Supply and Demand for Productive Resources

  1. Resource Markets
    1. Resources are used to produce goods and services.
      1. Land
      2. Labor
      3. Capital
      4. Natural resources
    2. Resource markets are those in which business firms demand factors of production from household suppliers.
      1. Business firms demand resources. They need resources in order to produce goods and services.
      2. Households or individuals supply resources. They supply resources in order to earn income to exchange for goods and services.
    3. Sometimes Resource marketsare referred to as factor markets. (i.e., resources are factors of production)
  2. Human and Nonhuman resources
    1. Nonhuman Resources
      1. These are durable, nonhuman inputs that are used to produce goods and services.
        1. Physical Capital -- Machines, buildings, tools are all part of the capital stock.
        2. Land
        3. Natural Researches
      2. Net investment increases stock of nonhuman resources. Net investment requires sacrifice of current consumption. Investment usually increases future consumption by making other resources more productive.
    2. Human Resources
      1. The abilities, skills, and health of human beings contributes to the production of goods and services.
      2. Investment in training and education can improve the quantity and quality of human resources.
      3. Economists refer to the quantity and quality of human resources as HUMAN CAPITAL. Expenditures on training, education, skill development that is designed to increase human productivity is called investing in human capital.
  3. Demand for Resources
    1. The firm's demand for resources is derived from the demand for its product.
      1. As the price of a resource increases, the quantity demanded of that resource will decline. This occurs for two reasons:
        1. Firm will try to substitute other resources for the one whose price rises (Substitution in production)
        2. An increase in resource price increases the firm's overall cost. This reduces supply causing market price of output to rise. As product price rises, quantity demanded falls, and demand for all resources will fall. (Substitution in Consumption).
    2. The elasticity of demand for resources in directly related to the elasticity of demand for the products they are used in.
    3. Price elasticity of demand for a resource will generally increase with time.
    4. Shifts in Resource Demand -- Demand for a resource may change (shift) for any one of the following reasons.
      1. A change in product demand will cause a similar change in the demand for the resources used in its production.
      2. A change in the productivity of a resource will change the demand for it (an increase in productivity increases demand).
        1. The quantity and quality of resource A will affect the productivity of resource B.
        2. Technological advances improve the productivity of resources.
        3. Improvements in the quality (skill) of a resource will increase its productivity.
      3. A change in the price of a substitute resource will affect demand for the original resource.
        1. Substitutes--Increase in a resource substitute's price will increase demand for a given resource.
        2. Complements--An increase in the price of a complementary resource will usually decrease demand for the given resource.
  4. Marginal Productivity and the Firm's Hiring Decision
    1. Definitions
      1. Marginal Product--change in total output that results from the employment of one more unit of a resource.
      2. Marginal Revenue Product--The change in total revenue that results from the employment of one more unit of the resource. This amount is equal to marginal product multiplied by marginal revenue.
      3. Value of the Marginal Product--This is the price of the product multiplied by the marginal product of the ith resource.

        Note: If the firm is a pure competitor then P=MR. In this case VMP=MRP.

    2. Decision Rule: A firm will hire additional units of a resource as long as: MRPi > Pi, where MRPi is the marginal revenue product associated with the ith resource and Pi is the price of the ith resource.
  5. Adding other factors of production
    1. When profits are maximized, the marginal revenue product of each resource equals its price.
    2. When costs are minimized, the marginal product per dollar spent on each resource will be equal if the firm is maximizing profit.

  6. Supply of Resources--Resource owners will supply a resource to an employer if the benefits of doing so exceed the costs. Other things equal, more resource suppliers will be attracted into the market as the resource price rises.
    1. In the short-run, resources may not be very mobile. Consequently, supply may not be very elastic in the short-run.
    2. In the long-run, the supply of resources can change substantially.
      1. Investment will affect supply. For instance, higher salaries in Engineering eventually create greater supply of engineers.
      2. Depreciation will affect supply. Suppose that the engineer does not continue to learn (invest in human capital), then his or her productivity relative to new engineers falls. Consequently, the aging engineer can expect lower relative wages if he or she does not invest in additional human capital.

Problem: Magic Carpet, Inc., produces and sells handmade rugs in a competitive industry. The firm receives $100 for each square meter of rug it sells.
Units of Skilled Labor Total Output MP Price per Square Meter TR MRP
0 0 $100
1 5 $100
2 12 $100
3 18 $100
4 21.5 $100
5 24 $100
6 25 $100

Units of Skilled Labor Total Output MP Price per Square Meter TR MRP
0 0 - $100
1 5 5 $100 500 500
2 12 7 $100 1200 700
3 18 6 $100 1800 600
4 21.5 3.5 $100 2150 350
5 24 2.5 $100 2400 250
6 25 1 $100 2500 100

a) What is the firm's demand for Labor?

b) Given that the equilibrium wage is $200 per week, indicate how workers the firm will hire if it desires to maximize profits.

c) How many will it hire if W goes up to $300?

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This page was last modified Wednesday, March 19, 1997.