The Supply and Demand for Productive Resources Two classes of productive resources: Non-human resources: Physical capital Land Natural resources Human resources: (Human capital) Composed of the skills, knowledge, and experience of workers.

The Circular Flow of Goods and Services Goods and Services Markets Payments $$ . a. Businesses supply goods & services b. Receive sales revenue. c. Households, (investors, governments, and foreigners) demand goods. a. Business firms demand resources b. Households supply labor and other resources c. in exchange for income. Businesses Households Resource Markets Resources

The Demand for Resources Resource price As a resource price increases, producers will: use substitute resources, or face higher costs These lead to higher prices and a reduction in consumption. B P2 At the lower output, firms use less of the resource that increased in price. A P1 Both contribute to the inverse relationship between the price and quantity demanded of a resource. D Q2 Q1 Quantity

Resource Supply Resource price Quantity S As a resource’s price increases, individuals have a greater incentive to supply it. Thus, a positive relationship will exist between a resource’s price and the quantity supplied in the market. B P2 A P1 Q1 Q2

Equilibrium market demand is downward sloping, reflecting declining MRP Wage (resource price) S D market supply slopes upward as higher prices (wages) induce individuals to supply more. price P1 brings the choices of buyers and sellers into harmony. A P1 At equilibrium price P1, the quantity demanded will just equal the quantity supplied. Quantity Q1

Annual Salary Quantity Demanded Quantity Supplied $55,000 45,000 20,000 $60,000 40,000 27,000 $65,000 37,000 31,000 $70,000 35,000 35,000 $75,000 33,000 38,000 $80,000 32,000 41,000 Demand and Supply of Nurses in Minneapolis-St. Paul

Derived Demand for Resources The demand for resources is derived from the demand for the products that the resources help produce. A service station hires mechanics because of their customers’ demand for repair services.

Derived Demand for Resources The demand for chefs is dependent on the demand for restaurant meals. The demand for pharmacists is dependent on the demand for prescription drugs. The demand for attorneys is dependent on the demand for legal services.

Other Demand Factors for Labor 1. Education and training: Increased education and training increases output. (Shifts to the right.) Increased levels of productivity increase the demand for these workers. 2. Technology: Technology can be a substitute or a complement to labor. If a complement, it increases the demand for certains types of labor. If a substitute, then the demand for labor decreases. (Shifts to the left.)

Other Demand Factors for Labor 3. Number of companies: More businesses, more labor. (Shifts to the right.) Businesses leave, demand drops. 4. Regulations: May require specific workers to carry out certain tasks (Shifts right) May eliminate others. (Shifts to the left.) 5. Complementary Resources: More trucks require more truck drivers (Shifts right)

The Green Sheet What effect would each of the following tend to have on a firm’s demand for a particular resource, increase (a) or decrease (b) a. An increase in the demand for the firm’s product ___ b. A decrease in the amounts of all other resources the firm employs. ____ c. An increase in the productivity of the resource ____ d. An increase in the price of a substitute resource when the output effect is greater than the substitution effect. _____ e. A decrease in the price of a complementary resource. ___ f. A decrease in the price of a substitute resource when the substitution effect is greater than the output effect. ___ a a a b b b

Other Supply Factors for Labor 1. Number of workers: Increased number shifts to the right. Policies encouraging immigration will increase the supply of labor. 2. Required education: Keeps the supply of labor lower. If a complement, it increases the demand for certains types of labor. If a substitute, then the demand for labor decreases. (Shifts to the left.)

Other Supply Factors for Labor 3. Government policies: Higher qualifications and licensing limit the supply of labor. Maternity leave, unemployment insurance, and welfare programs may affect long-run supply of labor.

Supply Positively Related to Price The short-run supply elasticity is determined by how easily the resource can be transferred from one use to another, or resource mobility. If resources are highly mobile then the supply curve will be elastic even in the short run. The supply of a resource will be more elastic in the long run than the short run. In the long run, investment can increase the supply of both physical and human resources.

Earnings Differences: Skilled and Unskilled Workers The wages of unskilled workers are low relative to skilled workers due to the less demand and large supply of skilled workers relative to unskilled workers. Wages Quantity Ds Ss Su Du Skilled workers face strong demand and small supply relative to unskilled workers. Ws Wu

Resources Prices Determined by supply and demand. Changes in the market prices influence the decisions of both users and suppliers. Higher resource prices - more substitutes used. Higher resource prices - more of the resource supplied.

Labor and Product Markets Economic Examples 1. Linkage Between Labor and Product Markets An increase (decrease) in resource prices will reduce (increase) supply in the product market. An increase in product demand will increase the demand for resources used in production of the good.

Resource Prices, and Product Markets S2 S1 DR A reduction in the supply of unskilled labor … pushes the wage rates of fast-food workers upward. Resources Market Price (wage) S2 S1 $7.50 $6.25 DR Employment E2 E1

Resource Prices, and Product Markets S2 S1 DP Higher wages cause a reduction in supply. This leads to higher hamburger prices. Product Market Price S2 S1 $2.25 $2.00 DP Quantity Q2 Q1

Price Controls A. Price Floors Price floor is a legally established minimum price that buyers must pay. It stops the price from dropping down to equilibrium level. Example: minimum wage The direct effect of a price floor above the equilibrium price is a surplus: quantity supplied exceeds quantity demanded.

