Chapter 18 Blog

In this chapter, Mankiw dives into explaining the economics of the factors of production, with a specific focus on labor markets. The economy’s income is distributed into the markets of the factors of production, those being labor, land, and capital (the equipment and structures used to produce goods and services). The demand for these factors is a derived demand, which means that it comes from firms that use these factors to produce other things like goods and services. Assuming that firms are competitive and profit-maximizing, a firm will utilize a factor up to the point where the value of the marginal product of the factor is equal to the price of what they are producing. The supply of the most important factor, is derived from individuals’ trade-off between work and leisure time, since leisure time has an opportunity cost of whatever wage you could’ve been earning. Additionally, the price paid to each factor is adjusted based on the supply and demand for that factor, and because the demand for the factor reflects the VMP of that factor, the equilibrium is where each factor is compensated based on the marginal amount that they contribute to the production of goods and services. The marginal product of any factor depends on the quantities of all factors that are available, meaning that a change in the supply of one factor changes the equilibrium of all factors.