Five practice questions are below. Answer on the page: each one is marked the moment you pick, the correct option is shown whether or not you found it, and the full explanation opens either way.
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Factor Markets: five questions to try now
Real questions, the answer key from the mark scheme, and the explanation that goes with it. No account needed to answer them.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not AP Economics past-paper material.
Question 1
A firm faces a downward-sloping demand for its product. Assuming that labour is its only variable factor input, how does the firm derive its demand curve for labour?
Answer: C.
A firm's demand curve for labour is its marginal revenue product curve, which measures what one more worker adds to revenue. That has two parts: the extra output the worker produces, which is the marginal physical product, and the extra revenue that output brings in, which is marginal revenue. Multiplying the two schedules together gives the demand curve, and both are needed. Using the current price of output instead of marginal revenue would only work for a price taker, because a firm facing a downward sloping demand curve must lower its price to sell the extra units, so marginal revenue lies below price and using price would overstate the value of every additional worker. Marginal factor cost is the cost of employing one more worker and belongs to the supply side of the labour market, so it helps determine how many are hired once the demand curve exists rather than shaping the curve itself. Pairing marginal physical product with the money wage makes the same mistake, mixing a demand-side schedule with a cost, and the money wage is what the curve is read against, not what it is built from.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not AP Economics past-paper material.
Question 2
Labour is the only variable factor of a profit-maximising firm which is a price-taker in the labour market. From what is the firm’s demand curve for labour derived?
Answer: C.
Labour is wanted for what it produces, which is why the demand for it is a derived demand. The marginal revenue product measures the extra revenue one more worker brings in, and a profit-maximising firm keeps hiring while that exceeds the wage. Every point on the MRP curve therefore states how many workers the firm would want at that wage, which is exactly what a demand curve does.
The other options name different things. Marginal factor cost (A) is what an extra worker COSTS, the other side of the same decision, and for a price-taker in the labour market it is simply the wage. Marginal revenue (B) belongs to the product market. Short-run marginal cost (D) is the cost of an extra unit of OUTPUT, not of an extra worker.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not AP Economics past-paper material.
Question 3
A firm is operating in a perfectly competitive market. Why does the marginal revenue product of a factor of production employed by the firm fall as more of the factor is employed?
Answer: B.
Marginal revenue product is marginal physical product multiplied by marginal revenue, so if it is falling, one of those two must be falling. The stem specifies a perfectly competitive market, which makes the firm a price taker: it sells any quantity at the going price, so marginal revenue is constant and equal to that price. With marginal revenue pinned down, the decline has to come from the physical side, and it does, because the law of diminishing returns means each extra worker added to a fixed quantity of capital contributes less output than the one before. That is why both the option about falling marginal revenue and the option about falling average revenue are ruled out by the words perfectly competitive rather than by anything about labour. The supply price of the factor rising describes what the firm has to pay for labour, which is the cost side of the hiring decision and sits on the other curve entirely; marginal revenue product measures only what the worker brings in. Under imperfect competition both the physical product and marginal revenue fall together, which is why the curve declines more steeply there.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not AP Economics past-paper material.
Question 4
When will a profit-maximising firm employ the optimum number of workers?
Answer: C.
The correct answer is C: when the marginal revenue product of labour equals the marginal cost of hiring workers.
This is the marginal condition applied to the labour market. MRP is the extra revenue generated by employing one more worker; the marginal cost of labour is the extra cost of employing them. While MRP exceeds marginal cost, each additional worker adds more to revenue than to cost, so profit rises and the firm should hire. Once marginal cost exceeds MRP, the last worker reduces profit. Profit is therefore maximised where the two are equal, the same logic as MC = MR applied to a factor of production.
Why the other options are wrong:
A uses average revenue product and average cost. Averages describe the workforce as a whole and cannot identify whether the next hire is worthwhile. Decisions at the margin require marginal quantities.
B mixes the two, comparing marginal revenue product with average cost of hiring. In a competitive labour market where the wage is constant, average and marginal cost of labour coincide, which is why this feels acceptable, but under monopsony the firm must raise the wage for all workers to attract one more, so marginal cost exceeds the average wage and the two conditions diverge. The correct rule is always stated in marginal terms.
D refers to a "trade union supplied cost of workers", which is not an economic concept. A union may raise the wage, but the profit-maximising rule is unchanged; only the level of marginal cost differs.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not AP Economics past-paper material.
Question 5
What is a definition of transfer earnings?
Answer: B.
Transfer earnings are the MINIMUM a factor has to be paid to keep it where it is, which in a labour market means what the worker could earn in the next best alternative job. Pay less than that and the worker moves; pay more and the excess is a surplus. B states that minimum, so it is right. A defines the surplus instead, because earnings above the amount needed to keep the worker in the current job are economic RENT, and rent plus transfer earnings together make up the whole wage. C describes welfare payments, which move money between the state and households and have nothing to do with splitting a wage into its two components. D is looser still: the amount that would tempt a worker into a different job depends on what that other job offers, whereas the definition has to be anchored to keeping the factor in its PRESENT use.
These questions are drawn from past Cambridge papers, mapped across to this topic because the concept is the same. You answer, you find out immediately whether you were right, and you get the reasoning for the correct option and for each distractor. Wrong answers go to a mistakes locker so you can come back to exactly those.
Practice is free. You need an account only so your progress and your mistakes are still there next time.
These are the errors that cost marks on factor markets, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
Using MP instead of MRP in the hiring rule.
Forgetting that MRP = MP × MR, and that MR = P only in a competitive product market.
Computing MRC as the wage rather than as the change in total labour cost.
Drawing MRC below the labour supply curve in monopsony, it lies above.
Reading the monopsony wage off the MRC curve instead of down to supply.
Claiming a minimum wage always causes unemployment, without checking whether the market is monopsonistic.
Confusing the least-cost rule (MP/P equal) with the profit-maximising rule (MRP/P = 1).
Treating labour demand as if it were independent of product demand.