FACTOR MARKETS AND INCOME

DISTRIBUTION
Objectives:
1. Determine the interaction between
supply of labor and demand of labor
in the factor market.
2. Discuss the effects of this interaction
to wages and quantity of labor
supplied.
3. Evaluate how income are distributed
to the people.
4. Determine what causes income
1
inequality.
5. Evaluate the effects of factor
payments to the production of goods
and services
 MARKET ECONOMY
 Product market
 goods and services

Supplies the goods and services

Business Firms Households
Pays the goods and services

 Business firms – suppliers of goods and services in the

product markets

 Household – buyers of goods and services

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 MARKET ECONOMY
 Factor market
 productive resources or factors of production like land,
labor, capital and entrepreneur.

Supplies the factor of production

Households Business firms
Pays the factor of production

 Households – suppliers of the productive resources to

the business firms

 Business firms – buyers of the productive resources

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Income of households depend on
the prices of their productive
resources.
Such incomes determine their
ability to buy the goods and
services offered by business
firms.

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DETERMINANTS OF FACTOR DEMAND
A. DEMAND FOR GOODS AND SERVICES
1. Direct demand – the demand for goods and
services
 Example: A individual buys a kilo of rice for
consumption. He purchases a radio for his
pleasure.

2. Derived demand – productive resources

 Example: A firm buys a machine not for
satisfaction or pleasure, but for the production of
goods or services. 5
A. Other determinant of the demand for productive
factors is their productivity.

B. Prices of factor substitutes and complementary

resources affect the demand for productive
resources.
 Ex. It is economical to use machines than labor if
labor is scarce and therefore, very expensive.

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DEMAND FOR LABOR
 Like the quantity demanded for goods in relation
to prices, the quantity demanded for labor has an
inverse relationship with wage rates.
 Businesses are willing and able to hire more
workers at lower wage rates and vise versa.
 Example.

laborer wages
1 1000
2 500
3 300
4 250
7
5 200
 Whenever wage rates rise due to command of the
government laws:
 inefficient firms either shut down or reduce the
number of their workers.
 Other firms schedule the work of their workers
on rotation basis.

 NOTE:
 A firm hires additional labor if it gets additional
profits.
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 In the language of economics, a firm’s decision to
employ an additional man-hour depends on the
difference between marginal revenue product of
said man-hour, and the marginal resource cost of
employing it.

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 A marginal product of labor is the additional
output produced by the employment of an
additional man-hour of labor.

 A marginal revenue product of labor is defined as

the additional revenue (income) obtained by
selling the marginal product of labor.

 Marginal resource cost is the payment of the

additional man-hour of labor – and other
productive resources like land and capital.
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EMPLOYMENT DECISIONS
 Rules:
 A. MRP > MRC, employ more man-hours of labor.
 MRP of the additional man-hour is greater than its
wage, the additional man-hour adds more to the
firm’s revenue than its cost.
 With this situation, the firm keeps on employing
additional labor until the MRP no longer exceeds the
wage.
 There is profit as long as MRP is greater than MRC.

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 B. MRP < MRC, reduce man-hours of labor.
 If MRP is less than the wage, the firm reduces the
number of man-hours.
 Such reduction in labor continues as long as wage
exceeds marginal revenue product.
 When MRC is greater than MRP, it is a loss for the
firm

 C. MRP = MRC, maintain man-hours of labor.

 The firm maximizes its profits up to a point where
MRP is equal to MRC.

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SUPPLY IN THE FACTOR MARKET
 The law of supply governs the behavior of
resources in the factor market just like the
behavior of goods and services in the product
market.

 Households – the sellers of productive resources –

land, labor, capital and entrepreneur

 Their willingness to offer their productive

resources to the business firms depends on the
prices of such resources. In general at higher
prices, more productive resources are offered in
the factor market. 13
PROFIT MAXIMIZATION
 One common goal of the suppliers of
goods and services.
 Thus, all economic decisions are
based on production costs and
product prices.

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SUPPLY OF LABOR
 More individuals are willing to work when wage
rates are higher.

