Chapter 11

Resource Markets

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2006 Thomson/South-Western
 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

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Exhibit 1: Resource Market for Carpenters

S
The demand curve

Dollars per hour of labor

slopes downward
and the supply curve
slopes upward
The demand for
and supply of W
resources depends on
the willingness and D
ability of buyers and
sellers in resource
markets
0 E Hours of labor per
period

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 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
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 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

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 Market Demand for Resources

A lower price for a resource also

increases a producers ability to hire that
resource

For example, if the wage for carpenters

falls, homebuilders can hire more
carpenters for the same cost

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 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

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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 resources

total earnings that is not necessary to keep the
resource in its present use form of producer
surplus earned by resource suppliers

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 Exhibit 3: Opportunity Cost and Economic Rent

(a) All Resource Returns are Economic Rent

The supply of grazing land
is shown by the perfectly
inelastic vertical supply S
curve, indicating 10 million
acres have no alternative use

Dollars per unit

Since the supply of land is
fixed, the amount paid to
rent the land has no effect on
the quantity supplied: the
$1
lands opportunity cost is
zero and all earnings are Economic
economic rent rent
The fixed supply
determines the equilibrium
D
quantity of the resource,
while demand determines the 0 10 Millions of acres
equilibrium price per month

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 Exhibit 3: Opportunity Cost and Economic Rent

At the other extreme is the case in

(b) All Resource Returns are Opportunity Costs
Dollars per unit
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
$10 S elastic, supply determines the
equilibrium wage while demand
Opportunity determines the equilibrium quantity
costs The more elastic the resource
supply, the lower the economic rent as
a portion of total earnings
D
0 1,000 Hours of labor
per week 14
 Exhibit 3: Opportunity Cost and Economic Rent

(c) Resource returns are divided between

economic rent and opportunity cost
If the supply curve slopes
upward, the resource S
supplier earns some
economic rent and some

Dollars per unit

opportunity cost
$10
At a market clearing
wage of $10, the pink Economic rent
shaded area identifies
the opportunity cost
and 5
the blue shaded area
the economic rent Opportunity costs D
Both demand and supply
determine the equilibrium
price and quantity Hours of labor
0 5,000 10,000
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.

Marginal
Workers Total Marginal Product Total Revenue
per day Product Product Price Revenue Product
(1) (2) (3) (4) (5) (6)

0 0 - $20 $0 -
1 10 10 20 200 $200
2 19 9 20 380 180
3 27 8 20 540 160
4 34 7 20 680 140
5 40 6 20 800 120
6 45 5 20 900 100
7 49 4 20 980 80
8 52 3 20 1040 60
9 54 2 20 1080 40
10 55 1 20 1100 20
11 55 0 20 1100 0
12 53 -2 20 1060 -40 17
 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

Marginal
Workers Total Product Total Revenue
per day Product Price Revenue Product
(1) (2) (3) (4) = (2) (3) (5)

1 10 $40.00 400.00 $400.00

2 19 35.20 668.80 268.80
3 27 31.40 847.80 179.00
4 34 27.80 945.20 97.40
5 40 25.00 1000.00 54.80
6 45 22.50 1012.50 12.50

7 49 20.50 1004.50 -8.00

8 52 19.00 988.00 -16.50

9 54 18.00 972.00 -16.00

10 55 17.50 962.50 -9.50 18
 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 Firms
Employment Decision
In panel (a) the intersection of market In panel (b) the marginal resource cost
demand and supply determines the market curve is shown by the $100 market wage.
wage of $100 per day becomes the The marginal revenue product, or
marginal resource cost of labor to the firm resource demand curve, is based on the
regardless of how many workers the firm firm being a price taker. In this case the
employees. firm will hire 6 workers per day.

a) Market demand for factory workers b) Firm

Dollars per worker per da y

Dollars per worker per day

Resource Marginal revenue product =

$200 demand $200 resource demand

Resource Marginal resource cost =

supply resource supply
100 100

0 E Workers 0 6 10 Workers
per day per day
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 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 labors
marginal revenue product equals the market
wage

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 Shifts in the Demand for Resources

A resources marginal revenue product consists

of two components

The resources 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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