Download CHAPTER 11 – RESOURCE MARKETS

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.]
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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.
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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.
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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
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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
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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.
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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.
END
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