|Firms use resources to produce goods and services for households
- Resource markets - factors of production
- Nonhuman resources
- Physical capital
- Natural resources
- Human capital
- More human capital increases productivity
- Workers produce more with same level of resources
- Differences - worker can quit and work for another firm.
- Households buy goods and services from firms.
- Red Arrow - flow of goods, services, and resources.
- Green Arrow - flow of money.
- Firms produce goods and services from resources.
- Firms hire labor and pay them.
- Red Arrow - use labor services to produce goods &
- Green Arrow - wages to workers. Income for workers to buy
goods & services.
||Goods and Services Market
Note: When firms uses capital, land, and natural
resources, the payments eventually go to households in the form of income: Wages and interest.
- Firm extracts oil.
- Firm hires workers to drill & extract.
- Firms buy machines which were made by workers.
1. Derived demand - demand for
resources is derived from the consumers demand for the finished products.
Example: Consumers eat (demand) at a restaurant. The restaurant demands
workers to meet the demand for food service.
|Firms demand for labor|
|# of laborers|
- As the price of a resource increases, the quantity decreases.
- Consumers will buy less of a product, when the product's price increases, resulting from the higher resource prices.
- Consumers eat less at a cafe, if the cafe's prices increase from higher wages.
- Computer prices increase very little, but consumers' demand for computers drop drastically.
- The computer firm sees a significant drop in demand, so it has to cut back significantly on its resources, usually labor
- Two reasons for the negative slope:
- Substitution Effect - firms will substitute the expensive resource for a cheaper one.
- If cotton becomes more expensive, textile firms will substitute with cheaper fibers (such as synthetic fibers).
- If land becomes too expensive (or high taxes) in the city, then firms relocate outside of city limits.
- Output Effect - capital becomes cheaper
- Firm's costs are lower and they hire more labor
- Labor may become more expensive, but is more productive from the capital
2. Elasticity of resource demand -
similar to price elasticity of demand. Elasticity is defined as:
- Note - this elasticity will be negative, but economists usually drop the minus sign
- The demand elasticity for resources comes from the demand elasticity for the goods or services
- If Eresource>1, resource demand is elastic
- Businesses are sensitive to changes in the resource price
- Example - labor become mores expensive, then firm replaces labor with machines
- Firm may not be able to pass the higher price to consumers, because consumers are sensitive to a price increase
- If Eresource < 1, resource demand is inelastic
- Businesses are not sensitive to changes in the resource price
- Resources that are critical or hard to replace
- Example - hospitals cannot reduce quantity of doctors if their wages increases
- Hospitals may be able to pass the wage increase onto consumers, because medical services may be
- The demand for resources is more elastic in the long run than the short run.
- Demand for resources is flatter in long run.
- Firms have more time to adjust for price changes.
3. Shifting demand curves for resources.
- Anything that changes consumers' demand for a product will change the demand for resources.
- Consumer tastes & preferences
- Price of substitute & complement goods
- Number of consumers
- Example: Consumers' income increases and they buy more new cars. Car producers increase production and their demand for resources
increase: Labor, steel, plastics, etc.
- Productivity increase - if resources become more productive, then the demand for those resources increase.
- Example: Computers allow workers to be more productive.
- A price change of a related resources.
- If a price of a substitute resource increases, then the demand for the resource increases.
- If the price of lumber increases, home builders will try to substitute lumber for bricks. Demand for bricks increases, causing
the price for bricks to increase.
- If a price of a complement resource increases, then the demand for the resource decreases.
- If price of lumber increases, the demand for nails will decrease, because less lumber is used as well as
4. Examples using derived demand
- Example: Labors unions become less restrictive and more workers enter the labor market for auto-manufacturing, ceteris paribus.
- Supply of workers increases (shifts right)
- The graph on the left panel
- Equilibrium wages decrease
- Number of workers increases
- Production costs decrease, so firms produce more cars
- Supply for cars increases (shifts right)
- The graph on the right panel
- More cars are produced and sold
- Market price for cars is lower
|Market for Auto workers (Resource)
||Market for Automobiles (Good)|
- Example: Income increases, so consumers buy more computers, ceteris paribus.
- The demand shifts right
- The graph in the left panel
- Computer prices increases
- Quantity of computers sold increases
- As companies make more computers, they need more computer memory chips
- Demand for resources increases (shifts right)
- The graph on the right panel
- The price of memory chips increases
- Quantity sold increases
|Computer Market (Good)
||Memory Chips Market (Resource)|
||If demand increases in consumer good market, then demand increases for resources, and
1. Marginal Revenue Product (MRP) -
the increase in a firm's revenue while using one more unit of resource (i.e. labor or capital).
