Lecture Notes for Economics 435: Economics of Resources
Prepared by Gunnar Knapp, Professor of Economics
January 7, 2000
RESOURCE SUPPLY AND DEMAND
Supply and demand analysis is a fundamental tool of resource economics. You should already
understand supply and demand analysis from earlier courses in economics. These lecture notes
review some of the most important principles of supply and demand analysis, and some of the
insights that supply and demand analysis can provide about resources.
The Supply Curve
The supply curve shows, for a given period of a time and for a given group of potential
suppliers, how much of a resource will be offered for sale at any given price. Usually, supply
curves are depicted as upward sloping, implying that as the price rises, suppliers would be
willing to offer more of the resource for sale.
The quantity of a resource offered for sale depends upon many different factors, of which price is
only one. The supply curve represents the relationship between the price of the resource and the
quantity of the resource offered for sale, if all other factors are held constant. The effects of
other changes in other factors upon the quantity offered for sale is measured by a shift in the
supply curve.
Price
B
P2
P1
A
Q1
B*
The dashed line shows
the effect of an
"increase in supply":
for any given price,
suppliers are willing to
supply more.
A*
Q1*
Q2
Q2*
Quantity which suppliers
offer to sell
For example, suppose we are interested in the market for catfish. And suppose the catfish market
is very simple. Suppose farmers raise catfish in ponds and take them to the city to sell directly to
consumers.
Why does the supply curve slope upwards? If the price is low, only a few farmers will think it
worth their while to raise catfish--only those farmers who are really skilled at raising catfish, and
who have ponds just suited for growing catfish, and who have time for growing catfish, and so
forth. But if the price is high, many more farmers will be willing to raise catfish. In the graph,
point A on the supply curve shows that if the price is P1, catfish farmers would supply quantity
Q1. Point B shows that if the price is P2, suppliers would supply quantity Q2.
Economics of Resources Lecture Notes: Supply and Demand, page 1
The quantity of a resource offered for sale depends upon many different factors, of which price is
only one. The supply curve represents the relationship between the price of the resource and the
quantity of the resource offered for sale, if all other factors are held constant. The effects of
other changes in other factors upon the quantity offered for sale is measured by a shift in the
supply curve.
If the cost of catfish feed gets cheaper, then for any given price, catfish farming is relatively more
profitable. So the effect of a cheaper price of catfish feed would be to shift the whole supply
curve to the right.
The dashed line shows the effect of this "increase in supply." At price P1, the catfish farmers
would now be willing to supply quantity Q1*, and at price P2, they would be willing to supply
quantity Q2*.
Other factors might cause the supply curve to shift inwards--to the left. For example, if the price
of catfish feed got higher, the supply curve would shift to the left: at any given price, fewer
farmers would be interested in supplying catfish. Of if there were a drought that dried up catfish
farms, then at any given price, fewer farmers would find it profitable to grow catfish.
The Demand Curve
The demand curve shows, for a given period of a time and for a given group of potential
purchasers, how much of a good or service buyers will offer to purchase at any given price.
Usually, demand curves are depicted as downward sloping, implying that as the price rises,
buyers would be willing to purchase less of the resource.
Price
The dashed line shows the
effect of an "increase in
demand": at any
given price, buyers
wish to purchase more.
Quantity which buyers are
willing to purchase
Why does the demand curve slope downwards? If the price is high, only those few people who
really love catfish will buy it. But as the price becomes cheaper, more and more people who
wouldn't ordinarily eat catfish will want to buy it, as it becomes a better deal relative to other
alternative kinds of fish--or protein.
The quantity of a good buyers wish to purchase depends upon many different factors, of which
price is only one. The demand curve represents the relationship between the price of the
resource and the quantity of the resource buyers wish to purchase, if all other factors are held
constant. The effects of other changes in other factors upon the quantity buyers wish to
purchase is measured by a shift in the demand curve--as depicted by the dashed line in the graph.
