Changes in Factor Prices
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Changes in Factor Prices
Changes in Factor Prices
• Remember our basic cost function
C = C(q,r,w)
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
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
An Exogenous Change
• Suppose the price of a factor of production changes.
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.
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.
An Exogenous Change
p*
q*
An Exogenous Change
p*
D
q*
An Exogenous Change
p*
D
q* Q* = Nq*
An Exogenous Change
p*
D
q* Q* = Nq*
p**
q**
An Exogenous Change
p*
D
q* Q*
p**
q** Q** = N’q**
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.
An Endogenous Change
pmin SLR
SSR
D
Now let’s talk about how a change in demand can affect factor prices.
An Endogenous Change
pmin SLR
SSR
D
An Endogenous Change
pmin
p1
SLR
SSR
D D’
An Endogenous Change
pmin
p1
SLR
SSR
D D’
An Endogenous Change
pmin
p1
SLR
SSR
D D’
An Endogenous Change
pmin
p1
SLR
SSR
D D’
No change in factor prices means no long run change in product price.
An Endogenous Change
pmin
p1
SLR
SSR
D D’
No change in factor prices means no long run change in product price.
But it does not have to be this way.
The demand for lumber
• Lumber is a highly competitive business.
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.
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.
The Demand for Lumber and Timber
Lumber
D
The Demand for Lumber and Timber
Lumber Timber
D D
S
The Demand for Lumber and Timber
Lumber Timber
DD’
D’
D
S
The Demand for Lumber and Timber
Lumber Timber
DD’
D’
D
SIf 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.
Effect of Price Changes
p*
q*
Q*
Effect of Price Changes
p*
q* q**
p**
Q*Q**
Effect of Price Changes
p*
q* q**
p**
Q*Q**
Q* Q**
S
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
Long Run and Short Run Changes
D
SLR
p1
q1
Long Run and Short Run Changes
DD’
SLR
SSRp2
p1
q1 q2
Initial effect is movement along SR Supply Curve
Long Run and Short Run Changes
DD’
SLR
S’SRSSR
p3
p2
p1
q1 q2 q3
New firms enter, pushing SR supply curve to right.
Long Run and Short Run Changes
DD’
SLR
S’SRSSR
p3
p2
p1
q1 q2 q3
Then, a movement down new demand curve.
Long Run and Short Run Changes
DD’
SLR
S’SRSSR
p3
p2
p1
q1 q2 q3
Net effect is movement along LR supply curve.
Long Run and Short Run Changes
DD’
SLR
S’SRSSR
p3
p2
p1
q1 q2 q3
Price goes up, even though industry is perfectly competitive and all firms are alike.
End
©2003 Charles W. Upton
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