This document discusses resource markets and how demand and supply determine resource prices and allocation. It makes the following key points: 1) Firms demand resources as long as the marginal revenue of an additional unit exceeds the marginal cost, and households supply resources to the highest paying use. This interaction between firm demand and household supply determines the market price and quantity of resources. 2) The demand for a resource is a derived demand, arising from the demand for the final good that the resource helps produce. The market demand is the sum of demands across all uses. 3) Resources tend to flow to their highest valued uses, with adjustments across uses until the price is equal. However, some price differences persist due to lack

1. Resource Markets

2.  As long as the additional revenue from
employing another worker exceeds the
additional cost, the firm should hire that
worker.
 What about capital?
 What about natural resources?
 A producer demands another unit of a
resource as long as its marginal revenue
exceeds its marginal cost.

3.  People supply their resources to the
highest paying alternative, other things
held constant.

4.  In the market for goods and services-
who is the demander? Who is the
supplier?
 What about the resource market??
• Firms-Demanders
• Households-Suppliers

5. LO2 Resource Market for
Carpenters
S
Dollars per hour of labor
Exhibit 1
W
D
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.

6.  Because the value of any resources
depends on what it produces, the
demand for a resources is said to be a
derived demand, meaning the demand
arises from the demand of the final
product.

7.  The market demand for a particular
resource is the sum of demands for the
resource in all its different uses.
 As the price of a resource falls, producers
are more willing and able to employ that
resource.

8.  The market supply curve for a resource
sums all the individual supply curves for
that resource.
 As the price increases, resource
suppliers are more WILLING and ABLE to
supply the resource.
• This means that the market supply curve will
slope UPWARD.

9.  Resources tend to flow to their highest –
valued use.
 As long as the nonmonetary benefits of
supplying resources to alternative uses
are identical and as long as resources are
freely mobile, resources adjust across
uses until they earn the same in different
uses.

10.  Adjustment takes time

11. LO2 Exhibit 2
Market for Carpenters in Alternative Uses
(a) Home building (b) Furniture making
per hour
Sh
per hour
Dollars
S’f
Dollars
S’h
Sf
$25
24 $24
20
Dh Df
Hours of labor
0 58 60 Hours of labor 0 10 12
per day (thousands) per day (thousands)
The wage differential prompts carpenters to shift from furniture making to home
building until the wage is identical in the two markets

12.  Not all resource price differences cause
reallocation.
• Example- Land in cities
• They are explained by:
1) A lack of resource mobility ( Urban land vs. rural
land)
2) Differences in the inherent quality of the resource
(fertile land vs. non-fertile land)
3) Differences in the time and money involved in
developing the necessary skills
4) Differences in nonmonetary aspects of the job

13.  Opportunity cost is what that resource
could earn in its BEST alternative use.
 Economic rent is the amount earned in
excess of his opportunity cost.
• The portion of a resource’s earnings that
exceeds the amount necessary to keep the
resource in its present use.
• It’s “pure gravy.”

14.  The less elastic the resource supply, the
greater the economic rent as a
proportion of total earnings.

15.  The supply of a resource market is
perfectly inelastic, meaning the resource
has no alternative use.
 NO opportunity cost.
 ALL earnings are economic rent

16.  The supply of a resource is perfectly
elastic supply.
 The market for the resource can earn as
much in its best alternative use as in its
present use.
 ALL earnings are opportunity cost.
 There is NO economic rent.

17.  The supply curve slopes upward, then
most resource suppliers earn economic
rent in addition to their opportunity cost.

18. LO3 Exhibit 3
Opportunity Cost and Economic Rent
(a) All earnings are (b) All earnings are (c) Earnings divided
economic rent opportunity cost between economic rent and
opportunity cost
per unit
per unit
per unit
Dollars
Dollars
Dollars
S
S
$16
$1 $10 S Economic
rent
Economic Opportunity 8 D
rent cost Opportunity
D D cost
Millions of Hours of Hours of
0 10 0 1,000 0 5,000 10,000
acres labor labor
per month per day per day

19.  The marginal product: the change in total
product (output produced) from
employing one more unit of labor or
capital.

21.  The marginal revenue product of labor
indicates how much total revenue
changes as more labor is employed.
• Marginal revenue product (MRP) of a resource is
the change in the firm’s total revenue resulting
from employing an additional unit of the
resource.
• It is the firm’s “marginal benefit” of hiring a
resource (a worker or machine).

23.  What does another unit of labor cost the
firm?
• The change in total cost when an additional unit
of a resource is hired, other things held constant.
• The firm will hire MORE labor as long as doing
so adds more to revenue than to costs, meaning
as long as MRP > MRC

24.  Marginal revenue product = Marginal
resource cost
• This will hold for competitive markets or firms
with some market power.
• Profit maximization will occur where labor’s
marginal revenue product equals the market
wage.

25. LO4 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 Resource demand
supply
Marginal resource cost =
Resource supply
100 100
Resource
demand
Workers per day Workers
0 E 0 6 10
per day
In panel (a), market demand and supply determine the 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
MRC. The firm maximizes profit (or minimizes its loss) by hiring a resource up to the point where MRP =
MRC.

26.  Two things can change a resource’s
marginal product:
1) A change in the amount of other resources
employed
2) A change in technology

27.  Substitutes
• An increase in the price of one increases the
demand for the other.
 Complements
• A decrease in the price of one leads to an
increase in the demand for the other.

28.  Technological improvements can boost
the productivity of some resources but
make other resources obsolete.
• Computer-controlled machines

29.  Since the demand for a resource is
DERIVED from the demand for the final
output, any change in the demand for
output affects resource demand.
• CDs