Economics of Resources Lecture Notes: Supply and Demand, page 2
If chicken gets more expensive, then for any given price of catfish, consumers might want to buy
more catfish (because that price now represents a relatively better deal, compared with chicken,
than it used to be). So the effect of a chicken being more expensive would be to shift the whole
demand curve for catfish to the right.
Another example of a factor which might shift the whole demand curve to the right would be a
report by the FDA that catfish makes you live longer, or makes you a better lover. At any given
price, more people would want to buy catfish--and the whole supply curve would shift to the
right.
Equilibrium Price and Quantity
The intersection of the supply and demand curves--where they cross--shows the
prices and quantities at which the quantity which suppliers wish to sell and the
quantity which buyers wish to purchase are equal. This is the equilibrium price
and the equilibrium quantity. If the price were lower, buyers would wish to
purchase more than suppliers would be willing to sell. If the price were higher,
buyers would wish to purchase less than suppliers would be willing to sell. If the
market is competitive, and if all other factors remain the same, the price and
quantity will be at or close to these equilibrium levels. If for some reason they
are not, then they will move towards these equilibrium levels.
The above paragraph is the essence of supply and demand analysis. It is simple to say, and it is
simple to show on a graph where the supply and demand curves cross, but it is not simple to
understand. Although many people talk glibly about supply and demand, in fact it is quite a
subtle concept. So don't be worried if at first it seems confusing. But it's important to study and
understand.
Price
P*
P
D*
D
Q
Q*
Quantity
Other Examples of Equilibrium
Equilibrium means the point at which things come to a rest if nothing changes. Equilibrium is an
important concept--and not an entirely easy one to understand--not only in economics but in
many other areas, such as physics, chemistry, and ecology.
Economics of Resources Lecture Notes: Supply and Demand, page 3
For example, we may think of an equilibrium moose population as the level at which the moose
population will stabilize if nothing changes--if the amount of habitat stays the same and the
hunting regulations stay the same. But if any of these “exogenous” factors change, then the
moose population may change to a new equilibrium.
The graph below, which is analogous to a supply and demand graph, might be used to show the
determination of equilibrium populations of “predators” and “prey”--for example wolves and
caribou. The upward sloping "predator population curve" shows the predator population that can
be supported at any given prey population. The more prey there are, the more predators that can
survive. The downward sloping "prey population curve" shows the prey population that can
survive at any given predator population. The more predators there are, there fewer prey that can
survive. Equilibrium is the point at which the prey and predator populations are in balance. If it
is a "stable equilibrium," then the prey and predator populations will move toward these levels,
and once they get there, they will stay at these levels until something happens to change one of
the curves.
The dark dots show how the
actual prey & predator
populations might change
over time to move from
point A towards equilibrium.
Prey
Predator population
curve: the more prey
there are, the more
predators can survive
B
A
Equilibrium: Prey and
predators are in balance.
C
Prey population curve:
the more predators
there are, the fewer
prey will survive
Predator
For example, suppose the populations are at point A. At this prey population, far more predators
could survive than the are presently shown. So the predator population will rise. With the low
predator population, more prey could also survive. So the prey population will also rise--at first,
until it reaches the prey population curve. Then as the predator population continues to rise, the
prey population will gradually decline till it reaches the equilibrium level.
Shifts in the Supply Curve, Shifts in the Demand Curve,
and Changes in Equilibrium Quantity
It is very important to be able to distinguish between a "change in supply" and a change in
equilibrium quantity purchased. Similarly, it is very important to be able to distinguish between
a "change in demand" and a change in equilibrium quantity purchased. A "change in demand"
refers to a shift in the demand curve: a change in the quantity which would be demanded at any
given price. This is illustrated in the above diagram (and in the left-hand diagram below) by the
shift in the demand curve outward from D to D*.
This shift in the demand curve leads to a change in the "quantity purchased," or "equilibrium
quantity supplied and demanded," from Q to Q*. Note that there has been no change in the
Economics of Resources Lecture Notes: Supply and Demand, page 4
supply curve. The quantity which suppliers are willing to supply at price P* is the same as it was
before. The only difference is that buyers are now willing to purchase more at price P*, resulting
in Q* being the equilibrium quantity purchased.
