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Resource Markets
CHAPTER
11
© 2003 South-Western/Thomson Learning
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Resource Demand
As long as the additional revenue from
employing another worker exceeds the
additional cost, the firm should hire the
worker
The same would be true for adding one
more unit of capital or land
A producer demands an additional unit
of a resource as long as its marginal
revenue exceeds its marginal cost
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Resource Supply
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
In the case of labor, the worker’s utility
depends on both the monetary and
nonmonetary aspects of the job
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Demand and Supply of Resources
Firms demand resources so as to
maximize profit and households supply
resources so as to maximize utility
Any differences between the profitmaximizing goals of firms and the
utility-maximizing goals of households
are reconciled through voluntary
exchange in markets
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Market Demand for Resources
Why do firms employ resources?
Resources are used to produce goods
and services, which firms try to sell at a
profit
A firm does not value the resource itself
but the resource’s 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
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Market Demand for Resources
The market demand for a particular
resource is the sum of demands for that
resource in all its different uses
The demand curve for a resource, like
the demand curves for the goods
produced by the resource, slopes
downward  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
Consider first the producer’s greater
willingness to hire resources as the
resource prices fall
In developing the demand curve for a
particular resource, we assume the prices of
other resources remain constant
Thus, 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
Thus, we observe substitution in production
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Market Demand for Resources
A lower price for a resource also
increases a producer’s ability to hire
that resource
For example, if the wage for carpenters
fall, 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
as shown in Exhibit 1
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Market Supply for Resources
Resource suppliers are more willing
because a higher resource price, other
things constant, means more goods and
services can be purchased with the
earnings from each unit of the resource
supplied
Resource prices are signals about the
rewards for supply resources to
alternative activities  higher prices
will draw resources from lower-valued
uses
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Market Supply for Resources
Resource supply curves also slope
upward because resource owners are
able to supply more of the resource at a
higher price
Higher wages enable resource suppliers
to increase their quantity supplied
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Temporary and Permanent Resource Price Differences
Resource owners have a strong interest
in selling their resources where they are
most valued  resources tend to flow to
their highest-valued use
Because resource owners seek the
highest pay, other things constant, the
prices paid for identical resources tend
toward equality
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Temporary Differences in Resource Prices
Resource prices sometimes differ
temporarily across markets because
adjustment takes time
However, despite the time that this may
take, 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, which is relatively
immobile, may lead to permanent
differences in land prices
Similarly, 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
Recall that opportunity cost is what that
resources could earn in its best
alternative use
Economic rent is that portion of a
resource’s 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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Opportunity Cost and Economic Rent
The division between these two
categories depends on the resource
owner’s elasticity of supply
In general, the less elastic the resource
supply, the greater the economic rent as
a proportion of total earnings
Conversely, the more elastic the
resource supply, the lower the economic
rent as a proportion of total earnings
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All Earnings are Economic Rent
If the supply of a resource to a
particular market is perfectly inelastic,
that resource has no alternative use 
there is no opportunity cost and all
earnings are economic rent
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Summary
Note that specialized resources tend to
earn a higher proportion of economic
rent than do resources with many
alternative uses
Given a resource demand curve that
slopes downward
When supply is perfectly inelastic, all
earnings are economic rent
When supply is perfectly elastic, all earnings
are opportunity cost
When the supply curve slopes upward,
earnings divide economic rent and
opportunity cost
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Closer Look at Resource Demand
In our discussion of a firm’s costs, we
varied the amount of labor employed
and examined the relationship between
the quantity of labor and the amount of
output
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Marginal Revenue Product
The important question is what happens
to the firm’s revenue when additional
workers are hired?
The marginal revenue product of any
resource is the change in the firm’s total
revenue resulting from employing an
additional unit of the resource, other
things constant  marginal benefit
from hiring one more unit of the
resource
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Marginal Revenue Product
A resource’s marginal revenue product
depends on
How much additional output the resource
produces
The price at which output is sold
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Selling Output as a Price Taker
The calculation of marginal revenue
product is simplest when the firm sells
output in a perfectly competitive market
Since an individual firm in perfect
competition can sell as much as it wants
at the market price
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Selling Output as a Price Maker
If the firm has some market power over
the price that it charges, the demand
curve slopes downward  to sell more
the firm must lower price  they must
search for the price that maximizes its
profit
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Marginal Resource Cost
Marginal resource cost is 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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Resource Employment
For all resources employed, the firm
should hire additional units up to the
level at which
Marginal revenue product = marginal
resource cost
MRP = MRC
Profit maximization occurs where
labor’s marginal revenue product equals
the market wage
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Summary
Maximum profit (or minimum loss)
occurs where the marginal revenue
from output equals its marginal cost
Likewise, maximum profit (or minimum
loss) occurs at the resource level where
the marginal revenue from an input
equals its marginal resource cost
First rule focuses on output while the
second on input, the two approaches
are equivalent ways of deriving the
same principle of profit maximization
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Shifts in the Demand for Resources
A resource’s marginal revenue product
consists of two components
The resource’s 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
In this case, 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
Examples
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  increase the marginal
revenue product of autoworkers and
other resources employed by the
automobile industry
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More than One Resource
As long as the marginal revenue product
exceeds the marginal resource cost, the
firm can increase profit or reduce a loss
by employing more of a resource
This holds for all resources  profitmaximizing employers will hire each
resource up to the point at which the
last unit hired adds as much to revenue
as it does to cost
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