB’ must
shift outwards, parallel to itself, at a distance corresponding to the
increase in the firm’s outlays. Actually the new isocost can be
determined by dividing the increase (addition) in total cost by the
price of capital, r, and adding the result to the distance OA.
The new point, A’, on the vertical axis is the vertical intercept of the
required isocost. The location of the firm’s new isocost curve is now
determined, since this isocost is parallel to AB’. The final equilibrium
of the firm will be denoted by the point of tangency of the new isocost
A’B” with the isoquant denoting the profit-maximising output X*
(point e3 in figure 21.10).

In summary, the substitution effect of a decrease in the wage rate

causes a decrease in the MPPL because there is a smaller quantity of
capital with which labour is combined. However, the output effect and
the profit-maximising effect result in an increased employment of
both inputs. Thus both these effects cause the MPPL of labour to shift
upwards to the right.
In general the output and profit-maximising effects more than offset
the substitution effect, so that the final result of a fall in the wage rate
is a shift of the MPPL curve of labour to the right. Given the price of the
final commodity, Px, the VMPL shifts to the right when several variable
factors are used in the production process.
The shift is shown in figure 21.11. The new equilibrium demand for
labour is denoted by point B on VMPLr By repeating the above analysis
with different wage rates we can generate a series of points such as A
and B. The locus of these points is the demand for labour by the firm
when several factors are variable. This is sometimes referred to as the
long-run demand for labour by the firm.
In summary, the demand of the firm for a single variable factor is its
VMP curve. The demand for a factor when several resources are
variable is the locus of points belonging to shifting VMP curves. This
long-run demand for a factor is negatively sloped, because, on balance,
the three effects of an input-price change must cause quantity
demanded of the factor to vary inversely with price. Before we proceed
further it is useful to summaries the determinants of the demand for a
variable factor by an individual firm.

The demand for a variable factor depends on:

1. The price of the input. The higher the price of a factor, the smaller
the demand for its services.

2. The marginal physical product of the factor, which is derived by the

production function.

3. The price of the commodity produced by the factor. Recall that the
VMPL is the product of the MPPL times the price of the commodity, Px.
4. The amount of the other factors which are combined with labour.
An increase in the collaborating factors will shift the MPPL outwards to
the right and hence will raise its VMPL curve (and vice versa).
5. The prices of other factors, since these prices will determine their
demand (and hence the demand for labour).

6. The technological progress. Technological progress changes the

marginal physical product of all inputs, and hence their demand.

(iii) The Market Demand for a Factor:

The demand curve of an individual firm for an ‘input. The next step is
to use the demand curves of the individual firms in order to derive the
market demand curve for the input. The market demand for an input
is not the simple horizontal summation of the demand curves of
individual firms. This is due to the fact that as the price of the input
falls all firms will seek to employ more of this factor and expand their
output. Thus the supply of the commodity shifts downwards to the
right, leading to a fall in the price of the commodity, Px.
Since this price is one of the components of the demand curves of the
individual firms for the factor, these curves shift downward to the left.
Figure 21.12 shows the demand curve d1 of an individual firm for
labour. Initially, suppose the wage rate is w1. The firm is at point a on
its demand curve and employs l1 units of labour. Summing over all
employing firms, we obtain the total demand for the input at the wage
rate w1. Point A in figure 21.13 is one point on the market demand
curve for labour.

Assume next that the wage rate declines to w2. Other things being
equal, the firm would move along its demand curve d1, to point b’,
increasing the employed labour to l’2. However, other things do not
remain equal. When the wage rate falls, all firms tend to demand more
labour, and the increased employment leads to an increase in total
output. The market supply curve for the commodity produced shifts
downward to the right, and the price of the commodity (given its
demand) falls.
The decline in the price of the good reduces the value of the marginal
product of labour at all levels of employment. In other words, the
VMPLcurves (the individual demand curves for labour) shift
downward. In figure 21.12 the new demand curve is d2. When the wage
rate falls to w2the firm is in equilibrium not at point b’ (on the original
d1 curve) but at point b on the new demand curve d2.
Summing horizontally over all firms we obtain point B of the market
demand curve. If the fall of the commodity-price was not taken into
account, we would be led to an overestimation of the demand for
labour following a decline in the wage rate. In figure 21.13 point B’
represents the demand for labour in the market with the price of the
commodity unchanged. Note, however, that this point does not belong
to the market demand curve for labour.

2. The Supply of Labour (A Variable Factor) in Perfectly

Competitive Markets:
In this part we will concentrate on the derivation of the market supply
of a variable factor. The most important variable factors are raw
materials, intermediate goods and labour. The first two types are
commodities, and hence their market supply is derived on the same
principles as the supply of any commodity. The supply of labour,
however, requires a different approach. To begin with we assume that
labour is a homogeneous factor: all labour units are identical.