P
Demand curve shifts out. The
shift in demand leads to aP change
in the quantity demanded.
Q Q*
Q
Supply curve shifts out.
There is a change in
quantity demanded, but
no shift in demand.
Q Q*
Q
In contrast, in the right-hand diagram, the supply curve has shifted out, leading to a lower
equilibrium price and a higher quantity demanded. There has been a shift along the demand
curve, but there has been no shift in demand.
Causes of Changes in the Supply or Demand Curves
Many different factors can cause changes in the supply or demand curves. For example, changes
in consumers tastes can shift the demand curve. If scientists discover that apples help you live
longer, this will tend to shift the demand curve for apples out. If scientists discover that apples
cause cancer, this will tend to shift the demand curve in. If scientists discover a cheap new
fertilizer that makes apples grow faster or bigger or tastier, this will shift the supply curve out. If
the climate changes and gets colder, this will shift the supply curve for apples in. All of these
factors which cause shifts in the supply or demand curves, with resulting effects on the price and
quantify demanded, are known as exogenous or external factors influencing the supply and
demand curves.
To figure out how different factors affect the supply or demand curves, always go back to the
simple question: how would this affect how much consumers want to buy at a given price, and
how would this affect how much producers want to supply at a given price?
Elasticity of Supply or Demand
Elasticity of supply or demand refers to the percent change in quantity supplied or demanded in
response to a 1 percent change in price. A simple way to think of elasticity is price-sensitivity.
Supply or demand is said to be elastic if a small change in price results in a large change in
quantity supplied or demanded (technically, if elasticity is greater than one). Supply or demand
is said to be inelastic if a large change in price results in only a small change in quantity supplied
or demanded (technically, if elasticity is less than one). Here are some examples:
Elastic demand: An example of elastic demand would be demand for Idaho potatoes. If the
price goes up we are likely to look around for potatoes from other potato-growing areas, or other
Economics of Resources Lecture Notes: Supply and Demand, page 5
food products. Demand is typically elastic for goods or services for which substitutes are readily
available or which are considered non-essential. An elastic demand curve is relatively flat. A
perfectly elastic demand curve is flat: demand would be zero at any higher price, and unlimited
at any lower price.
Inelastic demand: Examples of inelastic demand would be the demand for emergency medical
services (we don’t call the ambulance less if the price goes up) or demand for gasoline by
commuters who have no alternative way of getting to work. Demand is typically inelastic for
goods or services for which substitutes are not readily available or which are considered
essential. An inelastic demand curve slopes down steeply. A perfectly inelastic demand curve is
vertical: demand is the same at any price.
P
P
Elastic demand: A
small change in price
causes a large
change in the
quantity demanded.
Inelastic demand: A
large change in price
causes only a small
change in the
quantity demanded.
Q
Q
Inelastic supply: Examples of inelastic supply would be the supply of Alaska salmon or the
supply of super bowl tickets. Supply is typically inelastic for goods for which it is difficult to
increase quantity supplied. An inelastic supply curve slopes up steeply. A perfectly inelastic
supply curve is vertical: supply is the same at any price.
Elastic supply: Examples of elastic supply would be the supply of sport fishing guides or the
supply of hot-dogs at a football game. Supply is typically elastic for goods for which it is
relatively easy to increase quantity supplied. An elastic supply curve is relatively flat. A
perfectly elastic supply curve is flat: for a given price, an unlimited quantity can be supplied.
P
P
Inelastic supply: A
large change in price
causes only a small
change in the
quantity supplied.
Elastic supply: A
small change in price
causes a large
change in the
quantity supplied.
Q
Economics of Resources Lecture Notes: Supply and Demand, page 6
Q
As shown in the examples below, different combinations of elastic or inelastic supply and
demand can result in significantly different effects of shifts in supply or demand on price and
quantity.
