Chapter 25: Pricing in Resource Markets Resource markets Resource demand The labor market Resource markets Resource demand The labor market.

Chapter 25: Pricing in Resource Chapter 25: Pricing in Resource MarketsMarketsChapter 25: Pricing in Resource Chapter 25: Pricing in Resource MarketsMarkets

• Resource markets

• Resource demand

• The labor market

• Resource markets

• Resource demand

• The labor market

Factor/Resource marketsFactor/Resource marketsFactor/Resource marketsFactor/Resource markets

• Factors of production: land labor capital entrepreneurship

• factor prices determined in resource markets

• Factors of production: land labor capital entrepreneurship

• factor prices determined in resource markets

resources marketsresources marketsresources marketsresources markets

• same concepts of demand and supply now applied to factors of

production

• same concepts of demand and supply now applied to factors of

production

resource demandresource demandresource demandresource demand

• producer will demand an additional unit of resource if

• producer will demand an additional unit of resource if

MR of resource > MC of

resource

example: Wal Martexample: Wal Martexample: Wal Martexample: Wal Mart

• labor market

• 1 more clerk costs $400 per week

• 1 more clerk increases revenue by $500 week

• hire 1 more clerk? Yes! $500 > $400

• labor market

• 1 more clerk costs $400 per week

• 1 more clerk increases revenue by $500 week

• hire 1 more clerk? Yes! $500 > $400

example: lawn serviceexample: lawn serviceexample: lawn serviceexample: lawn service

• capital market

• larger, faster mower costs extra $400/wk.

• but mow more lawns, extra $600/wk. in revenue

• buy the mower? Yes! $600 > $400

• capital market

• larger, faster mower costs extra $400/wk.

• but mow more lawns, extra $600/wk. in revenue

• buy the mower? Yes! $600 > $400

termstermstermsterms

• marginal revenue product (MRP) extra revenue from one more unit

of resource

• marginal resource cost (MRC) extra cost for one more unit of

resource

• marginal revenue product (MRP) extra revenue from one more unit

of resource

• marginal resource cost (MRC) extra cost for one more unit of

resource

rule for resource demandrule for resource demandrule for resource demandrule for resource demand

• firm hires additional resources until MRC = MRP

cost of the extra resource =

extra revenue from the resource

• firm hires additional resources until MRC = MRP

cost of the extra resource =

extra revenue from the resource

resource supplyresource supplyresource supplyresource supply

• you will supply your resources to the “best” option highest paying (if all else equal)

• nonmonetary factors are important firms must compensate when jobs

are

dirty, dangerous, illegal…..

• you will supply your resources to the “best” option highest paying (if all else equal)

• nonmonetary factors are important firms must compensate when jobs

are

dirty, dangerous, illegal…..

The Market for ResourcesThe Market for ResourcesThe Market for ResourcesThe Market for Resources

• resource demand downward sloping producers less willing, able to buy

resources at higher prices

• resource demand downward sloping producers less willing, able to buy

resources at higher prices

• resource demand is a DERIVED demand it depends on the demand for the

final product

• resource demand is a DERIVED demand it depends on the demand for the

final product

examplesexamplesexamplesexamples

• demand for nurses depends on demand for healthcare

• demand for steel depends on demand for cars

• demand for plywood depends on demand for houses

• demand for nurses depends on demand for healthcare

• demand for steel depends on demand for cars

• demand for plywood depends on demand for houses

Shifts in demand for a resourceShifts in demand for a resourceShifts in demand for a resourceShifts in demand for a resource

• demand for final product if product demand rises, MRP rises resource demand shifts right

• productivity of resource better resource, higher MP & MRP resource demand shifts right

• demand for final product if product demand rises, MRP rises resource demand shifts right

• productivity of resource better resource, higher MP & MRP resource demand shifts right

examplesexamplesexamplesexamples

• increase demand for healthcare increase demand for nurses increase demand for syringes

