Ch 11 resource markets micro econ4

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Chapter 11 ECON4 William A. McEachern

1

Resource

Markets





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 utility2

Exhibit 1

3

Resource Market for Carpenters

Hours of labor per periodE0

Dolla

rs p

er

hour

of

labor

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.







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





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 2

8

Market for Carpenters in Alternative Uses

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.

(a) Home building

Dh

Sh

Dolla

rs

per

hour

$25

24

S’h

Hours of labor

per day (thousands)580 60

(b) Furniture making

Df

SfDo

llars

per

hour

20

$24

S’f

Hours of labor

per day (thousands)100 12





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

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• 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 rent11






• 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



Exhibit 3

13

Opportunity Cost and Economic Rent (a, b)

(a) All earnings are economic rent (b) All earnings are opportunity costs

S

Millions of

acres per month100

Hours of

labor per day1,0000

D

Do

llars

pe

r u

nit

$1

D

S

Do

llars

pe

r u

nit

$10

Economic

rent

Opportunity

costs

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 demand-

determined, and all earnings are opportunity cost.



Exhibit 3

14

Opportunity Cost and Economic Rent (c)

(c) Earnings divided between economic rent and opportunity cost

Hours of

labor per day5,0000 10,000

D

S

Do

llars

pe

r u

nit

$20

10

Opportunity

costs

Economic

rent

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.





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

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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

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Exhibit 4

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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.





Exhibit 5

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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.





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

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Exhibit 6

21

Market Equilibrium for a Resource and the

Firm’s Employment Decision

(a) Market

Dolla

rs p

er

work

er

per

day

$200

100

Workers per dayE0

(b) Firm

Resource

supply

Resource

demand

Dolla

rs p

er

work

er

per

day

$200

100

Marginal resource cost =

Resource supply

Marginal revenue product =

Resource demand

Workers

per day60 10

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





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

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• 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

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• 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 demand24





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)

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Ch 11 resource markets micro econ4

Economy & Finance

Transcript of Ch 11 resource markets micro econ4