 This is true in an economy or society where there

are abundant job opportunities. Why?

 People can choose their jobs and their wages.

The firms which offer the highest wage rates,
together with the best working conditions and
fringe benefits, attract most of the competent
workers.

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 How about in the Philippines, can people choose
their jobs and wages?
 Why?

 In poor countries, jobs are scarce. Poor

individuals are forced to accept unsuitable jobs
with very low wage rates to be able to survive.

 In the Philippines, not a few are willing to receive

wage rates lower than the legal minimum wage
jus to get a job.
 College graduates – factory workers, salesgirls
and office clerks.
 The oversupply of labor has encouraged most
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employees to exploit their employees.
 There is no doubt that high wage rates attract
more labor. But individuals balance their desire
to work more to get more income and their desire
to have more leisure. At a certain point, money
is not the most important factor. People also
need time for rest and recreation.

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Backward bending supply curve for labor shows that above
Z, individuals want more leisure when wage increases. This
reduces the quantity of labor. Below wage Z, which is a
lower wage, they want less leisure and supply more labor.

wages

Individual supply of labor

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0
Quantity of labor (hours)
 LABOR MARKET
 The market demand for labor constitutes all the
demands of all firms for labor.
 Whenever wage rises, a firm’s demand for labor
falls.
 This makes the demand curve downward sloping.

D
wages

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Q
LABOR MARKET
 In the case of market supply of labor, it is the
sum of all individuals’ supply of labor.
 The supply curve of labor is backward bending.

 This means that as wage increases, work hours

also increase. But beyond a certain point, further
wage increase results in a decrease in work
hours. S

wages

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Q
 LABOR MARKET

S Market Supply of Labor

wages D

Surplus
X

Y
Market Demand of Labor
T
Shortage
0
W V R U Q 21

Quantity of labor
 The equilibrium wage is Y and the equilibrium
man-hour is R.

 Above the equilibrium wage (indicated by

X), there is a labor surplus. This means supply
of labor is greater than demand of labor. More
people like to work due to higher wage, but there
is less demand for labor by the business firms.

 On the other hand, wage below the

equilibrium wage (indicated by T) creates a
labor shortage. This means that demand for
labor exceeds the supply of labor. At a lower
wage, individuals are discouraged to work while
business firms are willing and able to employ
more workers. 22
 When there is a labor surplus, wage moves down
towards the equilibrium point. When supply
exceeds demand, the price of labor falls. In this
case of labor shortage, wage moves up towards
the equilibrium point. Again, such behavior of
wage follows the law of supply and demand.

 When demand is greater than supply, the price of

labor goes up. In a perfect competition, the
market wage is determined by the free
interaction between demand and supply. There
is no government intervention. This is an
assumption in a free market economy.
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INCOME DISTRIBUTION
 Is the allocation of income among the owners of
the factors of production.

 Various ideas or theories of income distribution:

 Early social philosophers – crusaded not for
economic equality but also for social and political
equality.
 1. Rousseau (French philosopher) – contended
that private property was robbery and it did
not exist in the state of nature.
 2. Babeuf (social reformer) – stated that nature
has given to every man an equal right in the
enjoyment of all goods. 24
 3. Proudhon (a believer in equality and bitter
enemy of private property) – claimed that
employers robbed laborers by not rendering to
them the full value of their labor.
 4. Karl Marx (father of modern socialism) – said
that the capitalist is a recipient, of surplus value
(profit). He claimed further that the capitalist, in
the process of accumulating wealth for himself,
therefore, robs and exploits the worker.

 The maldistribution of income and wealth among

the less developed countries has been more
widespread.