• higher-skilled labor increases demand for labor

• increase demand for healthcare increase demand for nurses increase demand for syringes

• higher-skilled labor increases demand for labor

• price of other resources if price of substitute resource falls

-- substitute cheaper resource

-- demand for original resource shifts left

• price of other resources if price of substitute resource falls

-- substitute cheaper resource

-- demand for original resource shifts left

exampleexampleexampleexample

• bank ATMs vs bank tellers ATM costs falls

-- demand for bank tellers falls

• bank ATMs vs bank tellers ATM costs falls

-- demand for bank tellers falls

exampleexampleexampleexample

• office buildings skyscrapers in Manhattan 3 stories in Oswego

• why? cost of land vs. cost of

construction

• office buildings skyscrapers in Manhattan 3 stories in Oswego

• why? cost of land vs. cost of

construction

if price of complement resource falls

-- use more of both resources

-- demand for original resource shifts right

if price of complement resource falls

-- use more of both resources

-- demand for original resource shifts right

exampleexampleexampleexample

• price of trucks (18-wheeler) fall increase demand for truck drivers

• price of trucks (18-wheeler) fall increase demand for truck drivers

notenotenotenote

• sometimes resources are BOTH substitutes and complements: computers do some clerical

functions AND need clerical workers to operate

them

• sometimes resources are BOTH substitutes and complements: computers do some clerical

functions AND need clerical workers to operate

them

• technology decrease demand for some types

of labor increase demand for other types of

labor

• technology decrease demand for some types

of labor increase demand for other types of

labor

exampleexampleexampleexample

• better/cheaper computer technology increases demand for

programmers decrease demand for architects

• better/cheaper computer technology increases demand for

programmers decrease demand for architects

• resource supply upward sloping suppliers more willing, able to

provide resources at higher prices

• resource supply upward sloping suppliers more willing, able to

provide resources at higher prices

Q res.

P res.S

D

P*

Q*

resource pricesresource pricesresource pricesresource prices• tend to equalize across alternative uses

carpenters for houses carpenters for furniture

• UNLESS other nonmonetary differences economics professors vs. business

economists land in Manhattan vs. land in Oswego

• tend to equalize across alternative uses carpenters for houses carpenters for furniture

• UNLESS other nonmonetary differences economics professors vs. business

economists land in Manhattan vs. land in Oswego

The Labor MarketThe Labor MarketThe Labor MarketThe Labor Market

• Labor supply

• Labor demand

• Earnings differences

• Labor supply

• Labor demand

• Earnings differences

Labor SupplyLabor SupplyLabor SupplyLabor Supply

• time is a scarce resource market work (for pay) nonmarket work (not for pay)

(cleaning, studying) leisure (for fun)

• time is a scarce resource market work (for pay) nonmarket work (not for pay)

(cleaning, studying) leisure (for fun)

work and utilitywork and utilitywork and utilitywork and utility

• work is a disutility but allows you to buy stuff or to enjoy stuff

(clean house, dinner, good grades)

• work is a disutility but allows you to buy stuff or to enjoy stuff

(clean house, dinner, good grades)

• tradeoff between consumption & leisure work to buy stuff or to make stuff but working leaves less time for

leisure

• tradeoff between consumption & leisure work to buy stuff or to make stuff but working leaves less time for

leisure

implicationsimplicationsimplicationsimplications

• higher wages

= higher opp. cost of leisure, nonmarket work

most surgeons don’t mow their lawn

many college sports stars head to the draft early

• higher wages

= higher opp. cost of leisure, nonmarket work

most surgeons don’t mow their lawn

many college sports stars head to the draft early

• two effects: substitution effect income effect

• two effects: substitution effect income effect

Effect of a wage increaseEffect of a wage increaseEffect of a wage increaseEffect of a wage increase

substitution effectsubstitution effectsubstitution effectsubstitution effect

• as wage rises opp. cost of other time uses rises spend more time on market work

• Qs of labor rises as wages rise

• as wage rises opp. cost of other time uses rises spend more time on market work

• Qs of labor rises as wages rise

income effectincome effectincome effectincome effect

• as wages rise income rises consumer more of what you like:

-- stuff, leisure

• Qs of labor falls as wages rise

• as wages rise income rises consumer more of what you like:

-- stuff, leisure

• Qs of labor falls as wages rise

• if substitution effect > income effect labor supply is upward sloping

• if substitution effect < income effect labor supply is downward sloping

• which is it?

