Unit 5 Factor Markets: Capital, Land, and Inequality (AP Microeconomics)

Physical capital (in AP Micro)

Human-made inputs used to produce goods and services (e.g., machines, tools, buildings, equipment), treated as a factor of production.

Factor market

A market where factors of production (land, labor, capital) are bought and sold/rented; firms demand factors and households (or firms) supply them.

Derived demand

Demand for an input that exists because the input helps produce a final good; it comes from (is derived from) demand for the product.

Rental rate of capital (r)

The per-period price paid to use a unit of capital services (e.g., the cost per day/month/year to rent a machine).

Interest rate (in relation to capital)

The cost of borrowing funds or the opportunity cost of tying up money to buy capital; related to ownership decisions but distinct from the rental-rate analysis of capital services.

Marginal product of capital (MPK)

The additional output produced by employing one more unit of capital, holding other inputs constant.

Diminishing marginal returns

As more of a variable input is added (holding other inputs fixed), the marginal product of that input eventually decreases.

Marginal revenue product (MRP)

The additional revenue generated by employing one more unit of an input; computed as MRP = MP × MR.

Value of the marginal product (VMP)

For a price-taking firm, the additional revenue from one more unit of input: VMP = MP × P (since MR = P under perfect competition).

Marginal factor cost (MFC)

The additional cost of employing one more unit of an input (e.g., the cost of renting one more machine or hiring one more worker).

Competitive input market (price-taker)

An input market where the firm takes the input price as given; for capital, MFC equals the rental rate (MFC = r).

Profit-maximizing input rule (capital)

A firm rents/uses capital until MRP = MFC; in a competitive capital market this becomes MRP = r.

Firm’s demand curve for capital

The MRP (or VMP) curve for capital; it shows the profit-maximizing quantity of capital at each possible rental rate.

Why factor demand slopes downward

Because of diminishing marginal returns: as more of the input is used, MP falls, so MRP (or VMP) falls.

Shifter of capital demand: output price (P)

For a competitive firm, a higher output price raises VMP = MP × P at every quantity, shifting the demand for capital right.

Shifter of capital demand: technology/productivity

If capital becomes more productive (higher MPK), MRP rises and the demand for capital shifts right.

Shifter of capital demand: complementary inputs

If complementary inputs (especially labor) increase in quantity/quality, capital’s productivity (MPK) can rise, increasing MRP and shifting capital demand right.

Substitutes (labor vs capital) and wage changes

If labor and capital are substitutes, higher wages may increase capital demand (substitution effect), but may also reduce output and reduce input demand (output effect).

Present value (PV)

The value today of a future amount of money; for FV received in n years at interest rate i: PV = FV/(1+i)^n.

Land (economic definition)

All natural resources used in production (e.g., physical land, minerals, oil reserves, fishing grounds).

Perfectly inelastic supply of land

A vertical supply curve for a fixed quantity of land in a specific location; quantity does not change with price.

Economic rent

Payment to a factor of production in excess of what is necessary to keep it in its current use; commonly associated with very inelastic (especially vertical) factor supply.

Wage inequality vs income inequality

Wage inequality is differences in wages across workers; income inequality is differences in total income (wages plus profits, interest, rents, etc.).

Human capital

Skills, education, training, and experience that raise worker productivity; higher human capital tends to raise labor demand (MRP) and wages.

Monopsony (labor market)

A labor market with a single (or dominant) employer; the firm faces upward-sloping labor supply so MFC exceeds the wage, leading to lower wages and employment than in a competitive labor market.