Resource Markets 1
Demand & Supply of Resources Resource demand Firms demand resources As long as marginal revenue exceeds marginal cost To maximize profit Resource supply People supply resources To the highest-paying alternative To maximize utility 2
Dollars per hour of labor Exhibit 1 Resource Market for Carpenters S W D 0 E Hours of labor per period The intersection of the upward-sloping supply curve of carpenters with the downward-sloping demand curve determines the equilibrium wage, W, and the level of employment, E. 3
Market Demand for Resources Resource demand Derived demand Arises from the demand for the product the resource produces Market demand Sum of demands for a resource In all its uses Downward sloping 4
Market Demand for Resources As price falls, producers More willing to buy Relatively cheaper Substitution in production Greater ability to buy Hire more at the same total cost 5
Market Supply of Resources Market supply Sum of all individual supply curves Upward sloping As price rises, resource suppliers More willing to sell Higher earnings More goods and services purchased More able to increase quantity supplied 6
Resources Resource Price Differences Flow to their highest-valued use If freely mobile Adjust across different uses until they earn the same wage Temporary differences Market adjustments Reallocation of resources 7
Dollars per hour Dollars per hour Exhibit 2 Market for Carpenters in Alternative Uses (a) Home building (b) Furniture making S h S h S f S f $25 24 $24 20 D h D f 0 58 60 Hours of labor 0 10 12 Hours of labor per day (thousands) per day (thousands) Suppose initially the hourly wage of carpenters is $25 in the homebuilding market but only $20 in the furniture-making market, and suppose also that carpenters view the jobs as equally attractive, aside from the wage. This differential prompts some carpenters to shift from furniture making to home building until the wage is identical in the two markets. In panel (b), the reduction of labor supplied to furniture making increases the market wage from $20 to $24. In panel (a), the increase of labor supplied to home building reduces the market wage from $25 to $24. Note that 2,000 carpenter-hours per day shift from furniture making to home building. 8
Resource Price Differences Permanent differences Lack of resource mobility Differences in the inherent quality of the resource Differences in time and money involved in developing necessary skills Differences in nonmonetary aspects of the job 9
Opportunity Cost & Economic Rent Opportunity cost What a resource could earn in its best alternative use Economic rent Earnings in excess of opportunity cost Pure gravy The less elastic the resource supply The greater the economic rent as proportion of total earnings 10
Opportunity Cost & Economic Rent Perfectly inelastic Supply No alternative uses No opportunity cost All earnings are economic rent Perfectly elastic Supply Earns the same in current and best alternative use All earnings are opportunity cost No economic rent 11
Opportunity Cost & Economic Rent Upward sloping Supply Earnings consist of both opportunity cost and economic rent Both demand and supply determine equilibrium price and quantity Specialized resources tend to earn a higher proportion of economic rent Than do resources with alternative uses 12
Dollars per unit Dollars per unit Exhibit 3 Opportunity Cost and Economic Rent (a, b) (a) All earnings are economic rent (b) All earnings are opportunity costs S $1 $10 S Economic rent D Opportunity costs D 0 10 Millions of acres per month 0 1,000 Hours of labor per day In panel (a), the resource supply curve is vertical, indicating that the resource has no alternative use. The price is demand-determined, and all earnings are economic rent. In panel (b), the resource supply curve is horizontal at $10 per hour, indicating that the resource can also earn that much in its best alternative use. Employment is demanddetermined, and all earnings are opportunity cost. 13
Dollars per unit Exhibit 3 Opportunity Cost and Economic Rent (c) (c) Earnings divided between economic rent and opportunity cost S $20 10 Economic rent Opportunity costs D Panel (c) shows an upward sloping resource supply curve. Earnings are partly opportunity cost and partly economic rent. Both demand and supply determine the equilibrium price and quantity. 0 5,000 10,000 Hours of labor per day 14
Firm s Demand for a Resource Quantity of resource, L Total product, TP, Q Amount produced Marginal product of labor, MP= TP/ L Change in total product from employing one more unit Diminishing marginal returns to labor 15
Marginal Revenue Product Marginal revenue product, MRP= TR/ L Change in total revenue when an additional unit of a resource is employed Other things constant Depends on additional output and the price of output MRP curve = Firm s demand curve for the resource 16
Marginal Revenue Product Perfectly competitive product market MRP = MP product P MRP curve slopes downward Diminishing marginal returns to resource Some market power in product market MRP curve slopes downward Diminishing marginal returns to resource Additional output can be sold only if price falls 17
Exhibit 4 Marginal Revenue Product When a Firm Sells in a Competitive Market Because of diminishing marginal returns, the marginal product of labor declines as more labor is employed, as shown in column (3). Because this firm sells in a competitive market, it can sell all it wants at the market price of $20 per unit of output, as shown in column (4). The marginal product of labor in column (3) times the product price of $20 in column (4) yields the marginal revenue product of labor in column (6). Labor s marginal revenue product is the change in total revenue as a result of hiring another unit of labor. 18
Exhibit 5 The Marginal Revenue Product When a Firm Sells with Market Power To sell more, this firm must lower the price, as indicated in column (3). Total revenue in column (4) equals total product in column (2) times the product price in column (3). Labor s marginal revenue product in column (5) equals the change in total revenue from hiring another worker. The marginal revenue product declines both because of diminishing marginal returns from labor and because the product price must fall to sell more. 19
Marginal Resource Cost Marginal resource cost, MRC= TC/ L Change in total cost when hiring one more unit of labor MRC curve Horizontal curve at the equilibrium market wage Labor supply curve to the firm Maximize profit Hire resources until MRC=MRP 20
Exhibit 6 Dollars per worker per day Market Equilibrium for a Resource and the Firm s Employment Decision Dollars per worker per day (a) Market (b) Firm $200 Resource supply $200 Marginal revenue product = Resource demand 100 100 Marginal resource cost = Resource supply 0 E Resource demand Workers per day 0 6 10 Workers per day Market demand and supply of a resource, in panel (a), determine that resource s market wage and quantity. In panel (b), an individual firm can employ as much as it wants at the market wage, so that wage becomes the firm s marginal resource cost. The marginal resource cost curve also is the supply curve of that resource to the firm. In panel (b), a resource s marginal revenue product is the firm s demand curve for that resource. The firm maximizes profit (or minimizes its loss) by hiring a resource up to the point where the resource s marginal revenue product equals its marginal resource cost, which is six workers per day in this example 21
Changes in Resource Demand Changes in MRP (demand) Marginal product of the resource Amount of other resources employed Technology Product s price Change in demand for the product Demand for resource = derived demand 22
Changes in Resource Demand Resource substitutes Resources that substitute in production An increase in the price of one resource increases the demand for the other Resource complements Resources that enhance one another s productivity A decrease in the price of one resource increases the demand for the other 23
Changes in Resource Demand Changes in technology Technological improvements Can boost the productivity of some resources But make other resources obsolete Demand for the final product Demand for a resource is derived from the demand for the final output Any change in the demand for output affects resource demand 24
More Than One Resource For every resource employed If MRP > MRC A firm can increase profit or reduce a loss by employing more of that resource If MRP = MRC Maximize profit (or minimize loss) 25