Question

1. Why is the MRP curve downward sloping? What factors cause it to shift? Answer with respect to the MRP for each of the factors of production.

2. Under what conditions is the labor supply curve upward sloping? When is it backward bending? What factors cause the labor supply curve to shift?

Thank you!!

Answer 1

1) The MRP curve is downward sloping because as more of a factor is used, the MRP goes on declining because of the law of diminishing marginal returns. MRP is derived by MR multiplied by MPP. As MPP declines the MRP also declines.

A change in MPP or price will shift the MRP.

2) The labor supply curve upward sloping when with the increase in wage rate the substitution effect is more than the income effect. This leads to more work being preffered by the worker. While when the income effect dominates the substitution effect, the labour supply curve is backwards bending.