Transcript Chapter 11 Resource Markets © 2006 Thomson/South-Western Resource Demand and Supply  As long as the additional revenue from employing another worker exceeds the.

Chapter 11
Resource Markets
© 2006 Thomson/South-Western
1
Resource Demand and Supply
 As long as the additional revenue from employing
another worker exceeds the additional cost, the firm
should hire the worker
 Resource owners will supply their resources to the
highest-paying alternative, other things equal
 Since other things are not always equal, resource
owners must be paid more to supply their resources to
certain uses
2
Exhibit 1: Resource Market for Carpenters
The demand curve
slopes downward
and the supply curve
slopes upward
The demand for
and supply of
resources depends on
the willingness and
ability of buyers and
sellers in resource
markets
Dollars per hour of labor
S
W
D
0
E
Hours of labor per
period
3
Market Demand for Resources
 Firms value a resource for its ability to produce
goods and services
 Demand depends on the value of what it produces
 It is a derived demand: derived from the demand for the
final product
 Market demand for a particular resource is the
sum of demands for that resource in all its different
uses
 The demand curve slopes downward because as the
price of a resource falls, producers are more willing
and able to employ that resource
4
Market Demand for Resources
If the price of a particular resource falls,
it becomes relatively cheaper compared
to other resources the firm could use to
produce the same output: they are more
willing to hire this resource
Substitution in production
5
Market Demand for Resources
A lower price for a resource also
increases a producer’s ability to hire that
resource
For example, if the wage for carpenters
falls, homebuilders can hire more
carpenters for the same cost
6
Market Supply for Resources
The market supply curve of a
resource sums all the individual
supply curves for that resource
Resource suppliers tend to be both
more willing and more able to supply
the resource as its price increases =>
the market supply curve slopes
upward
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Exhibit 2: Market for Carpenters in Alternative Uses
•If carpenters earn $25 an hour to build homes (panel a), $5 more than carpenters making
furniture (panel b), some will move from furniture making to home building: the wage in home
building decreases and the wage in furniture building increases. Eventually, this shift will
continue until the wage is equal at $24 in both markets.
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Temporary Differences in Resource Prices
Resource prices sometimes differ
temporarily across markets because
adjustment takes time
But when resource markets are free to
adjust, price differences trigger the
reallocation of resources, which equalizes
payments for similar resources
9
Permanent Differences in Resource Prices
Not all resource price differences cause a
reallocation of resources
For example, land may lead to permanent
differences in prices
Certain wage differentials stem from the different
costs of acquiring the education and training
required to perform particular tasks
Other earning differentials reflect differences in the
nonmonetary aspects of similar jobs
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Summary
 Temporary price differences spark the movement
of resources away from lower-paid uses toward
higher-paid uses
 Permanent price differences cause no such
reallocations
Lack of resource mobility
Differences in the inherent quality of the resource
Differences in the time and money involved in
developing the necessary skills
Differences in nonmonetary aspects of job
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Opportunity Cost and Economic Rent
Opportunity cost is what that resources could
earn in its best alternative use
Economic rent is that portion of a resource’s
total earnings that is not necessary to keep the
resource in its present use  form of producer
surplus earned by resource suppliers
12
Exhibit 3: Opportunity Cost and Economic Rent
The supply of grazing land
is shown by the perfectly
inelastic vertical supply
curve, indicating 10 million
acres have no alternative use
Since the supply of land is
fixed, the amount paid to
rent the land has no effect on
the quantity supplied: the
land’s opportunity cost is
zero and all earnings are
economic rent
The fixed supply
determines the equilibrium
quantity of the resource,
while demand determines the
equilibrium price
(a) All Resource Returns are Economic Rent
S
$1
Economic
rent
D
0
10
Millions of acres
per month
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Exhibit 3: Opportunity Cost and Economic Rent
(b) All Resource Returns are Opportunity Costs
S
$10
Opportunity
costs
D
0
1,000
Hours of labor
per week
At the other extreme is the case in
which a resource can earn as much
in its best alternative use as in its
present use
 the supply curve is perfectly
elastic  horizontal  all
resource returns are
opportunity costs as shown by
the shaded area
Here, the horizontal, perfectly
elastic, supply determines the
equilibrium wage while demand
determines the equilibrium quantity
The more elastic the resource
supply, the lower the economic rent as
a portion of total earnings
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Exhibit 3: Opportunity Cost and Economic Rent
(c) Resource returns are divided between
economic rent and opportunity cost
S
Dollars per unit
If the supply curve slopes
upward, the resource
supplier earns some
economic rent and some
opportunity cost
At a market clearing
wage of $10, the pink
shaded area identifies
the opportunity cost
and
the blue shaded area
the economic rent
Both demand and supply
determine the equilibrium
price and quantity
$10
Economic rent
5
Opportunity costs
0
5,000
10,000
D
Hours of labor
per week
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Marginal Revenue Product
Marginal product is the change in total
product from employing one more
worker and reflects the law of
diminishing returns
Marginal revenue product is the marginal
product of the resource multiplied by the
product price
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Exhibit 4: Marginal Revenue Product
 Here, marginal revenue product is the marginal product of the resource
multiplied by the product price of $20, the marginal benefit from hiring
one more worker
 Note that because of diminishing returns, the marginal revenue product
falls steadily as the firm employs additional units of the resource.