The Impact of a Price Floor A price floor like P1 sets a price above market equilibrium Price S Surplus P1 causing quantity supplied QD … Price floor to exceed quantity demanded QS … P0 resulting in a surplus. Non-price factors will become more important than prices in determining where scarce goods go. D Quantity QD QS

Minimum Wage Effects Direct effect: Indirect effects: Reduces employment of low-skilled labor. Indirect effects: Reduction in non-wage component of compensation. Less on-the-job training. May encourage students to drop out of school A higher minimum wage does little to help the poor. http://www.thedailyshow.com/watch/tue-january-28-2014/wage-against-the-machine

Employment and the Minimum Wage If a price (wage) of $7.00 could bring equilibrium. Price (wage) Excess supply S minimum wage (price floor) of $10.00 would increase the earnings of those who stayed employed (E1), but would reduce the employment of others. $ 10.00 Minimum wage level $ 7.00 Those who lose their job (E0 to E1) would be pushed into either unemployment or some other less preferred form of employment. D Quantity (employment) E1 E0

2. Increase in the Demand for Loanable Funds Interest rate Lending D2 At the interest rate r the quantity of loanable funds demanded by borrowers into equals quantity supplied by lenders. S An increase in demand will move D1 to D2 r2 r1 the interest rises to r2 and increasing borrowing to Q2 Borrowing Higher interest rates encourage additional savings, making it possible to fund more borrowing. D1 Quantity of loanable funds Q1 Q2

Interest Rate Financial Capital Demanded Financial Capital Supplied (%) (Borrowing $ billions) (Lending $ billions) 11 $800 $420 13 $700 $510 15 $600 $600 17 $550 $660 19 $500 $720 21 $480 $750 Demand and Supply for Borrowing Money with Credit Cards

Examples: Usury laws and rent control Price Controls 2. Price Ceilings Price ceiling is a legally established maximum price that sellers may charge. It stops the price from rising to the equilibrium level. Examples: Usury laws and rent control The direct effect of a price ceiling is a shortage: quantity demanded exceeds quantity supplied.

Quantity of financial capital Example 1: Usury Laws Interest rate Financial capital market S In the financial capital market the price (interest) I0 would bring the quantity of capital demanded into balance with the quantity supplied. I0 A price ceiling like I1sets a price below equilibrium … Rate ceiling I1 Shortage quantity demanded QD … exceeds quantity supplied QS … D resulting in a shortage. Quantity of financial capital QS QD

Quantity of financial capital Example 1: Usury Laws Interest rate Financial capital market S A price ceiling like I1sets a price below equilibrium … resulting in a shortage. I2 However, some states have set the legal limit above equilibrium at (interest) I2 This would be an ineffective price floor because the rate would not rise above equilibrium rate Io. I0 Rate ceiling I1 Shortage D Quantity of financial capital QS QD

Example 2: Rent Control S D Price (rent) Rental housing market S In the rental housing market the price (rent) P0 would bring the quantity of rental units demanded into balance with the quantity supplied. P0 A price ceiling like P1sets a price below equilibrium … Price ceiling P1 quantity demanded QD … Shortage exceeds quantity supplied QS … resulting in a shortage. D Quantity of housing units QS QD

Effects of Rent Control 1. The future supply of housing will decline. 2. The quality of housing will deteriorate. 3. Non-price methods of rationing will increase in importance. 4. Long-term renters will benefit at the expense of newcomers.

1. The notion that the demand for inputs depends on the demand for outputs is termed a. inverse demand. b. derived demand. c. proportional demand. d. complementary demand. 2. If the demand for a consumer good decreases, the demand for resources required to make the good will a. increase. b. remain the same, but the quantity demanded will increase. c. decrease. d. increase or decrease depending on whether the demand for the product is elastic or inelastic.

3. An increase in the demand for a product will cause a. both the demand for and prices of the resources used to produce the product to decline. b. both the demand for and prices of the resources used to produce the product to increase. c. the demand for the resources used to produce the product to increase and their prices to decline. d. the demand for the resources used to produce the product to decline and their prices to increase. 4. If the demand for workers with doctorate degrees in economics increases, we would expect a. the wages of economists to increase in the short run and the number of economists employed to increase in the long run. b. the supply of economists to increase in the short run and their wages to rise in the long run. c. a rapid increase in the supply of economists, causing wages to remain constant. d. the wages of economists to decrease in the short run and the number of economists employed to increase in the long run.

5. In a market economy, which of the following is most important if one is going to achieve high earnings? a. hard work b. provision of goods and/or services that others value highly c. having a graduate degree in a field like history or sociology d. membership in a labor union 6. “Both buyers and sellers are protected by market competition. Competition is the great regulator that protects consumers against high product prices (relative to costs) and productive workers against low wages.” These statements are a. essentially true. b. false; competition protects consumers but cannot protect workers. c. false; competition protects workers but cannot protect consumers. d. true, when consumer protection organizations are active and labor unions are powerful; otherwise, it is false.