Chapter 11

Resource Markets

© 2009 South-Western/ Cengage Learning

Demand and Supply of Resources

• Resource demand– Firms demand resources– Hire as long as MR>MC– Objective is to maximize profit

• Resource supply– People supply resources– Sell to the highest-paying alternative– Objective is to maximize utility

•2

Exhibit 1Resource market for carpenters

3

Hours of labor per periodE0

Dol

lars

per

hou

r of

labo

r

W

D

S

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.

The Market Demand for Resources

• Resource demand– Derived demand– Arises from the demand for the final product

• Market demand– Sum of all demands for a resource, in all its uses– Downward sloping

•4

The Market Demand for Resources

• As price falls, producers– More willing to buy

• Relatively cheaper• Substitution in production, relatively cheaper resources

– Greater ability to buy• Hire more at the same total cost

•5

The Market Supply of Resources

• Market supply– Sum of all individual supply curves

– Upward sloping

• As price rises, resource suppliers– More willing to sell

• Meet reservation price—minimum required before selling• Higher earnings• More goods and services purchased from income earned

– More able to increase quantity supplied

•6

Resource Price Differences

• Resources– 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

Exhibit 2Market for carpenters in alternative uses

8

The wage differential prompts carpenters to shift from furniture making to home building until the wage is identical in the two markets

(a) Home building

Dh

Sh

Dol

lars

per

hou

r

$2524

S’h

Hours of labor

per day (thousands)580 60

(b) Furniture making

Df

SfDol

lars

per

hou

r

20

$24

S’f

Hours of labor

per day (thousands)100 12

Resource Price Differences

• Permanent differences– Lack of resource mobility– Inherent quality of the resource– Time and money involved in developing necessary

skills– Non-monetary aspects of the job

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Opportunity Cost and 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 and 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

Exhibit 3Opportunity cost and economic rent

12

(a) All earnings are economic rent

(b) All earnings are opportunity costs

(c) Earnings divided between economic rent and opportunity cost

S

Millions of

acres

per month

100Hours of

labor

per day

1,0000Hours of

labor

per day

5,0000 10,000

D

Dol

lars

per

uni

t

$1

D

S

Dol

lars

per

uni

t$10

D

S

Dol

lars

per

uni

t

$14

7Economic

rent

Opportunity

costs Opportunity

costs

Economic

rent

The Firm’s Demand for a Resource• Quantity of resource (labor, L)• Total product (TP) or Quantity (Q)

• Quantity of output

• Marginal product: MP=∆TP/∆L• Diminishing marginal returns—successive unit changes in

input results is progressively smaller increases in output

• Marginal revenue product: MRP=∆TR/∆L– How much total revenue changes as more labor is employed– Depends on ∆Q and Price of final product

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Marginal Revenue Product

• MRP curve = Firm’s demand curve for the resource

• Perfectly competitive product market: MRP = MP×Price of final product

• 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

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Exhibit 4MRP when a firm sells in a competitive market

15

(1)Workers per day

(2)Total

product

(3)Marginalproduct

(4)Product

price

(5)Total

Revenue(5)=(2)×(4)

(6)MarginalRevenueProduct

(6)=(3)×(4)

012345678

01019273440454952

-109876543

$202020202020202020

$02003805406808009009801040

-$2001801601401201008060

Exhibit 5MRP when a firm sells with market power

16

(1)Workers per day

(2)Total

product

(3)Product

price

(4)Total

Revenue(4)=(2)×(3)

(5)MarginalRevenueProduct

012345678

01019273440454952

-$40.0035.2031.4027.8025.0022.5020.5019.00

-$400.00668.80847.80945.20

1,000.001,020.501,004.50988.00

-$400.00268.80179.0097.4054.8012.50-8.00

-16.50

Marginal Resource Cost

• Marginal resource cost: MRC=∆TC/∆L– Change in total cost when hiring one more unit of

labor• MRC curve (individual firm)

– Horizontal supply curve at the equilibrium market wage—perfectly competitive labor market

– Firm can hire all labor at market wage• Maximize profit

– Hire resources until MRC=MRP

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Exhibit 6Market equilibrium for a resource and the firm’s employment decision

18

In panel (a), market demand and supply determine the 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 MRC. The firm maximizes profit (or minimizes its loss) by hiring a resource up to the point where MRP = MRC.

(a) Market

Dol

lars

per

wor

ker

per

day

$200

100

Workers per dayE0

(b) Individual Firm

Resource

supply

Resource

demand Dol

lars

per

wor

ker

per

day

$200

100

Marginal resource cost =

Resource supply

Marginal revenue product =

Resource demand

Workers

per day60 10

Changes in Resource Demand

• Changes in MRP (demand)– Marginal product of the resource

• Amount of other resources employed– Substitutes– Complements

• Technology

– Product’s price • Change in demand for the product

– Demand for resource = derived demand

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