Hiring Labor & Acquiring Capital in Factor Markets

Instructor: Martin Gibbs

Martin has 16 years experience in Human Resources Information Systems and has a PhD in Information Technology Management. He is an adjunct professor of computer science and computer programming.

Supply and demand concepts are everywhere in economic activity. In this lesson we will discuss how labor and capital decisions are interwoven in factor markets.

Labor and Capital Markets

When we look at markets and marketplaces, a factor market refers to the inputs of a finished good. Think of the market for mobile devices: The marketplace for the goods themselves is a goods market. However, the market for the raw materials (capital) AND the labor needed to manufacture the goods is a factor market. Labor and capital are factors of production that connect with the final production of goods.

Labor Markets

The concept of supply and demand applies to human capital as well. Organizations demand labor for the production of goods. Workers supply their skills and expertise to these organizations. This relationship is called the labor market.

Capital Markets

Nothing gets done without resources, be they financial or physical. The capital market refers to the equipment used in production, as well as the money used to purchase and maintain this equipment.

The Loop

Labor, capital, and production are connected in a circuitous cycle. The following diagram illustrates how this loop works:

Factor markets loop

Industry demands labor to produce goods, while workers supply the labor; in turn, wages are paid and the workers buy the goods from industry. Therefore, the labor (and wages paid to employees) and capital are integral parts of the economy. Let's take a look at how firms make decisions about acquiring labor and capital.

Acquiring Labor and Capital

When we talk about acquiring labor and/or capital, we return to supply and demand. Companies will not hire for the sake of hiring. For example, it shouldn't take ten employees to construct a single fidget-spinner. Hiring decisions are based on utility. In other words: Will hiring more workers positively impact the bottom line?

The same is true for capital. Will a more modern machine increase production or set a company back financially for ten years?

Labor

Let's take a look at labor acquisition. A company can examine the value of marginal product, a measurement of revenue as impacted by a factor of production (in this case, labor). In other words, how much value will one more employee add to the firm?

We can look at a demand curve to see how the addition of workers impacts profits. In the following graphic, we show the wage-per-hour line and how it intersects with a value of marginal product curve. Where the two intersect is the optimal amount of additional employees. We can hire three employees at $20/hour and still make a profit, but any more and profit isn't increased.


Value of marginal product and wages


Although this is a simple chart, the basic idea is this: A company is only going to hire labor to a point where the value of marginal product matches the rate of pay. If the value of marginal product is MORE than rate of pay, it can hire another worker, but the inverse is also true. This means we hire one less worker (hopefully this worker is able to retire or find another position in the organization)!

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