• if substitution effect > income effect labor supply is upward sloping

• if substitution effect < income effect labor supply is downward sloping

• which is it?

labor supplylabor supplylabor supplylabor supply

• economists observe upward sloping for most wages downward sloping at very high

wages

• backward-bending supply curve

• economists observe upward sloping for most wages downward sloping at very high

wages

• backward-bending supply curve

wage

Q labor

S

subst. > inc. effect

subst. < inc. effect

Changes in market labor supplyChanges in market labor supplyChanges in market labor supplyChanges in market labor supply

• adult population births rates, immigration increase will shift labor supply

right

• adult population births rates, immigration increase will shift labor supply

right

• preferences willingness of groups to work women have increasingly entered

labor force

-- shift labor supply right

• preferences willingness of groups to work women have increasingly entered

labor force

-- shift labor supply right

• skills, education, training education increases opp. cost of

not working for pay

-- labor supply increases with education

increase HS, college graduation

-- increase supply high-skill labor

-- decrease supply low-skill labor

• skills, education, training education increases opp. cost of

not working for pay

-- labor supply increases with education

increase HS, college graduation

-- increase supply high-skill labor

-- decrease supply low-skill labor

• other sources of income nonwage income lowers labor

supply less labor supply among those

over 50 with the growth of pensions, disability

less labor supply among women with high-earning husbands

• other sources of income nonwage income lowers labor

supply less labor supply among those

over 50 with the growth of pensions, disability

less labor supply among women with high-earning husbands

Labor demandLabor demandLabor demandLabor demand

• firm’s demand for labor

• car wash perfectly competitive

• marginal revenue product (MRP) change in total revenue when one

more unit of labor is hired

• firm’s demand for labor

• car wash perfectly competitive

• marginal revenue product (MRP) change in total revenue when one

more unit of labor is hired

example: car washexample: car washexample: car washexample: car wash

• price of car wash = $3

• car washes per hour• price of car wash = $3

• car washes per hour

Q labor TP MP MRP

0 01 5

2 93 124 145 15

54

3

21

1512

9

63

how much labor to hirehow much labor to hirehow much labor to hirehow much labor to hire

• MC of one more unit of labor marginal resource cost (MRC) wage

• MR of one more unit of labor MRP

• hire until MRP = wage

• MC of one more unit of labor marginal resource cost (MRC) wage

• MR of one more unit of labor MRP

• hire until MRP = wage

• if MRP > wage hire more labor and still add to

profit

• if MRP < wage last units labor taking away from

profit, hire less labor

• if MRP > wage hire more labor and still add to

profit

• if MRP < wage last units labor taking away from

profit, hire less labor

wage

Q labor

15

12

9

6

3

1 2 3 4 5

LD

if wage = $9

hire 3 units labor

wage

Q labor

15

12

9

6

3

1 2 3 4 5

LD

wage = $6,hire 4

wage = $12,hire 2

Earnings differencesEarnings differencesEarnings differencesEarnings differences

• based on both demand-side and supply side factors

• based on both demand-side and supply side factors

Human CapitalHuman CapitalHuman CapitalHuman Capital

• Skill set Education, training, experience

• increases MP of labor & labor demand

• cost of education means supply of skilled labor lower relative to unskilled labor

• result is a higher market wage

• Skill set Education, training, experience

• increases MP of labor & labor demand

• cost of education means supply of skilled labor lower relative to unskilled labor

