David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 11 Factor markets and income distribution
D SS
The industry begins in equilibrium at E. Overnight its
short-run supply of capital is fixed at K0, but in the long
run it faces the horizontal supply curve S'S' at the going
rental, R0. Suppose a wage increase shifts the demand
GI
curve for capital from DD to D'D'. The new short-run
..
0
.. Ro
equilibrium is at E'. Since the rental R1 fails to provide
0 the required rate of return, owners of capital goods
..
c
allow these goods slowly to depreciate without buying
GI
Cl:
any new capital goods. The industry's capital stock and
'
the services it provides gradually fall back. Eventually the
Ri
D'
'
----------T
'
---------
-- S'S'
D'
K1 Ko
Quantity of capital services
industry reaches long-run equilibrium at E". Since capital
is again earning the required rate of return, owners of
capital goods now replace goods as they depreciate.
Figure 11.6
Short- and long-run adiustment of capital to a wage rise
The industry faces a long-run supply curve S'S' for capital services. Eventually it must pay the going rate.
At E', owners of capital do not get the required rental for the capital services they supply. They let their capital
stock depreciate. Over time, the industry's capital stock and supply of capital services fall until equilibrium
is reached at E". The capital services used by the industry have fallen to K1• Less capital means a higher
marginal product of capital and higher rentals. At E", users of capital again pay the required rental R0.
The arrows in Figure 1 1.6 show the dynamic path that the industry will follow. When demand for capital
falls, there is a sharp fall in the rental on capital. Owners of the fixed factor cannot adjust the quantity of
capital services supplied. As time elapses, they adjust the quantity, allowing capital goods to depreciate,
and the rental gradually recovers.
Factor markets: a summary
II
Chapters 10 and 11 examine markets for production inputs. In the long run, when all inputs can
be freely varied, the firm's choice of technique at each output level is determined by technology
and relative factor rentals. At a given output, a higher relative price of one factor makes the firm substitute
towards techniques using that factor less intensively. The long-run total cost curve shows the cheapest way to
produce each output level when production techniques are optimally chosen.
From long-run total cost, we calculate long-run marginal cost and hence the output at which marginal cost
and marginal revenue are equal. For each factor, the firm's demand is a derived demand that reflects the
factor's marginal physical product in making extra output and the marginal revenue from selling that extra
output. A competitive firm's demand curve for a factor is the marginal value product schedule, which assumes
a given output price, given quantities of all other inputs, and given technology. Changes in any of these shift
the marginal value product schedule. In the short run, a competitive firm demands that quantity of its variable
factor which equates its marginal value product and its factor rental. In the long run, every factor can be
varied. Each factor is demanded to the point at which its factor rental equals its marginal value product given
the quantity of all other factors, each having been adjusted in the same way.
What distinguishes labour, capital and land is mainly the speed with which their supply can adjust. The input
of casual labour on construction sites or during crop picking is easily variable, even in the short run. The
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