 Rich Poor
25
 gap is getting wider and wider
 TYPES OF INCOME DISTRIBUTION
 1. Personal distribution
 Is the allocation of income among persons or
households
 The degree of income inequality among
households or families is shown by the Lorenz
Curve

Perfect equality Lorenz Curve

 Unequal real
Percent of income distribution
income  The further the
Lorenz curve from
the line of equality,
the greater is
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income inequality
Percent of families among families
TYPES OF INCOME DISTRIBUTION
 2.Functional distribution
 Is the allocation of income among the
factors of production: land, labor,
capital and entrepreneur
 The incomes of the factors of production
are:
 Rent for land

 Wages for labor

 Interests for capital

 Profits for the entrepreneur

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CAUSES OF INCOME INEQUALITY
 1. Intelligence and talents
 Individuals who are more intelligent and
talented are more likely to earn more income.
Bright persons have greater opportunities to
fame and fortune.
 Those who have exceptional talents for singing,
painting, acting, and so forth have good economic
future.

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 2. Education and Training
 Higher levels of education and training = higher
incomes

 Examples:
 with high salaries:
 Top level scientists
 Individuals with doctorate degrees

 Low salaries:
 Finished elementary or high school education

 However, in countries where there is an over-

supply of professionals, their salaries are low.
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 3. Unpleasant and risky jobs
 To work dirty, unpleasant, difficult, and
risky jobs => employers provide financial
incentives (in highly developed countries).
Ex.: Hazard pay

 In poor countries where the rate of

unemployment is very high, workers have
very little choice or no choice at all. They
are forced to take dirty and risky jobs in
order to eat three times a day.
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 4. Ownership of productive factors
 Rich – own land, machines, buildings and so forth

 - derive income from their properties

 - such unjust distribution of wealth and income is

the root of poverty

 Poor – almost all people who are born poor have

remained poor for the rest of their lives.
 Their chances of improving their economic
conditions are extremely slim, except in a kind of
society where there are many opportunities, and
these are available to everyone.

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 5. Luck and connections
 The more experienced old folks claim that it is
LUCK that counts much.
 It has been said that the DESTINY of a person
has been made, and no amount of hard work can
change it.
 Those who will first prize in lotteries are lucky.

 Those who are born rich are fortunate.

 Likewise, people with BIG CONNECTIONS are

more likely to SUCCEED in life. It is whom you
know that matters.

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 THEORIES OF INCOME DISTRIBUTION:
 1. Marginal Productivity
 Holds that the income of the factors of production
(factor payment) is equal to the value of its
marginal product.
 This simply means that the owners of the factors of
production are paid based on their contribution to
production under a competitive market condition.
 Example:
 If you contribution to production is worth
PhP20,000 a month, then your wage should be
PhP20,000 a month.

 However, in the real world, this does not exactly

happen. There are government laws to comply with and
that the market is not perfectly competitive. Another, 33
capitalists have another idea of income distribution.
 2. Needs
 Determine the amount of income of families or
individuals
 Those who have more needs receive more income in
proportion to their needs.

 Example:
 Janitor A is single while Janitor B is married and has
4 children. Based on this theory, Janitor B gets more
income.

 Both get the same basic pay, but Janitor B receives

allowances for his 4 children.

 This theory is used by highly developed countries.

They provide allowances to the children of their 34
employees.
 3. Social usefulness
 Is the basis of income distribution.

 Jobs which are useful to society are paid

higher.
 Example: teachers, farmers, fisherman,
doctors, and nurses

 Such theory encounters difficulties in

implementation.
 Singers, actors, comedians, and other
groups are most likely to oppose such social
usefulness theory of income of distribution.
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 4. Equality
 Refers to an income distribution in which all
members of society receive equal amount of
income.
 This is the idea of communism in an attempt to
erase the gap between the rich and the poor.
 Such theory is good to others but not to all.

 Lazy and have little qualifications – happy under

this arrangement.
 Highly qualified and ambitious – discouraged or
demoralized.
 Consequently, both economy and society will not
progress for lack of economic incentives to
deserving individuals. 36
 PRICING OF RESOURCES
 Refers to payments of the factors of production
 Capitalist or market economy => factor prices of factor
payments are determined by the law of supply and
demand.