• result is a higher market wage

ability/talentability/talentability/talentability/talent

• Human capital, but hard to measure

• the best athletes, most popular movies stars, CEOs command HUGE salary premium over others

• Human capital, but hard to measure

• the best athletes, most popular movies stars, CEOs command HUGE salary premium over others

Efficiency wage theoryEfficiency wage theoryEfficiency wage theoryEfficiency wage theory

• Higher pay leads to better productivity

• Why? Better morale, lower turnover “Cherry pick” the best workers Workers do not want to risk losing

job

• Higher pay leads to better productivity

• Why? Better morale, lower turnover “Cherry pick” the best workers Workers do not want to risk losing

job

Non-wage job characteristicsNon-wage job characteristicsNon-wage job characteristicsNon-wage job characteristics

• Risk/danger

• Working conditions

• Work is meaningful or glamorousHolding all else constant,

• dangerous jobs pay more

• jobs with higher layoff probability pay more

• Risk/danger

• Working conditions

• Work is meaningful or glamorousHolding all else constant,

• dangerous jobs pay more

• jobs with higher layoff probability pay more

geographygeographygeographygeography

• wages higher in U.S. encourages immigration

• teacher’s salaries vary significantly by state

• wages lower in South than Northeast

• wages higher in U.S. encourages immigration

• teacher’s salaries vary significantly by state

• wages lower in South than Northeast

discriminationdiscriminationdiscriminationdiscrimination

• age, race, gender

• wage differentials remain EVEN after controlling for other factors occupation education/experience risk

• age, race, gender

• wage differentials remain EVEN after controlling for other factors occupation education/experience risk

unionizationunionizationunionizationunionization

• union workers earn more than nonunion workers doing the same jobs janitors auto workers teachers

• union workers earn more than nonunion workers doing the same jobs janitors auto workers teachers

26. Markets for Capital and Natural 26. Markets for Capital and Natural ResourcesResources26. Markets for Capital and Natural 26. Markets for Capital and Natural ResourcesResources

• Financial markets

• Natural Resource markets• Financial markets

• Natural Resource markets

Financial MarketsFinancial MarketsFinancial MarketsFinancial Markets

• Demand for financial capital

• Supply of financial capital

• interest rate

• financial capital = loanable funds

• Demand for financial capital

• Supply of financial capital

• interest rate

• financial capital = loanable funds

Demand for Financial capitalDemand for Financial capitalDemand for Financial capitalDemand for Financial capital

• firms demand funds to finance capital purchases

• higher interest rate, more expensive to borrow lower Q demanded of funds

• firms demand funds to finance capital purchases

• higher interest rate, more expensive to borrow lower Q demanded of funds

interest rate

Q funds

D

Shifts in demand for fundsShifts in demand for fundsShifts in demand for fundsShifts in demand for funds

• population growth increase demand for goods, increase demand for capital, increase demand for funds

• population growth increase demand for goods, increase demand for capital, increase demand for funds

• technology increase demand for new capital, increase demand for funds to

finance it

• technology increase demand for new capital, increase demand for funds to

finance it

• Government borrowing Federal gov’t deficits shift demand

to the right

• Government borrowing Federal gov’t deficits shift demand

to the right

Supply of Financial capital Supply of Financial capital Supply of Financial capital Supply of Financial capital

• people’s savings decisions tradeoff between consuming today &

consuming tomorrow• Time preference

• higher interest rates encourage saving higher opportunity cost of current

consumption higher Q supplied of funds

• people’s savings decisions tradeoff between consuming today &

consuming tomorrow• Time preference

• higher interest rates encourage saving higher opportunity cost of current

consumption higher Q supplied of funds

Shifts in supply of fundsShifts in supply of fundsShifts in supply of fundsShifts in supply of funds

