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Demand and Supply in Resource Markets

Demand and Supply in Resource Markets. Principles of Microeconomic Theory, ECO 284 John Eastwood CBA 247 523-7353 e-mail address: John.Eastwood@nau.edu. Learning Objectives. Explain how firms choose the quantities of labor, capital, and natural resources to employ

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Demand and Supply in Resource Markets

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  1. Demand and Supply in Resource Markets • Principles of Microeconomic Theory, ECO 284 • John Eastwood • CBA 247 • 523-7353 • e-mail address: John.Eastwood@nau.edu

  2. Learning Objectives • Explain how firms choose the quantities of labor, capital, and natural resources to employ • Explain how people choose the quantities of labor, natural resources, and entrepreneurship to supply

  3. Learning Objectives (cont.) • Explain how wages, interest, natural resource prices, and normal profit are determined in competitive resource markets • Explain the concept of economic rent and distinguish between economic rent and opportunity cost

  4. Learning Objectives • Explain how firms choose the quantities of labor, capital, and natural resources to employ • Explain how people choose the quantities of labor, natural resources, and entrepreneurship to supply

  5. Resource Prices and Incomes • Incomes are determined by resource prices: • the wage rate for labor • the interest rate for capital • the rental rate for land • the rate of normalprofit for entrepreneurship • and the quantities of resources used.

  6. An Overview of aCompetitive Resource Market • The supply and demand model will be used to explain how markets determine prices, quantities, and incomes of the productive resources.

  7. Demand and Supplyin a Resource Market Resource price (dollars per unit) 0 Resource of production(units)

  8. Demand and Supplyin a Resource Market Resource price (dollars per unit) D 0 Resource of production(units)

  9. Demand and Supplyin a Resource Market S Resource price (dollars per unit) D 0 Resource of production(units)

  10. Demand and Supplyin a Resource Market S Resource price (dollars per unit) PR Resource income D 0 QR Resource of production(units)

  11. Labor Markets

  12. The Demand for Labor • Labor demand is a derived demand. • Derived demand is a demand for a productive resource, which is derived from the demand for the goods and services produced by the resource.

  13. Marginal Revenue Product • Marginal revenue product is the change in total revenue that results from employing one more unit of labor. • As the quantity of labor increases, its marginal revenue product diminishes--diminishing marginal revenue product. Let’s look at Max’s Wash ‘n’ Wax

  14. Marginal Revenue Product at Max’s Wash ’n’ Wax Marginal Marginal Marginal revenue revenue Quantity product product Total product of labor Output (MRP = P ´ MP)revenue (L) (Q)(additional washes (additional dollars(TR = P ´ Q) (additional dollars (workers) (car washes/hour) per worker) per worker) (dollars) per worker) a 0 0 b 1 5 c 2 9 d 3 12 e 4 14 f 5 15

  15. Marginal Revenue Product at Max’s Wash ’n’ Wax Marginal Marginal Marginal revenue revenue Quantity product product Total product of labor Output (MRP = P ´ MP)revenue (L) (Q)(additional washes (additional dollars(TR = P ´ Q) (additional dollars (workers) (car washes/hour) per worker) per worker) (dollars) per worker) a 0 0 b 1 5 c 2 9 d 3 12 e 4 14 f 5 15 5 4 3 2 1

  16. Marginal Revenue Product at Max’s Wash ’n’ Wax Marginal Marginal Marginal revenue revenue Quantity product product Total product of labor Output (MRP = P ´ MP)revenue (L) (Q)(additional washes (additional dollars(TR = P ´ Q) (additional dollars (workers) (car washes/hour) per worker) per worker) (dollars) per worker) a 0 0 b 1 5 c 2 9 d 3 12 e 4 14 f 5 15 5 20 4 16 3 12 2 8 1 4

  17. Marginal Revenue Product at Max’s Wash ’n’ Wax Marginal Marginal Marginal revenue revenue Quantity product product Total product of labor Output (MRP = P ´ MP)revenue (L) (Q)(additional washes (additional dollars(TR = P ´ Q) (additional dollars (workers) (car washes/hour) per worker) per worker) (dollars) per worker) a 0 0 0 b 1 5 20 c 2 9 36 d 3 12 48 e 4 14 56 f 5 15 60 5 20 4 16 3 12 2 8 1 4

  18. Marginal Revenue Product at Max’s Wash ’n’ Wax Marginal Marginal Marginal revenue revenue Quantity product product Total product of labor Output (MRP = P ´ MP)revenue (L) (Q)(additional washes (additional dollars(TR = P ´ Q) (additional dollars (workers) (car washes/hour) per worker) per worker) (dollars) per worker) a 0 0 0 b 1 5 20 c 2 9 36 d 3 12 48 e 4 14 56 f 5 15 60 5 20 20 4 16 16 3 12 12 2 8 8 1 4 4

  19. The Labor Demand Curve • The labor demand curve is derived from the marginal revenue product curve. • Why? • Firms hire employees until the wage rate equals the marginal revenue product.

