AP Microeconomics Unit 5 Cheatsheet: Factor Markets

Factors of production: Labor, capital, land

Factor prices: Wages (labor), interest (capital), rent (land)

Core principle: Firms hire factors when productivity and output price justify the cost. Workers supply labor more at higher wages; firms demand labor less at higher wages.

Key relationship: Factor prices convey information and create incentives for both firms and workers.

• Firms respond to factor prices when making hiring decisions
• Workers respond to wage changes when deciding labor supply
• Ceteris paribus: quantity of labor demanded ↓ as wage ↑; quantity supplied ↑ as wage ↑

Labor demand shifts when:

• Output price ↑: MRP ↑ → demand labor more at each wage
• Worker productivity ↑: MP ↑ → MRP ↑ → demand labor more
• Technology improves: Workers produce more → MP ↑
• Complementary capital increases: Workers more productive

To minimize the cost of producing a given output level:

Logic: If one input gives more output per dollar, reallocate spending to it until marginal products per dollar equalize.

• Applies to all factor combinations (labor, capital, land)
• Ensures no reallocation can improve efficiency