• population higher population, more saving supply shifts right

• income higher income, more savings supply shifts right

• population higher population, more saving supply shifts right

• income higher income, more savings supply shifts right

• expected future income save today based on future needs

-- retirement, college save to smooth consumption over time expect income to rise

-- save less today, supply falls expect income to fall

-- save more today, supply rises

• expected future income save today based on future needs

-- retirement, college save to smooth consumption over time expect income to rise

-- save less today, supply falls expect income to fall

-- save more today, supply rises

interest rate

Q funds

S

D

Financial market equilbriumFinancial market equilbriumFinancial market equilbriumFinancial market equilbrium

i*

Q*

Natural Resource marketsNatural Resource marketsNatural Resource marketsNatural Resource markets

• renewable resources land, forests, livestock

• nonrenewable resources fossil fuels, metals

• renewable resources land, forests, livestock

• nonrenewable resources fossil fuels, metals

Market for landMarket for landMarket for landMarket for land

• supply is fixed for type or location perfectly inelastic

• supply is fixed for type or location perfectly inelastic

Srent

Q land

D

r*

Q*

economic renteconomic renteconomic renteconomic rent

• rent for land is special land is available even if rent=0 demand affects P, not Q

• economic rent rent above what is required to

induce Q supplied of factor

• rent for land is special land is available even if rent=0 demand affects P, not Q

• economic rent rent above what is required to

induce Q supplied of factor

Srent

Q land

D

r*

Q*

economic rent

• Pure economic rent Income earned by resource with a

perfectly inelastic supply

• Pure economic rent Income earned by resource with a

perfectly inelastic supply

Economic RentEconomic RentEconomic RentEconomic Rent

• amount of resource earnings ABOVE opportunity cost

• or

resource earnings – minimum required earnings

• “gravy”! “bonus”!

• amount of resource earnings ABOVE opportunity cost

• or

resource earnings – minimum required earnings

• “gravy”! “bonus”!

example: Shaquille O/Nealexample: Shaquille O/Nealexample: Shaquille O/Nealexample: Shaquille O/Neal

• 2000: $35 million

• what is minimum for which he would play basketball and endorse stuff? suppose $1 million

• economic rent: $34 million

• 2000: $35 million

• what is minimum for which he would play basketball and endorse stuff? suppose $1 million

• economic rent: $34 million

when do resources earn rent?when do resources earn rent?when do resources earn rent?when do resources earn rent?

• less elastic (more inelastic) the supply, more rent as a % of total earnings

• less elastic (more inelastic) the supply, more rent as a % of total earnings

Differential rentDifferential rentDifferential rentDifferential rent

• Rents earned to superior units of a resource Where quality of resource affects

productivity

• Examples Highly fertile farmland Highly skilled trial lawyer

• Rents earned to superior units of a resource Where quality of resource affects

productivity

• Examples Highly fertile farmland Highly skilled trial lawyer

Inframarginal rentInframarginal rentInframarginal rentInframarginal rent

• Total rent when units of resource differ in their opportunity costs

• What causes differences? Differences in objectives Differences in constraints

• Total rent when units of resource differ in their opportunity costs

• What causes differences? Differences in objectives Differences in constraints

examplesexamplesexamplesexamples

• Nursing Find the work rewarding Other constraints in the job market

• Teaching summer school Presence of small children Children in college

• Nursing Find the work rewarding Other constraints in the job market

• Teaching summer school Presence of small children Children in college

Q res.

