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Home Theory of Factor Pricing OR Theory of Distribution Firm's Equilibrium in the Factor Market Under Perfect Competition

Firm's Equilibrium in the Factor Market Under Perfect Competition:

 

Definition and Explanation:

 

In a perfectly competitive market, an individual firm cannot influence the market price of a factor by increasing or decreasing its demand. So it has to hire units of a factor at its prevailing price in the market. Same is the case with the supplier of a factor. As the supplier of a factor sells an insignificant quantity of the total supply, it is therefore not in a position to alter the market price of a factor by its own individual action. The individual buyers and sellers of a factor take the market price of a factor as given and adjust the quantity of a factor in the light of market factor price. The buyers and sellers of a factor are therefore called price takers.

 

Since a firm in a perfect competitive factor market is a price taker, so the marginal product of the factor (MP) and the average product (AP) are the same and their curves coincide. They are a horizontal straight time and parallel to the X-axis.

 

Equilibrium of the Firm:

 

When a factor of product is to be hired by a firm, it compares the marginal revenue productivity of the factor (MRP) with that of its marginal cost (MC). So long as the MRP of the factor is greater than its MC. (MRP > MC), a firm will continue hiring the units of a factor (because the factor adds more to its total revenue than to its total cost). When the marginal revenue productivity of a factor is equal to the marginal cost of the factor, the firm will be in equilibrium and its profits maximized MRP = MC.

 

If the output is increased by hiring additional units of the factor, then the MRP < MC, and firm incurs loss.

 

Formula For Firm's Equilibrium:

 

Marginal Revenue Productivity of Labor = Marginal Cost of Labor

 

The equilibrium of the firm in the factor market is explained with the help of a diagram.

 

Diagram:

 

 

In figure (18.2), we assume that labor is the only variable factor in the factor market. KL straight line represents the marginal wags rate. All the firms in the factor market can hire any number of workers at the ruling wage of OK. The marginal revenue product curve of labor cuts the wage line KL at two points P and R. The firm is not in equilibrium at point P because by the employment of increasing number of workers, the marginal revenue product rises higher than the marginal cost or the marginal wage OK. At point R, the marginal revenue productivity of the labor is equal to its marginal cost When the firm employs OE number of workers, it is in equilibrium because at point R marginal revenue product of the variable factor is equal to marginal cost of that factor. In case a firm decides to engage more than OE workers, the marginal cost of the workers {marginal wage) will exceed its marginal revenue productivity. The firm with there^^e, not be, in equilibrium.

 

Summing up we can say that a firm in the labor market is in equilibrium when:

 

(i) Marginal revenue productivity of labor = Marginal cost of labor.

 

(ii) Marginal revenue productivity curve of labor cuts the marginal cost curve {marginal wage) from above.

Relevant Articles:

Introduction to Theory of Factor Pricing or Theory of Distribution
Marginal Productivity Theory (Neo-Classical Version)
Firm's Equilibrium in the Factor Market Under Perfect Competition
Modern Theory of Factor Pricing Under Perfect Competition
 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Rent
Wages
Interest
Profits
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance
History of Money

 

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