- An employer will hire one more worker when:
- MRP > wages
- wages are costs while MRP is a benefit
- Book uses Marginal Resource Costs (MRC)
- Profit-maximizing firms hire additional units of a resource up to the point where the MRP = wages
- Wages are the price for labor, but MRP can be used for other resources.
|Wage rate of worker
||Firm's revenue increases (MRP)
|$10 per hour
||$15 per hour
||Hire the worker|
|$10 per hour
||$10 per hour
||Hire the worker|
|$10 per hour
||$5 per hour
||Do not hire!|
Marginal Product (MP) - the increase in the firm's output from using one more additional unit of labor or
Marginal Revenue (MR) - the increase in the firm's revenue from producing & selling one more
MRP is related to MP and MR by:
MRP = MP * MR
Example: MP = 10 units per worker and MR=$5 per unit.
If the firm hires one more worker, then production increases by 10 units. The firm sells each unit of output for $5, so total revenue
increases by $50 for hiring this worker.
MRP = $5 per unit * 10 units per worker = $50 per worker
- The marginal product of a resource will fall as the firm uses more and more of a resource.
- Law of Diminishing Returns.
- Firm has 50 workers and hires 1 more worker, output increases by 100 units.
- Firm has 100 workers and hires 1 more worker, output increases by 10 units.
- Marginal Revenue Product will fall as a firm uses more and more of a resource.
|Demand for Labor|
|Wages, resource price|
|Quantity demanded for labor|
||The MRP is the firm's demand for that resource.|
2. Market structure impacts the demand for resources
- For competitive markets, P = MR, thus MRP = MP*P
- For a monopoly, MRP = MP*MR
- Monopoly has higher market price and lower market quantity
- To produce lower output, monopoly demands less resources
- Monopolist has a more inelastic demand function for resources
3. Firms use many resource inputs. They use more resources and expand production until the following is true:
MRP skilled labor = P skilled labor
MRP unskilled labor = P unskilled labor
machine A = P machine A
Price of labor is P and is also wages.
Machine Price - the price is
calculated as if the machine is rented by the hour.
Divide by the respective prices:
MRP skilled labor / P skilled labor
MRP unskilled labor / P unskilled labor = 1
MRP machine A / P machine A = 1
The firm will spend his last dollar in such a way to achieve:
MRP s / P s = MRP u / P
u = MRP m-A / P m-A = 1
Using this equation:
- If a skilled worker is twice as productive as an unskilled worker, his salary is twice higher.
- It is not always cheaper to hire the lowest wage workers. Firms compare the workers' productivity to the wage rate.
- Many firms did not relocate to Mexico with the NAFTA trade agreement. Wages in Mexico are much lower, but productivity is very low.
- U.S. wages are 3 time higher and productivity is 4.5 times higher.
Firms are minimizing their costs, which in turn are maximizing profits. Firms use resources when:
benefits (increased revenue) => costs
(prices of resources)
||Firms cannot estimate these equations, but with experience and intuition, they approximate them. Profit rewards entrepreneurs who
channels resources to highly-valued consumer goods.|
1. Resources owners supply their resources when benefits of production costs.
- If resource price increases, then more resources will be provided in the market.
- Resource mobility - how easily factors of production can be moved to alternative uses.
- Human capital is complicated:
- Affected by working conditions
- Job prestige
- People will trade better working conditions for less wages
- Movements of people with one skill to another is costly
- Example: Electrician cannot do plumbing
- Highly-skilled people can perform lower skilled positions
- PhDs can mow lawns, work at restaurants, clerks, etc.
|Supply of a Resource|
2. Long-run supply - resources can change drastically.
- The supply of a resource is more elastic in the long run than the short run.
- As the price of a resource increases, people will invest more resources.
- Machines, human capital, and land depreciate.
- Reduces resources.
- Investment forms.
- Buying more machines
- Improving land
- Health - Some firms have fitness centers and gyms
- Example: Wage rate for lawyers increases
- Short run - supply increases from people who already have the skills.
- Could be attracted from government
- Law professors
- More people take the bar exam (who already have law degrees).
- Long run - more students will major in law
- An 1% increase in lawyer starting salaries causes a 2% first-class enrollment in law schools.
- The long run is a relative term.
- Truck driver's Commercial Driver's License (CDL): < 1 year.
- Medical doctor: > 11 years
- 4 years of college
- 4 years of medical school
- 3 years internship
1. Supply & demand determine resource prices. Equilibrium prices and quantities in a resource market.
- Education - teachers are a resource input.
- Many schools have teacher shortages.
- Allow the salaries of teachers to increase.
- Schools will decrease quantity demanded for teachers, because they are more expensive.
- More students will choose education as a major, causing quantity supplied of teachers to increase.
- The market wants to approach equilibrium, but school boards (like government) keeps wages artificially low.
- Wages are "locked" in a budget based on tax revenues.
|Teacher Resource Market|
|# of Teachers|
2. Changes in resource prices.
- U.S. government passes a more complicated tax code.
- Demand for tax specialists increases.
- Accountants - resource input.
- Short run:
- Price and quantity for tax services increase.
- Long run:
- More students are attracted to accounting and supply increases.
- Market price will decrease in the long run, but still greater