P res.S

D

P*

Q*

upward-sloping supply

earnings split

rent

opp.cost

Supply of nonrenewable resourceSupply of nonrenewable resourceSupply of nonrenewable resourceSupply of nonrenewable resource

• at point in time Q is fixed

• but over time use

-- decrease supply new discoveries

-- increase supply technology for better use

-- decrease demand

• at point in time Q is fixed

• but over time use

-- decrease supply new discoveries

-- increase supply technology for better use

-- decrease demand

example: metalsexample: metalsexample: metalsexample: metals

• nonrenewable resource

• discover new sources

• use substitutes (plastic)

• Recycling technology

• nonrenewable resource

• discover new sources

• use substitutes (plastic)

• Recycling technology

Market-guided conservationMarket-guided conservationMarket-guided conservationMarket-guided conservation

• Markets have built-in incentives for efficient resource use

• If a resource becomes scarce Prices rise

• Copper is up 50% in 2006

• Markets have built-in incentives for efficient resource use

• If a resource becomes scarce Prices rise

• Copper is up 50% in 2006

• If prices rise People use less (conserve) People substitute Firms look for new sources Firms look for alternatives

• If prices rise People use less (conserve) People substitute Firms look for new sources Firms look for alternatives

Problems with markets & Problems with markets & nonrenewable resourcesnonrenewable resourcesProblems with markets & Problems with markets & nonrenewable resourcesnonrenewable resources

• Externalities Extraction of oil, metals, natural gas

have huge negative externalities Market results in too much extraction

• Government policies Major tax breaks to domestic energy

producers

• Prices may not be sending the right signals

• Externalities Extraction of oil, metals, natural gas

have huge negative externalities Market results in too much extraction

• Government policies Major tax breaks to domestic energy

producers

• Prices may not be sending the right signals

Doomsday scenariosDoomsday scenariosDoomsday scenariosDoomsday scenarios

• Aka

• “We are running out of everything and we are all going to die”

• Aka

• “We are running out of everything and we are all going to die”

Paul EhrlichPaul EhrlichThe Population BombThe Population Bomb, , 19681968

Paul EhrlichPaul EhrlichThe Population BombThe Population Bomb, , 19681968

• "a major food shortage in the United States in the 1970s. . .hundreds of millions of people are going to starve to death."

• By 1999 U.S. population would be only 23 million(actual 1999 U.S. population = 288 million)

• "a major food shortage in the United States in the 1970s. . .hundreds of millions of people are going to starve to death."

• By 1999 U.S. population would be only 23 million(actual 1999 U.S. population = 288 million)

Limits to GrowthLimits to Growth19741974Limits to GrowthLimits to Growth19741974

World will run out of• gold by 1981• mercury by 1985• tin by 1987• zinc by 1990• petroleum by 1992, and• copper, lead, and natural gas by 1993

World will run out of• gold by 1981• mercury by 1985• tin by 1987• zinc by 1990• petroleum by 1992, and• copper, lead, and natural gas by 1993

An economist’s refutation:An economist’s refutation:An economist’s refutation:An economist’s refutation:

• Julian Simon

• The Ultimate Resource (1983)

• Hoodwinking the Nation (1999)

• Doomsayers underestimate human ingenuity

• Julian Simon

• The Ultimate Resource (1983)

• Hoodwinking the Nation (1999)

• Doomsayers underestimate human ingenuity

Simon vs. EhrlichSimon vs. EhrlichSimon vs. EhrlichSimon vs. Ehrlich

• Made a bet in 1980 for $1000

• Simon bet price of 5 key metals would be LOWER in 1990 Signaling less scarcity

• Simon won. Ehrlich paid Simon offered to renew the bet,

Ehrlich refused

• Made a bet in 1980 for $1000

• Simon bet price of 5 key metals would be LOWER in 1990 Signaling less scarcity

• Simon won. Ehrlich paid Simon offered to renew the bet,

Ehrlich refused

Real concerns about resources Real concerns about resources today:today:Real concerns about resources Real concerns about resources today:today:

• Has natural gas production peaked

• Will oil production soon peak?• Has natural gas production peaked

• Will oil production soon peak?

Hubbert’s curve

• Are we running out of copper?

• Are we past the tipping point on global warming?

BUT….

• Doomsayers need to take some responsibility for lack of world action

• Are we running out of copper?

• Are we past the tipping point on global warming?

BUT….

• Doomsayers need to take some responsibility for lack of world action