1. Changes in Factor Prices

2. Remember our basic cost function C = C(q,r,w)

3. Changes in Factor Prices Remember our basic cost function C = C(q,r,w) The Impact of a change in factor prices on the market

4. Changes in Factor Prices Remember our basic cost function C = C(q,r,w) The Impact of a change in factor prices on the market How a shift in market demand can cause a change in factor prices

5. An Exogenous Change Suppose the price of a factor of production changes.

6. An Exogenous Change Suppose the price of a factor of production changes. While there is obviously some substitution, there will be an increase in cost.

7. An Exogenous Change Suppose the price of a factor of production changes. While there is obviously some substitution, there will be an increase in cost. This is called an exogenous (external) change.

8. An Exogenous Change p* q*

9. An Exogenous Change p* D q*

10. An Exogenous Change p* D q* Q* = Nq*

11. An Exogenous Change p* D q* Q* = Nq* p** q**

12. An Exogenous Change p* D q* Q* p** q** Q** = N’q**

13. An Exogenous Change p* D q* Q* = Nq* p** q** Q** = N’q** Price goes up. Quantity sold does down. Average size of firm and number of firms indeterminate.

14. An Endogenous Change p min S LR S SR D Now let’s talk about how a change in demand can affect factor prices.

15. An Endogenous Change p min S LR S SR D

16. An Endogenous Change p min p1p1 S LR S SR DD’

17. An Endogenous Change p min p1p1 S LR S SR DD’

18. An Endogenous Change p min p1p1 S LR S SR DD’

19. An Endogenous Change p min p1p1 S LR S SR DD’ No change in factor prices means no long run change in product price.

20. An Endogenous Change p min p1p1 S LR S SR DD’ No change in factor prices means no long run change in product price. But it does not have to be this way.

21. The demand for lumber Lumber is a highly competitive business.

22. The demand for lumber Lumber is a highly competitive business. It has a key factor of production: timber. A change in the demand for lumber can have feedback effects on the price of timber.

23. The demand for lumber Lumber is a highly competitive business. It has a key factor of production: timber. A change in the demand for lumber can have feedback effects on the price of timber. This is the case of a pecuniary external diseconomy.

24. The Demand for Lumber and Timber Lumber D

25. The Demand for Lumber and Timber Lumber Timber D D S

26. The Demand for Lumber and Timber Lumber Timber D D’ D S

27. The Demand for Lumber and Timber Lumber Timber D D’ D S If lumber production is increasing due to a demand shift, then there is a shift in the demand for timber. Timber prices will be going up.

28. Effect of Price Changes p* q* Q*

29. Effect of Price Changes p* q*q** p** Q* Q**

30. Effect of Price Changes p* q*q** p** Q* Q** Q*Q** S

31. Effect of Price Changes p* q*q** p** Q* Q** Q*Q** S Because of external pecuniary diseconomies, we get an upward sloping supply curve for lumber

32. Long Run and Short Run Changes D S LR p1p1 q1q1

33. Long Run and Short Run Changes D D’ S LR S SR p2p2 p1p1 q1q1 q2q2 Initial effect is movement along SR Supply Curve

34. Long Run and Short Run Changes D D’ S LR S’ SR S SR p3p3 p2p2 p1p1 q1q1 q2q2 q3q3 New firms enter, pushing SR supply curve to right.

35. Long Run and Short Run Changes D D’ S LR S’ SR S SR p3p3 p2p2 p1p1 q1q1 q2q2 q3q3 Then, a movement down new demand curve.

36. Long Run and Short Run Changes D D’ S LR S’ SR S SR p3p3 p2p2 p1p1 q1q1 q2q2 q3q3 Net effect is movement along LR supply curve.

37. Long Run and Short Run Changes D D’ S LR S’ SR S SR p3p3 p2p2 p1p1 q1q1 q2q2 q3q3 Price goes up, even though industry is perfectly competitive and all firms are alike.

38. End ©2003 Charles W. Upton