AP Microeconomics Unit 5 Cheat Sheet: Factor Markets

The basics

What it covers: Factor markets and derived demand, marginal revenue product as the firm's demand for labor, what shifts factor supply and demand, the least-cost and profit-maximizing input rules, and monopsony.

Exam weight: About 10–13% of the AP Microeconomics exam.

The big question: How does a firm decide how many workers to hire and what they get paid — and what changes when the firm is the only employer in town?

Recurring themes: Demand for a resource is derived from demand for its output; hire while MRP > MFC; in competition MFC = wage, but under monopsony MFC rises above the wage.

Key topics at a glance

Factor Markets and Derived Demand

Roles reverse: firms are buyers, households are sellers, and the price is a wage. No firm wants labor for its own sake — demand for a worker is derived from demand for what the worker produces. If output demand rises, labor demand rises with it.

Marginal Revenue Product

MRP = MP × MR, and MRP = MP × P when the firm sells in a perfectly competitive product market. The MRP curve is the firm's labor demand curve. It slopes down because of diminishing marginal returns — and more steeply still if the firm has market power, since MR falls too.

The Hiring Rule

Hire until MRP = MFC. In a competitive labor market the firm is a wage taker, labor supply to the firm is horizontal, and MFC = wage — so the rule collapses to MRP = wage.

Shifts in Labor Demand

Three shifters: the price of the output (higher output price → higher MRP → demand shifts right), worker productivity (better training or technology → higher MP), and the price of other inputs (substitutes and complements in production).

Shifts in Labor Supply

Driven by worker choices: the number of qualified workers, immigration, wages in alternative occupations, non-wage conditions of the job, and government policy affecting participation.

Least-Cost and Profit-Maximizing Rules

Least cost: MPL/PL = MPK/PK — equal output per dollar across inputs. Profit maximizing: MRPL/PL = MRPK/PK = 1 — each input hired until the last dollar spent returns exactly a dollar. Least cost is necessary but not sufficient for profit maximization.

Monopsony

One buyer of labor. To hire another worker the firm must raise the wage for everyone, so MFC lies above the supply curve. Find quantity where MRP = MFC, then read the wage down on the supply curve. Result: fewer workers, lower wages, and deadweight loss.

Minimum Wage in a Monopsony

The counterintuitive case. A minimum wage set between the monopsony wage and the competitive wage flattens labor supply over that range, so MFC equals the minimum wage there. Employment rises — the opposite of the competitive-market result.

The key terms you must know

Derived demand — demand for a resource that comes from demand for the output it produces.
Marginal product (MP) — extra output from one more unit of a resource.
Marginal revenue product (MRP) — MP × MR; the firm's demand curve for a resource.
Marginal factor cost (MFC) — the extra cost of one more unit of a resource; equals the wage only in competition.
MRP = MFC — the profit-maximizing hiring rule for any factor market.
Least-cost rule — MPL/PL = MPK/PK, the cheapest way to make a given output.
Monopsony — a single buyer of a resource, facing MFC above supply.
Monopsonistic exploitation — the gap between MRP and the wage actually paid.

Key themes to remember

Everything is derived. Labor demand only moves because something happened in the output market or to productivity.
MRP = MFC mirrors MR = MC. If you can do Unit 3's profit maximization, you can do this unit's hiring decision.
Competition makes MFC = wage; monopsony breaks that. Almost every Unit 5 exam question turns on which case you're in.
Read the wage off supply, not off MFC. This is the monopsony twin of Unit 4's "read price off demand, not MR."
Small unit, formulaic points. The calculations are mechanical — MRP tables and the least-cost rule are among the most reliably scoreable items on the exam.

Common exam traps

Don't read the monopsony wage off the MFC curve. Quantity comes from MRP = MFC; the wage comes down to the SUPPLY curve. This is the unit's single biggest point-loser.
MFC = wage only in a competitive factor market. Writing MFC = wage in a monopsony problem contradicts the entire graph.
MRP uses marginal revenue, not price, when the firm has market power. MRP = MP × P is a special case, not the general formula.
A minimum wage can raise employment under monopsony. The competitive-market intuition (minimum wage → unemployment) does not transfer.
Least-cost is not the same as profit-maximizing. MPL/PL = MPK/PK finds the cheapest way to make a given quantity; it doesn't tell you whether that quantity is the profitable one.
The individual competitive firm's labor supply curve is horizontal. Only the market supply curve slopes upward — don't draw the market graph when asked for the firm.