The main determinants of the market supply of labour are:

(a) The price of labour (wage rate).

(b) The tastes of consumers, which define their trade-off between

leisure and work.

(c) The size of the population.

(d) The labour-force participation rate.

(e) The occupational, educational and geographic distribution of the

labour force.

The relationship between the supply of labour and the wage rate
defines the supply curve. The other determinants can be considered as
shift factors of the supply curve. Since we are interested in the supply
curve, we assume that all the other determinants are given (i.e. we
make use of the ceteris paribus clause) in order to concentrate on the
slope of the supply curve. The market supply is the summation of the
supply of labour by individuals. Thus we begin by the derivation of the
supply of labour by a single individual.

(i) The supply of labour by an individual:

The supply of labour by an individual can be derived by indifference
curves analysis. On the horizontal axis of figure 21.14 we measure the
hours available for leisure (and work) over a given period of time. For
example there are 0Z maximum hours in a day, which an individual
can use for leisure or for work. On the vertical axis we measure money
income. The slope of a line from Z to any point on the vertical axis
represents the wage per hour. For example, if the individual were to
work all the 0Z hours and earn a total income of 0Y0, the wage rate
would be

The indifference curves represent the preferences of the individual

between leisure and income. For example on indifference curve II of
figure 21.14 the individual is indifferent between OB hours of leisure
and BZ hours of work (which bring to him an income of BN), and 0C
hours of leisure and CZ hours of work (from which he earns an income
of CM).

When the wage rate is wt the individual is in equilibrium by working

AZ hours, earning AA (= OA”) income and spending OA hours on
leisure. If the wage rate increases to w2 the individual will work more
hours (BZ > AZ), will earn a higher income (BB’) and will have less
hours (OB) for leisure. The supply of labour can be obtained from the
locus of the equilibrium points A’, B, C’, etc. This supply curve is
shown in figure 21.15.

However, at some higher wage rate the hours offered for work may
decline. For example in figure 21.16 if the wage rate is increased to
w4the individual will work BZ hours, the same amount as when the
wage rate was w2.

If the wage rate increases still further (to w5), the hours supplied for
work decline even more they drop back to AZ. This pattern of response
to higher wage rates produces a backward-bending supply curve for
labour (figure 21.17).
Up to w3, increases in wage rates create an incentive for increased
supply of labour. However, higher wage rates create a disincentive for
longer hours of work. The reason for this behaviour is the fact that
longer working hours imply less leisure hours. As the wage rate
increases, the individual’s income rises, and this enables the worker to
have more leisure activities. However, the time for such activities is
less. Hence beyond a certain level of the wage rate, the supply of
labour decreases as r prefers to use his income on more leisure
activities.
(ii) The Market Supply of Labour:
Although there is general agreement that the supply curve of labour by
single individuals exhibits the backward-bending pattern, economists
disagree as to the shape of the aggregate supply of labour. Several
writers argue that in the short run the market supply of skilled labour
may have segments with positive and segments with negative slope.

However, in the long run the supply must have a positive slope, since
young people will be attracted to the markets where the wages are high
and also older workers may undertake retraining and change jobs if
the wage incentive is strong enough. Others maintain that the
backward-bending supply curve of labour may be typical in most
markets of the rich nations.

As the standard of living increases people find that unless they have
the time to enjoy leisure activities it is not worth their while to work
harder in order to obtain the higher income required for more leisure.
Thus, as incomes reach the level required for a comfortable standard
of living, workers put forward greater demands (in labour
negotiations) for more holidays, longer vacations, shorter work weeks,
fewer hours per working day rather than demanding ever higher wage
rates associated with longer working hours. It seems that a positive
aggregate supply of labour is the general case even for the affluent
nations. Higher wages may induce some people less hours, but will
also attract new workers in the market in the long run.

3. The Determination of the Factor Price in Perfect Markets:

Given the market demand and the market supply of an input, its price
is determined by the intersection of these two curves.

In figure 21.18 the equilibrium wage is we and the employment level is

Le.

We see that the market model is valid for the determination of the
equilibrium price of a commodity or a productive resource. The
difference between commodity pricing and factor pricing lies in the
determinants of the demand for variable factors and the method used
to derive the supply of labour. The demand for factors is a derived
demand, in the sense that the demand for the services of the factors is
based on the demand of the commodities in whose production the
factors are used. The supply of labour is not cost determined like the
supply of commodities, but involves the attitudes of individuals
toward work and leisure.