The factors of production are the inputs used to produce goods and services. Labour demand is a derived demand, because it is a factor of production. Let's consider what a competitive and profit-maximizing firm would do. The production function is the relationship between the quantity of inputs used to make a good and the quantity of output of that good. The marginal product of labour is the increase in the amount of output from an additional unit of labour. Diminishing marginal product is the property whereby the marginal product of an input declines as the quantity of the input increases.
The value of the marginal product is the marginal product of the input times the price of the output. A competitive, profit-maximizing firm hires workers up to the point where the VmpL equals the wage (and MC). Thus, the VmpL-curve is the labour demand curve for this firm. What shifts the labour demand curve? - The output price: a decrease in the output price reduces the value of the marginal product and decreases labour demand. - Technological change: as technology advances, the VmpL rises, which in turn increases the demand for labour. - The supply of other factors: the quantity available of one factor of production can affect the marginal product of other factors.
The labor supply curve reflects how workers' decisions about the labour-leisure trade-off respond to a change in that opportunity cost. An upward-sloping curve means that higher wages induce people to work (more). What shifts the labour supply curve? - Changes in tastes: tastes or attitudes towards work changes (women working) - Changes in alternative opportunities: opportunities available in other labour markets. - Immigration: more immigrant 'a more labour supply Two facts about wages in competitive labour markets: - The wage adjusts to the balance of the supply and demand for labour. - The wage equals the VmpL Any event that changes the supply or demand for labour must change the equilibrium wage and the VmpL by the same amount, because these must always be equal. Other factors of production are capital, the equipment and structures used to produce goods and services, and land.
The rental price of capital is the price a person pays to own capital, the purchase price of land is the price a person pays to own land indefinitely. Labour, land and capital each earn the value of their marginal contribution to the production process. When the supply of any factor of production changes, the effects are not limited to the market for that factor. Because they are used together, the marginal product of any one factor depends on the quantities of all factors that are available. Mankiw, Principles of economics, second edition.