Economics 7th Edition – N Gregory Mankiw Mark P Taylor (1)

The marginal product of any factor, in turn, depends on the quantity of that factor that is available. Because of diminishing marginal product, a factor in abundant supply has a low marginal product and thus a low price, and a factor in scarce supply has a high marginal product and a high price. As a result, when the supply of a factor falls, its equilibrium factor price rises.

When the supply of any factor changes, however, the effects are not limited to the market for that factor. In most situations, factors of production are used together in a way that makes the productivity of each factor dependent on the quantities of the other factors available to be used in the production process. As a result, a change in the supply of any one factor alters the earnings of all the factors.

For example, suppose one night, lightning strikes the storehouse in which are kept the wooden ladders that the apple pickers use to pick apples from the orchards, and many of the ladders are destroyed in the ensuing fire. What happens to the earnings of the various factors of production? Most obviously, the supply of ladders falls and, therefore, the equilibrium rental price of ladders rises.

Those owners who were lucky enough to avoid damage to their ladders now earn a higher return when they rent out their ladders to the firms that produce apples. Yet the effects of this event do not stop at the ladder market. Because there are fewer ladders with which to work, the workers who pick apples have a smaller marginal product. Thus, the reduction in the supply of ladders reduces the demand for the labour of apple pickers, and this causes the equilibrium wage to fall. This story shows a general lesson in that an event that changes the supply of any factor of production can alter the earnings of all the factors.

The change in earnings of any factor can be found by analyzing the impact of the event on the value of the marginal product of that factor. What Is Capital Income? Labour income is a relatively easy concept to understand: it is the wages and salaries that workers get from their employers. The income earned by capital, however, is less obvious.

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