Chapter 15 - Resource markets

1. Chapter 15 - Resource markets

2. Economic Resources Resource Resource Payment land rent labor wages capital interest entrepreneurial ability profit

3. Economic Resources • Rent, wages, and interest are determined in the markets for land, labor, and capital. • Entrepreneurs, though, are residual claimants who receive profits, the revenue that is left over after all other factors of production have been paid.

4. Circular flow • The demand for resources is a “derived demand.” • Households are the source of supply and firms are the source of demand in resource markets.

5. Equilibrium in resource markets

6. Resource demand • Price elasticity of resource demand:

7. Determinants of price elasticity of resource demand • The price elasticity of demand for a resource is expected to be higher when: • the price elasticity of demand for the final product is relatively high • this resource accounts for a large share of the firm’s total costs • there are close substitutes for the resource, and • a longer time period is considered.

8. Determinants of resource demand • The demand for a resource will increase when: • the price of the final product rises • the productivity of the resource rises • the number of buyers increases • the price of a substitute resource rises • the price of a complementary resource declines, and/or • the firm possesses high levels of other resources.

9. Market supply • The price elasticity of supply of a resource is defined as:

10. Determinants of supply elasticity • The price elasticity of supply is greater when: • there are many alternative uses of the resource, and/or • a longer time period is considered.

11. Economic Rent • The earnings of a resource available in perfectly inelastic supply is called “economic rent.”

12. Transfer earnings • The earnings of a resource available in perfectly elastic supply are called “transfer earnings.”

13. Upward sloping resource supply curve • A resource that has an upward sloping resource supply curve receives a mix of transfer earnings and economic rent

14. Price floor

15. Price ceiling

16. Individual firm’s demand for a resource • A firm will hire an additional unit of a resource only if this increases the firm’s profits. • Economic profit = total revenue – total cost

17. Optimal level of resource use • Marginal revenue product (MRP) = additional revenue associated with the use of an additional unit of a resource • Marginal factor cost (MFC) = additional cost associated with the use of an additional unit of a resource • Increase resource use if MRP > MFC • Decrease resource use if MRP < MFC • Optimal level of resource use: MRP = MFC

18. Marginal revenue product • MRP = MR x MPP • If the output market is perfectly competitive MR = P, so MRP = P x MPP (in this case, a MRP curve is sometimes called a VMP curve = “value of the marginal product”)

19. MRP curve • MRP curve is downward sloping due to law of diminishing returns. • If the output market is imperfectly competitive MR also declines as resource use rises, contributing to the negative slope of the MRP curve.

20. Perfectly competitive resource market • Note that resource price = MFC in this case.

21. Individual firm in a perfectly competitive resource market

22. Monopsony resource market

23. Multiple resources • A cost-minimizing firm selects a mix of resources at which the ratio of the MRP to the MFC is the same for all resources.