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Unit 5 · Factor Markets Unit Hub Flashcards Cheat Sheet Essentials Visual Review MC Practice FRQ Practice
Unit 5 Essentials

Unit 5 Essentials

The 3 big ideas behind Factor Markets, plus a searchable glossary of all 18 vocabulary terms you need for the exam.

3 big ideas
18 key terms
Searchable glossary
College Board aligned
← Back to Unit 5 hub
Big Idea 1
Factor markets are output markets with the roles reversed
Everything you learned about supply, demand, and equilibrium still applies — but now firms are the buyers and households are the sellers. The price is a wage (or rent, or interest), and the quantity is a number of workers or machines. Recognising this symmetry means you already know most of the unit's machinery before you start.
Derived Demand Supply & Demand Wages
Big Idea 2
MRP = MFC is the same marginal logic as MR = MC
A firm hires one more worker for exactly the same reason it produces one more unit: because the benefit at the margin exceeds the cost at the margin. MRP measures the revenue a worker brings in, MFC measures what that worker costs, and the firm stops where they meet. Every hiring question in this unit is a version of that comparison.
MRP MFC Marginal Analysis
Big Idea 3
Buyer power breaks the wage away from productivity
In a competitive labor market the wage equals the MRP of the last worker — workers are paid what they contribute. A monopsonist must raise everyone's wage to attract one more worker, so its marginal factor cost exceeds the wage. It hires fewer workers and pays less than their MRP, and the gap is monopsonistic exploitation.
Monopsony MFC > Wage Deadweight Loss
Factor market
A market where firms buy productive resources — labor, land, capital, entrepreneurship — from households.
Factor Market Basics
Factors of production
The resources used to produce goods and services: land, labor, capital, and entrepreneurship.
Factor Market Basics
Derived demand
Demand for a resource that arises from demand for the output that resource produces.
Factor Market Basics
Marginal product (MP)
The extra output produced by one more unit of a resource, holding other inputs fixed.
Factor Market Basics
Marginal revenue product (MRP)
The extra revenue from hiring one more unit of a resource: MRP = MP × MR. It is the firm's demand curve for that resource.
Marginal Revenue Product
Value of the marginal product
MP × P — the form MRP takes when the firm sells in a perfectly competitive product market, where MR = P.
Marginal Revenue Product
Marginal factor cost (MFC)
The extra cost of hiring one more unit of a resource. Equals the wage in a competitive factor market.
Marginal Revenue Product
MRP = MFC rule
The profit-maximizing hiring condition: keep hiring while the revenue a unit adds exceeds the cost of hiring it.
Marginal Revenue Product
Wage taker
A firm so small in the labor market that it must accept the going wage, facing a perfectly elastic labor supply curve.
Marginal Revenue Product
Change in output price
Raises or lowers MRP at every quantity, shifting labor demand in the same direction.
Shifts in Factor Markets
Change in productivity
An increase in MP raises MRP and shifts labor demand right; better training or technology usually does this.
Shifts in Factor Markets
Substitutes in production
Inputs that can replace one another. If capital gets cheaper, a firm may substitute away from labor.
Shifts in Factor Markets
Complements in production
Inputs used together. Cheaper complementary capital can raise labor productivity and increase labor demand.
Shifts in Factor Markets
Least-cost rule
MPL/PL = MPK/PK — the input mix that produces a given output at minimum cost.
Optimal Input Combinations
Profit-maximizing rule
MRPL/PL = MRPK/PK = 1 — the input mix that maximizes profit, not merely minimizes cost.
Optimal Input Combinations
Monopsony
A factor market with a single buyer of a resource.
Monopsony
Monopsonistic exploitation
The gap between a worker's MRP and the lower wage a monopsonist actually pays.
Monopsony
Upward-sloping MFC
In monopsony, hiring one more worker requires raising the wage for all workers, so MFC lies above the supply curve.
Monopsony