AP Microeconomics, AP exams

Unit 5: Factor Markets

Unit 5 applies supply and demand to markets for labor and other productive resources. Derived demand and marginal revenue product explain why firms hire, and monopsony shows what happens when a single buyer dominates. The graphs mirror product markets, which makes the analogy worth learning explicitly.

Position: 5 of 6 units
Topics covered: 6 topics in this guide

What is covered

Topics inside this unit.

These topics describe the scope students most often review for this part of AP Microeconomics. Treat them as a study checklist rather than an exhaustive list of what a single exam form can sample.

Introduction to factor markets: Derived demand for resources, and the difference between product markets and factor markets.
Marginal revenue product: The value of an additional unit of a factor and the hiring rule that sets marginal revenue product equal to factor price.
Changes in factor demand and supply: Productivity, output price, and substitute factors shifting demand, and the determinants of factor supply.
Perfectly competitive labor markets: Market wage determination and the individual firm's horizontal factor supply curve.
Monopsony: A single buyer facing an upward-sloping factor supply curve, and the resulting lower wage and employment.
Least-cost hiring across factors: Allocating spending among factors so the marginal product per dollar is equal across inputs.

Study tips

How to practice Factor Markets.

Section-specific guidance that follows from how this material is usually tested.

Map each factor-market graph onto its product-market analogue to cut memorization in half.
Practice monopsony graphs specifically; the extra marginal factor cost curve is easy to omit.
State the hiring rule in words before drawing, since explanations carry rubric points.

Where this fits

Unit 5: Factor Markets is 5 of 6 units in the AP Microeconomics guide. Use the full guide to balance it against everything else you have to review.

Back to the AP Microeconomics guide Official exam information

Sample Factor Markets questions

Practice questions, not yet expert-reviewed

Original practice questions written to the published framework for this section. No expert has reviewed them, and they are not taken from any official exam. Try each one before you open the answer.

Question 1Foundational
Why do economists describe a firm's demand for labor as a derived demand?
1. AIt comes from the demand for the goods that the labor helps produce
2. BIt is derived from the wage rate the firm chooses to pay
3. CIt is derived from the total supply of workers in the economy
4. DIt comes from minimum wage rules set by government
Show answer
Answer: A. It comes from the demand for the goods that the labor helps produce
Firms hire workers not for their own sake but because those workers produce output that customers want, so a drop in product demand reduces labor demand. Deriving it from the wage is the tempting distractor, but the wage determines how many workers are hired along a given demand curve rather than where that curve sits.
Key insight: When the price of a firm's product rises, its labor demand curve shifts right even though nothing about the workers changed.
Question 2Foundational
What hiring rule does a firm follow when it buys labor in a perfectly competitive labor market?
1. AHire workers until marginal revenue product equals the wage
2. BHire workers until marginal product reaches its maximum
3. CHire workers until total revenue reaches its maximum
4. DHire workers until average product equals the wage
Show answer
Answer: A. Hire workers until marginal revenue product equals the wage
Marginal revenue product measures what an extra worker adds to revenue, so hiring continues while that exceeds the wage and stops when the two are equal. Hiring to the maximum marginal product is the tempting distractor, but the peak of marginal product ignores both the output price and what the worker costs.
Key insight: The factor market hiring rule is the same marginal logic as marginal revenue equals marginal cost, applied to inputs instead of output.
Question 3Intermediate
A firm sells its output at 5 dollars per unit in a perfectly competitive product market. Hiring a fifth worker would add 12 units of output and hiring a sixth would add 8 more. If each worker must be paid 50 dollars, which of these workers should the firm hire?
1. AThe fifth worker only
2. BBoth the fifth and the sixth worker
3. CThe sixth worker only
4. DNeither worker
Show answer
Answer: A. The fifth worker only
The fifth worker generates 12 units times 5 dollars, or 60 dollars of marginal revenue product against a 50 dollar wage, while the sixth generates only 40 dollars and would lose the firm money. Hiring both is the tempting distractor because both workers add output, but adding output is not enough when the added revenue falls short of the wage.
Key insight: Multiply marginal product by the output price to get marginal revenue product, then compare that figure with the wage one worker at a time.
Question 4Intermediate
What distinguishes a monopsony labor market from a perfectly competitive one?
1. AA single buyer faces an upward-sloping labor supply curve, so marginal factor cost exceeds the wage
2. BA single seller of labor sets the wage for the whole industry
3. CEach firm faces a perfectly horizontal supply of labor at the market wage
4. DThe wage is fixed by government regulation rather than by the market
Show answer
Answer: A. A single buyer faces an upward-sloping labor supply curve, so marginal factor cost exceeds the wage
A monopsonist is the only employer, so attracting one more worker requires raising the wage for everyone already hired, which makes the true cost of that worker exceed the posted wage. A horizontal labor supply is the tempting distractor, but that describes an individual firm in a competitive labor market, which can hire all it wants at the going wage.
Key insight: In monopsony the marginal factor cost curve lies above the labor supply curve, which is the single detail most often left off the graph.
Question 5Advanced
Compared with an otherwise identical perfectly competitive labor market, what wage and employment level does a profit-maximizing monopsonist choose?
1. AA lower wage and a lower level of employment
2. BA higher wage and a higher level of employment
3. CA lower wage and a higher level of employment
4. DA higher wage and a lower level of employment
Show answer
Answer: A. A lower wage and a lower level of employment
The monopsonist hires where marginal revenue product equals marginal factor cost, and because marginal factor cost lies above the supply curve it stops short of the competitive quantity and then pays only the wage on the supply curve at that reduced quantity. Expecting a lower wage with higher employment is the tempting distractor, but a cheaper wage here is the consequence of hiring fewer workers, not of hiring more.
Key insight: A monopsonist restricts hiring for the same reason a monopolist restricts output: buying one more unit raises the price paid on all of them.

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Unit 5: Factor Markets