 Due to limitations of the market force: High

Government pricing
(supports and Interferes of the
regulates the (to protect workers and consumers)
productive
market forces) resources
Unjust
pricing of Higher Higher price
some results cost of = of goods and
productive production services 37

factors
 SOCIALIST COUNTRIES
 Gov’t. assumed active role in determining the prices of
the factors of production.
 Fundamental goal: just price and just wage

 Just price = equivalent to cost of production, no

pure profit, only normal profit
 Just wage = means fair income for labor, enables
the workers to meet their basic needs
 Government grants security benefits to the low-income
groups.
 Social equalization programs of the government bridge
the gap between the rich and the poor.

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 WAGES – THE PRICE OF LABOR
 The most important price of the productive resources.
 Wage or salary = the only source of income to most people

 Wage rate is extremely low (Philippines) in relation to

high prices of goods and services
 It is one of the major reasons why most people are poor.

 Every time prices of goods and services increase, real

wages decrease.
 Real wages – refer to the number of goods and services
that a worker can buy with his money wage – his nominal
income (example: PhP20,000 a month).
 Real wage, therefore, is the purchasing power of the
worker.
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THE DETERMINANTS OF WAGE RATES ARE:
 1. Supply and Demand
 Wage rates increase = Demand for workers is greater than
supply of workers
 Wage rates decrease = supply of workers is greater than
demand for workers
 In countries where massive unemployment exists, wages are
very low.

 2. Minimum Wage
 government impose minimum wage rates for various workers
like those in the industrial and agricultural sectors.
 Objective of such wage determination is the desire of the
government to protect the interest of the low-income workers in
relation to the increasing cost of living.
 However, some firms violate the requirements of the minimum
wage law.
 Employees do not complain for fear of losing their jobs. 40
 Inefficient enterprises lay off some of their workers or they program
their operations on rotation basis.
 3. Labor unions
 More active labor unions are likely to protect and
promote legitimate interests of their members
against the exploitations of their employees.
 Through persistent collective bargaining
agreement (CBA), labor unions can realize fair
demands from their employers, especially under
a good government.
 Poor countries = the government use police or
military to discourage the legitimate activities of
labor unions
 Use of violence and destructive acts of labor
union members and officers should be prevented
 these have adverse effects on the whole economy
because the supply of goods and services is disrupted.
 Not also favorable to the public 41
ECONOMIC RENT
 To most people the word “rent” refers to the payment
of a room, apartment, building, or machine.
 However, in economics rent is the payment for the
use of land and other natural resources which
are completely fixed in total supply.

S
Rent The figure on the left
R2 illustrates the
relationship between
D2
R1 supply and demand of
D1 land. Rent increases as
R
demand increases. The
D supply curve is perfectly
0 Q inelastic. 42

Land
 INTEREST
 Interest rate is the payment for using the money of
other individuals.
 Usury – the imposition of unreasonably high interest rate on
loans
 Loan sharks – those who charge extremely high interest
rates
 At present, there’s no more legal limit to interest rates.
 These are determined by the law of supply and demand.

 Banks which need more savings grant higher interest

rates to attract more depositors.
 Interest rates on time deposits fluctuates depending on
the interaction between the supply of and demand for
money. Whenever demand is greater than supply,
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interest rate increases.
 Money
 is not a productive factor.
 It cannot produce goods and services.
 Its basic function is only as a medium of exchange.
 This means money can be exchanged with goods and
services.
 We borrow money from financial institutions like
banks. We use this money for production. And we
have to pay said money plus interest as payment for
the use of such money.

 Interest rates are different due to:

1. risk,
2. length or
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3. amount of the loan
PROFITS
 Economic or pure profits to the earnings of a firm
after deducting cost of production.
 Such cost include:
 1. explicit cost (actual expenditures of a firm)
 2. implicit cost (payments to productive resources
owned and self-employed by a firm)

 In the case of business profits, only the explicit cost is

computed. Any excess of such cost is known as
business profit.
 Profits are rewards for the entrepreneur for taking
the risks, or making innovations.
 Profits are usually bigger for a seller who has very
few competitors or none at all.
 Profit expectations induce investments. This
results in more employment, production and income. 45
THE END

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SEATWORK

1. Why are wage rates generally very low in the

Philippines?
2. Explain one cause of income inequality.
3. Graph and explain the Lorenz Curve

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