  20. The Demand for Laborat Max’s Wash ‘n’ Wax 20 20 Wage rate (dollars per hour) Marginal revenue product (dollars per hour) 10 10 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers) Labor (workers)

  21. The Demand for Laborat Max’s Wash ‘n’ Wax 20 20 Wage rate (dollars per hour) Marginal revenue product (dollars per hour) 10 10 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers) Labor (workers)

  22. The Demand for Laborat Max’s Wash ‘n’ Wax 20 20 Wage rate (dollars per hour) Marginal revenue product (dollars per hour) 10 10 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers) Labor (workers)

  23. The Demand for Laborat Max’s Wash ‘n’ Wax 20 20 Wage rate (dollars per hour) Marginal revenue product (dollars per hour) 10 10 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers) Labor (workers)

  24. The Demand for Laborat Max’s Wash ‘n’ Wax 20 20 Wage rate (dollars per hour) Marginal revenue product (dollars per hour) 10 10 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers) Labor (workers)

  25. The Demand for Laborat Max’s Wash ‘n’ Wax 20 20 Wage rate (dollars per hour) Marginal revenue product (dollars per hour) 10 10 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers) Labor (workers)

  26. The Demand for Laborat Max’s Wash ‘n’ Wax 20 20 Wage rate (dollars per hour) Marginal revenue product (dollars per hour) 10 10 MRP 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers) Labor (workers)

  27. The Demand for Laborat Max’s Wash ‘n’ Wax 20 20 Wage rate (dollars per hour) Marginal revenue product (dollars per hour) 10 10 MRP D 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers) Labor (workers)

  28. Two Conditions forProfit Maximization • Profit is maximized when marginal revenue equals marginal cost. • Likewise, profit is maximized when marginal revenue product equals the wage rate. These conditions are related, but different!

  29. Two Conditions forProfit Maximization • When firms produce the output that maximizes profit, MR = MC. • Also, the firm is employing the amount of labor that makes the marginal revenue product of labor equal to the wage rate.

  30. Two Conditions forProfit Maximization SYMBOLS Marginal product MP Marginal revenue MR Marginal cost MC Marginal revenue product MRP Resource price PR

  31. Two Conditions forProfit Maximization TWO CONDITIONS FOR MAXIMUM PROFIT 1. MR = MC 2. MRP = PR

  32. Multiply by MP to give MRP = MR ´ MP Flipping the equation over Multiply by MP to give MC ´ MP = PR Flipping the equation over Two Conditions forProfit Maximization EQUIVALENCE OF CONDITIONS 1. MRP/MP = MR = MC = PR/MP 2. MR ´ MP = MRP = PR = MC ´ MP

  33. Changes in the Demand for Labor • The demand for labor depends upon: • The price of the firm’s output • The prices of other productive resources • Technology

  34. A Firm’s Demand for Labor THE LAW OF DEMAND (movements along the demand curve for labor) The quantity of labor demanded by a firm Decreases if: • The wage rate increases • Increases if: • The wage rate • decreases

  35. A Firm’s Demand for Labor CHANGES IN DEMAND (Shifts in the demand curve for labor) A firm’s demand for labor Decreases if: • The firm’s output price decreases • A new technology decreases the marginal product of labor • Increases if: • The firm’s output price • increases • A new technology • increases the marginal • product of labor

  36. Market Demand • The market demand for labor is derived by adding together the quantities demanded by all firms at each wage rate.

  37. Elasticity of Demand for Labor • Elasticity of demand for labor measures responsiveness of the quantity of labor demanded to the wage rate. • It is less elastic in the short-run

  38. Elasticity of Demand for Labor • Depends upon: • The labor intensity of the production process • The elasticity of demand for the good • The substitutability of capital for labor

  39. Learning Objectives • Explain how firms choose the quantities of labor, capital, and natural resources to employ • Explain how people choose the quantities of labor, natural resources, and entrepreneurship to supply

  40. The Supply of Labor • Labor vs. Leisure • A reservation wage is the lowest wage at which someone is willing to supply labor.

  41. The Supply of Labor • Substitution Effect • Higher wages induce people to work more • Income Effect • Higher wages increase the demand for leisure, thus, inducing people to work less

  42. The Supply of Labor • Backward-Bending Supply of Labor Curve • As wage rates rise, the income effect eventually becomes larger than the substitution effect • Market Supply • The market supply of labor curve is the sum of the individual supply curves.

  43. The Supply of Labor Jill Jack Kelly Market 20 20 20 20 Wage rate (dollars/hour) 10 10 10 10 1 0 5 10 0 5 10 0 5 10 0 5 10 15 20 25 Labor(hours per day) Labor(hours per day) Labor(hours per day) Labor(hours per day)

  44. The Supply of Labor Jill SA 20 20 20 20 Wage rate (dollars/hour) 10 10 10 10 1 0 5 10 0 5 10 0 5 10 0 5 10 15 20 25 Labor(hours per day) Labor(hours per day) Labor(hours per day) Labor(hours per day)

  45. The Supply of Labor Jill Jack SB SA 20 20 20 20 Wage rate (dollars/hour) 10 10 10 10 4 1 0 5 10 0 5 10 0 5 10 0 5 10 15 20 25 Labor(hours per day) Labor(hours per day) Labor(hours per day) Labor(hours per day)

  46. The Supply of Labor Jill Jack Kelly SC SB SA 20 20 20 20 Wage rate (dollars/hour) 10 10 10 10 4 1 0 5 10 0 5 10 0 5 10 0 5 10 15 20 25 Labor(hours per day) Labor(hours per day) Labor(hours per day) Labor(hours per day)

  47. The Supply of Labor Jill Jack Kelly Market SC SB SA SM 20 20 20 20 Wage rate (dollars/hour) 10 10 10 10 4 1 0 5 10 0 5 10 0 5 10 0 5 10 15 20 25 Labor(hours per day) Labor(hours per day) Labor(hours per day) Labor(hours per day)

  48. Changes in the Supply of Labor • The key factors that change the supply of labor are: • Adult population • Capital in home production

  49. Learning Objectives (cont.) • Explain how wages, interest, natural resource prices, and normal profit are determined in competitive resource markets • Explain the concept of economic rent and distinguish between economic rent and opportunity cost

  50. Labor Market Equilibrium • Trends in the Demand for Labor • Technological change has increased the demand for labor • It has destroyed some jobs, but created more higher paying jobs.

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