Workers
per day
(1)
0
1
2
3
4
5
6
7
8
9
10
11
12
Total
Product
(2)
Marginal
Product
(3)
0
10
19
27
34
40
45
49
52
54
55
55
53
10
9
8
7
6
5
4
3
2
1
0
-2
Product
Price
(4)
$20
20
20
20
20
20
20
20
20
20
20
20
20
Total
Revenue
(5)
$0
200
380
540
680
800
900
980
1040
1080
1100
1100
1060
Marginal
Revenue
Product
(6)
$200
180
160
140
120
100
80
60
40
20
0
-40
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Exhibit 5: Marginal Revenue Product for a Price Maker
 If the firm has some market power over the price that it charges, the demand curve
slopes downward and price must be lowered to sell more
 The profit-maximizing firm should be willing and able to pay as much as the
marginal revenue product for an additional unit of the resource
 The marginal revenue product for the price maker declines because of the law of
diminishing returns and because additional output can be sold only if the price is
lower
Workers
per day
(1)
1
2
3
4
5
6
7
8
9
10
11
Total
Product
(2)
10
19
27
34
40
45
49
52
54
55
55
Marginal
Product
Total
Revenue
Price
Revenue
Product
(3)
(4) = (2)  (3)
(5)
$40.00
35.20
31.40
27.80
25.00
22.50
20.50
19.00
18.00
17.50
17.50
400.00
668.80
847.80
945.20
1000.00
1012.50
1004.50
988.00
972.00
962.50
962.50
$400.00
268.80
179.00
97.40
54.80
12.50
-8.00
-16.50
-16.00
-9.50
0.00
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Marginal Resource Cost
The additional cost to the firm of employing
one more unit of labor
Since the typical firm hires such a tiny fraction
of the available resources, its employment
decision has no effect on the market price of
that resource
Each firm usually faces a given market price
for the resource and decides only on how much
to hire at that price
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Exhibit 6: Market Equilibrium For a Resource and the Firm’s
Employment Decision
In panel (a) the intersection of market
demand and supply determines the market
wage of $100 per day  becomes the
marginal resource cost of labor to the firm
regardless of how many workers the firm
employees.
In panel (b) the marginal resource cost
curve is shown by the $100 market wage.
The marginal revenue product, or
resource demand curve, is based on the
firm being a price taker. In this case the
firm will hire 6 workers per day.
$200
Resource
demand
Resource
supply
100
0
E
Workers
per day
b) Firm
Dollars per worker per da y
Dollars per worker per day
a) Market demand for factory workers
$200
Marginal revenue product =
resource demand
Marginal resource cost =
resource supply
100
0
6
10
Workers
per day
20
Resource Employment
For all resources employed, the firm should
hire additional units up to the level at which
Marginal revenue product = marginal
resource cost, or
MRP = MRC
Profit maximization occurs where labor’s
marginal revenue product equals the market
wage
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Shifts in the Demand for Resources
A resource’s marginal revenue product consists
of two components
The resource’s marginal product; two factors can
cause this to change:
A change in the amount of other resources employed
A change in technology
The price at which the product is sold. One factor
can cause this to change
A change in the demand for the product
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Change in the Price of Other Resources
The marginal product of any resource depends
on the quantity and quality of other resources
used in production
Resources can be substitutes or complements
Substitutes
An increase in the price of one increases the demand
for the other
A decrease in the price of one decreases the demand
for the other
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Change in the Price of Other Resources
Complements
A decrease in the price of one resource leads to an
increase in the demand for the other
An increase in the price of one resource leads to a
decrease in the demand for the other
More generally, any increase in the quantity and quality
of a complementary resource boosts the marginal
productivity of the resource in question
Alternatively, any decrease in the quantity and quality
of a complementary resource reduces the marginal
productivity of the resource in question
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Changes in Technology
Technological improvements can boost the
productivity of some resources but can make
others obsolete
Development of computer-controlled machines
increased the demand for computer-trained
machinists, but decreased the demand for
machinists without computer skills
The development of synthetic fibers – rayon and
orlon – increased the demand for acrylics and
polyesters, but reduced the demand for natural
fibers
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Change in the Demand for the Final Product
Because the demand is derived from the
demand for the final output, any change in the
demand for output will affect resource demand
For example, an increase in the demand for
automobiles will increase their market price
and increase the marginal revenue product of
autoworkers and other resources employed by
the automobile industry
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