1. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 1 ECON Designed by Amy McGuire, B-books, Ltd. McEachern 2008-2009 11 CHAPTER Resource Markets Micro

2. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 2 Demand and Supply of Resources LO 1  Resource demand  Firms demand resources  As long as MR>MC  To maximize profit  Resource supply  People supply resources  To the highest-paying alternative  To maximize utility

3. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 3 LO 2 Resource Market for Carpenters Exhibit 1 Hours of labor per periodE 0 Dollars per hour of labor W D S The intersection of the upward-sloping supply curve of carpenters with the downward-sloping demand curve determines the equilibrium wage, W, and the level of employment, E.

4. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 4 The Market Demand for Resources LO 2  Resource demand  Derived demand  Arises from the demand for the final product  Market demand  Sum of demands for a resource  In all its uses  Downward sloping

5. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 5 Shifts of the Demand Curve LO 2  As price falls, producers  More willing to buy  Relatively cheaper  Substitution in production  Greater ability to buy  Hire more at the same total cost

6. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 6 LO 2 Case Study Lumber Prices and Housing Markets  Demand for lumber = derived demand  2001, increase in D for housing  Increased D for lumber  Increase lumber prices (68% by 2004)  2005-2007, decline in housing demand  Reduced D for building products  Sharp fall in lumber prices

7. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 7 The Market Supply of Resources LO 2  Market supply  Sum of all individual supply curves  Upward sloping  As price rises, resource suppliers  More willing to sell  Higher earnings  More goods and services purchased  More able to increase quantity supplied

8. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 8 Resource Price Differences LO 2  Resources  Flow to their highest-valued use  If freely mobile  Adjust across different uses until they earn the same wage  Temporary differences  Market adjustments  Reallocation of resources

9. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 9 LO 2 Market for Carpenters in Alternative Uses Exhibit 2 The wage differential prompts carpenters to shift from furniture making to home building until the wage is identical in the two markets (a) Home building DhDh ShSh Dollars per hour $25 24 S’ h Hours of labor per day (thousands) 58060 (b) Furniture making DfDf SfSf Dollars per hour 20 $24 S’ f Hours of labor per day (thousands) 10012

10. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 10 Resource Price Differences LO 2  Permanent differences  Lack of resource mobility  Inherent quality of the resource  Time and money involved in developing necessary skills  Nonmonetary aspects of the job

11. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 11 Opportunity Cost and Economic Rent LO 3  Opportunity cost –What a resource could earn in its best alternative use  Economic rent –Earnings in excess of opportunity cost –‘Pure gravy’  The less elastic the resource S –The greater the economic rent as proportion of total earnings

12. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 12 Opportunity Cost and Economic Rent LO 3  Perfectly inelastic supply –No alternative uses –No opportunity cost –All earnings are economic rent  Perfectly elastic supply –Earns the same in current and best alternative use –All earnings are opportunity cost –No economic rent

13. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 13 LO 3 Opportunity Cost and Economic Rent Exhibit 3 (a) All earnings are economic rent (b) All earnings are opportunity costs (c) Earnings divided between economic rent and opportunity cost S Millions of acres per month 100 Hours of labor per day 1,000 0 Hours of labor per day 5,000 0 10,000 D Dollars per unit $1 D S Dollars per unit $10 D S Dollars per unit $14 7 Economic rent Opportunity costs Opportunity costs Economic rent

14. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 14 The Firm’s Demand for a Resource  Quantity of resource L  Total product TP, Q  Quantity of output  Marginal product MP=∆TP/∆L  Diminishing marginal returns  Marginal revenue product MRP=∆TR/∆L  How much total revenue changes as more labor is employed  Depends on ∆Q and P LO 4

15. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 15 Marginal Revenue Product  MRP curve = Firm’s demand curve for the resource  Perfectly competitive product market: MRP = MP×P  MRP curve slopes downward  Diminishing marginal returns to resource  Some market power in product market  MRP curve slopes downward  Diminishing marginal returns to resource  Additional output can be sold only if price falls LO 4

16. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 16 LO 4 Marginal Revenue Product When a Firm Sells in a Competitive Market Exhibit 4

17. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 17 LO 4 Marginal Revenue Product When a Firm Sells with Market Power Exhibit 5

18. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 18 Marginal Resource Cost  Marginal resource cost MRC=∆TC/∆L  Change in total cost when hiring one more unit of labor  MRC curve  Horizontal curve at the equilibrium market wage  Maximize profit  Hire resources until MRC=MRP LO 4

19. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 19 LO 4 Market Equilibrium for a Resource and the Firm’s Employment Decision Exhibit 6 (a) Market Dollars per worker per day $200 100 Workers per day E 0 (b) Firm Resource supply Resource demand Dollars per worker per day $200 100 Marginal resource cost = Resource supply Marginal revenue product = Resource demand Workers per day 60 10 In panel (a), market demand and supply determine the resource’s market wage and quantity. In panel (b), an individual firm can employ as much as it wants at the market wage so that wage becomes the firm’s MRC. The firm maximizes profit (or minimizes its loss) by hiring a resource up to the point where MRP = MRC.

20. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 20 Changes in Resource Demand  Changes in MRP (demand)  Marginal product of the resource  Amount of other resources employed  Substitutes  Complements  Technology  Product’s price  Change in demand for the product  Demand for resource = derived demand LO 4

21. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 21 LO 4 Case Study The McMinimum Wage  May 2007, minimum hourly wage $7.25  Only 4% workers earned less  Advocates  Increase the income of the poorest workers  Critics  Encourage employers to  Cut nonwage compensation  Scale back employment

22. Chapter 11Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 22 LO 4 Case Study The McMinimum Wage  Higher minimum wage  Employers  Substitute part-time for full-time jobs  Substitute more qualified for less qualified workers  Adjust nonwage components  Higher opportunity cost of staying in school