Chapter 11 ECON4 William A.

McEachern
Resource
Markets

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 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 utility
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Exhibit 1
Resource Market for Carpenters

Dollars per hour of labor S

0 E Hours of labor per period

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.
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 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

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 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

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 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

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 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

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Exhibit 2
Market for Carpenters in Alternative Uses
(a) Home building (b) Furniture making
per hour

Sh

per hour
S’f
Dollars

Dollars
S’h
Sf

$25
24 $24

20

Dh Df

0 58 60 Hours of labor 0 10 12 Hours of labor

per day (thousands) per day (thousands)
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.
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 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

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 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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 Opportunity Cost & 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
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 Opportunity Cost & Economic Rent
• 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

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Exhibit 3
Opportunity Cost and Economic Rent (a, b)
(a) All earnings are economic rent (b) All earnings are opportunity costs
per unit

per unit
Dollars

Dollars
S

$1 $10 S

Economic Opportunity
rent costs
D D

Millions of Hours of
0 10 0 1,000
acres per month labor per day
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.
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Exhibit 3
Opportunity Cost and Economic Rent (c)
(c) Earnings divided between economic rent and opportunity cost
per unit
Dollars

Panel (c) shows an upward sloping

$20 resource supply curve. Earnings
Economic are partly opportunity cost and
rent partly economic rent. Both demand
10 D and supply determine the
Opportunity equilibrium price and quantity.
costs

0 5,000 10,000 Hours of

labor per day

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 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

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 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
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.
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Exhibit 5
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.
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 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 Market Equilibrium for a Resource and the
Firm’s Employment Decision

(a) Market (b) Firm

Dollars per worker per day

Dollars per worker per day

Resource Marginal revenue product =

$200 $200
supply Resource demand
Marginal resource cost =
Resource supply
100 100

Resource
demand

0 E Workers per day 0 6 10 Workers

per day
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
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 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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 Changes in Resource Demand
• 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 Resource Demand
• 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 demand
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 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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