1. Chapter 11 Resource Markets © 2009 South-Western/ Cengage Learning

2. 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

3. Exhibit 1 Resource market for carpenters 3 Hours of labor per periodE0 Dollars per 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.

4. 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

5. 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

6. 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

7. 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

8. Exhibit 2 Market 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 DhDh ShSh Dollars per hour $25 24 S’ h Hours of labor per day (thousands) 58060 (b) Furniture making DfDf SfSf Dollars per hour 20 $24 S’ f Hours of labor per day (thousands) 10012

9. 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 9

10. 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

11. 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

12. Exhibit 3 Opportunity 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 100 Hours of labor per day 1,0000 Hours of labor per day 5,0000 10,000 D Dollars per unit $1 D S Dollars per unit $10 D S Dollars per unit $14 7 Economic rent Opportunity costs Opportunity costs Economic rent

13. 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 13

14. 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 14

15. Exhibit 4 MRP when a firm sells in a competitive market 15 (1) Workers per day (2) Total product (3) Marginal product (4) Product price (5) Total Revenue (5)=(2)×(4) (6) Marginal Revenue Product (6)=(3)×(4) 012345678012345678 0 10 19 27 34 40 45 49 52 - 10 9 8 7 6 5 4 3 $20 20 $0 200 380 540 680 800 900 980 1040 - $200 180 160 140 120 100 80 60

16. Exhibit 5 MRP 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) Marginal Revenue Product 012345678012345678 0 10 19 27 34 40 45 49 52 - $40.00 35.20 31.40 27.80 25.00 22.50 20.50 19.00 - $400.00 668.80 847.80 945.20 1,000.00 1,020.50 1,004.50 988.00 - $400.00 268.80 179.00 97.40 54.80 12.50 -8.00 -16.50

17. 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 17

18. Exhibit 6 Market 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 Dollars per worker per day $200 100 Workers per day E0 (b) Individual Firm Resource supply Resource demand Dollars per worker per day $200 100 Marginal resource cost = Resource supply Marginal revenue product = Resource demand Workers per day 60 10

19. 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 19