CHAPTER 11 – RESOURCE MARKETS (6e)
In earlier chapters we have focused on the product markets (the markets for final goods and services). In this chapter we will focus on the resource markets (the markets for labor, land, capital, and entrepreneurial ability).
I. Introduction
In product markets, households are the primary demanders and firms are the primary suppliers of goods and services.
In resource markets, the roles are reversed:
Firms are the demanders of resources (they hire workers, purchase capital, etc.). A firm will demand an additional unit of a resource as long as the added output produced by the added resource generates a marginal revenue greater than the resource’s marginal cost. Firms demand resources to maximize profits.
Households, as resource owners, are the suppliers of resources (people go to work, provide their entrepreneurial skills, etc.) Resource owners will supply their resources to the highest paying alternative, other things equal, and will supply additional units of a resource as long as doing so increases their utility. Households supply resource to maximize utility.
II. The Demand and Supply of Resources
Ex. 1
This graph depicts the market supply and demand for a certain type of labor. [The supply curve reflects workers supplying their labor; the demand curve reflects firms demanding that labor.]
A. The Market Demand for Resources
The law of demand applies here, causing the D curve for a resource to slope downward. If the price of a resource falls, the quantity demanded of the resource will increase, other things being equal. This is shown by a movement along the resource D curve.
Derived demand: The demand for a resource is derived from the demand for the product produced by that resource.
B. Shifts in the Demand for Resources
(This topic is covered on pp. 252-253.)
Shifts of the demand curve for a resource are caused by:
1) Changes in the quantity, quality, and/or price of other resources used in production (i.e., of substitute or complement resources)
2) Changes in technology. If a change in technology makes a resource more productive, the demand for the resource will increase.
3) Changes in demand for the final product. If demand for the final product increases, demand for the resource used in its production will also rise.
C. The Market Supply of Resources
Ex. 1
The law of supply applies, causing the market S curve of a resource to slope upward. If the price of a resource increases, the quantity supplied of the resource will rise, other things being equal. This is shown by a movement along the resource S curve.
D. Temporary and Permanent Resource Price Differences
Read this section on pp. 243-244 for general understanding. Be able to answer the following:
If the nonmonetary benefits of supplying resources to alternative uses are the same, and if resources are freely mobile, what should be true about the payments received by such resources?
Why are resource prices sometimes temporarily different across markets?
Why are resource prices permanently different for certain resources across markets?
E. Opportunity Cost and Economic Rent
Opportunity cost of a resource:
Economic rent:
The division of earnings between opportunity cost and economic rent depends on the resource owner’s elasticity of supply.
Specialized resources tend to earn a higher proportion of their earnings from economic rent than do less specialized resources.
III. A Closer Look at Resource Demand
A. The Firm’s Demand for a Resource
Remember that the demand for a resource is derived from the demand for the product produced by that resource. So a firm’s demand for a resource is based on what the resource can do for the firm: produce output that can be sold in the market.
Ex. 4
Assume that labor is the only variable resource; all other resources are fixed. The table shows workers (the variable resource), TP, and MP. (These concepts were first introduced in Chapter 7, pp. 142-144. Please go back and review them.)
Total product:
Marginal product:
B. Marginal Revenue Product (MRP)
When the firm hires added units of a resource, what happens to total revenue? To answer this, we must calculate marginal revenue product (MRP).
Definition of marginal revenue product (MRP):
MRP = ∆TR ÷ ∆quantity of the variable resource
1) When the firm is selling its output as a product price taker
Ex. 4
The firm in this exhibit is selling its output in a perfectly competitive market. Product price = $20 at all levels of output.
To calculate MRP:
Step 1: Calculate the firm’s TR, which is PxQ of output (or PxTP)
Step 2: Calculate the change in TR for every one-unit change in the variable resource, i.e., MRP = ∆TR ÷ ∆quantity of the variable resource.
2) When the firm is selling its output as a product price maker (or searcher)
Ex. 5
The firm in this exhibit is selling its output in a market where it must lower its price to sell more units (see columns 2 and 3). Notice that product price falls as TP rises; therefore, this firm is a price maker (searcher).
To calculate MRP, follow the same steps as above:
Step 1: Calculate the firm’s TR, which is PxQ of output (or PxTP)
Step 2: Calculate the change in TR for every one-unit change in the variable resource, i.e., MRP = ∆TR ÷ ∆quantity of the variable resource.
3) The Marginal Revenue Product Curve
Since MRP indicates the added revenue to the firm generated by each added unit of a resource, it follows that the firm should be willing to pay as much as the MRP for each added unit of the resource. Thus, the MRP curve can be looked upon as the firm’s demand curve for that resource.
Ex. 6
C. Marginal Resource Cost (MRC)
When the firm hires added units of a resource, what happens to total cost? To answer this, we must calculate marginal resource cost (MRC).
Definition of marginal resource cost (MRC):
MRC = ∆TC ÷ ∆quantity of the variable resource
We will assume that the typical firm is a resource price taker: a firm that hires such a small amount of the available resource that it has no effect on the market price of the resource. The firm “takes” the market price for the resource and then must decide how much of the resource it wants to hire at that price.
Ex. 6(a)
The market demand and supply of the resource determine the market price of the resource (in this graph, $100 per worker per day).
Ex. 6(b)
In this graph, labor is available for $100 per day, no matter how many units the firm employs, so the market price of the resource = the firm’s MRC. Here the MRC is $100 because each worker hired adds $100 to total cost.
Since the firm can draw from a virtually unlimited pool of labor as long as the firm pays the market price for labor, the supply curve facing the firm is horizontal at the market price.
Thus, the MRC curve = the resource supply curve for the resource price taker.
D. Hiring Resource and Maximizing Profits
How many units of the resource should the firm employ in order to maximize profits?
As long as MRP>MRC, hiring one more unit of the resource will add more to revenue than to cost, and so will increase total profit. So hire more!
If MRP<MRC, hiring one more unit will add more to cost than to revenue, and so will decrease total profit. So hire less!
RULE: The firm should hire additional units of a resource up to the level at which MRP=MRC. This will be the profit-maximizing level of resource employment.
In Ex. 6(b), the firm should hire the first 6 workers. Each worker is paid $100, which is the prevailing market price of the resource.
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