P
Inelastic demand, elastic
supply: an increase in
demand has a large effect
on quantity supplied but
little effect on price.
P
Elastic demand,
inelastic supply: an
increase in demand
has a small effect on
quantity supplied but
a large effect on
price.
Q
P
Q
Inelastic demand,
P
elastic supply: an
increase in supply
has a large effect on
price but little effect
on quantity supplied.
Elastic demand,
inelastic supply: an
increase in supply
has a large effect on
quantity supplied but
little effect on price.
Q
Q
Long-Run vs. Short-Run Demand and Supply
Recall that we said above that the supply and demand curves are defined as of a given period of
time: they show how much, in response to a given price, suppliers would want to supply or
buyers would demand as of a given period of time. We may distinguish between a short-run and
a long-run demand curve, and a short-run and a long-run supply curve. In general, both demand
and supply are more elastic (price responsive) in the long run than in the short run.
Consider, for example, the demand and supply for gasoline. How would buyers and suppliers
respond to a large increase in the price of gas? In the short-run (say, a month or a year) demand
for gas is relatively inelastic. Even if gas were much more expensive (say, $3/gallon), American
drivers would probably not cut back very much on their consumption of gasoline in the short run,
because they don't have many alternatives for gasoline as a way of fueling their transportation.
They've already made significant investments in their cars, and cars are the only practical way
most Americans have to where they work, shop and play. But in the long run (say, 10 years), if
the price of gas went up to $3/gallon it might bring about significant changes in the American
lifestyle. Many more people might begin to carpool, or use public transportation, or ride
bicycles, or live closer to where they work--all of which combined would significantly tend to
reduce their demand for gasoline.
Economics of Resources Lecture Notes: Supply and Demand, page 7
P
P*
Demand is more elastic
in the long run than the
short run. P* is the
current price.
Long-run
demand curve
Short-run
demand curve
Q
Similarly, if the price of gasoline went up to $3/gallon, there might not be that large an increase
in the world supply of gasoline, which is limited by world production of crude oil. But over a
longer period of time, many more oil fields would probably be developed that are uneconomic at
today's prices, leading to a much greater supply.
P
P*
Supply is more elastic
in the long run than the
short run. P* is the
current price.
Long-run
supply curve
Short-run
supply curve
Q
Because demand and supply curves may be very different in the short-run and the long-run, it is
possible for the effects of changes in demand and supply due to external factors (changes in
taxes, changes in tastes, changes in resource conditions, etc.) to be very different in the short and
long run.
Consumer Surplus, Producer Surplus, and Economic Rent
For a given combination of demand and supply, resulting in a particular equilibrium price and
quantity, some consumers will be able to purchase the good for a cheaper price than they would
have been willing to pay. In the graph below, the consumer of the first apple would have been
willing to pay $6.00 for an apple, but she ended up having to only pay the equilibrium price of
$3.50. Economists say that she received a benefit, or consumer surplus, of $2.50, equal to the
difference between what she would have been willing to pay and what she actually had to pay. If
we add this benefit up for all consumers, it is equal to the area under the demand curve extending
down to the equilibrium price level.
Similarly, the supplier (producer) of the first apple would have been willing to supply it for a
price of only $1.50, but he ended up receiving the equilibrium price of $3.50. Economists say
that he received a benefit, or consumer surplus, of $2.00, equal to the difference between the
Economics of Resources Lecture Notes: Supply and Demand, page 8
price he actually received and what he would have been willing to supply the apple for. If we
add this benefit up for all suppliers, it is equal to the area above the supply curve extending up to
the equilibrium price level.
Economists consider the total of consumer surplus and producer surplus to be a measure of the
net benefit or total surplus derived by society from the good.1 The general idea is that the
greater the difference between what consumers are willing to pay for a product and what
producers are willing to supply the product for, the more benefit is being generated for society
from the fact that the product is being supplied and consumed.
P
Demand and Supply for Apples
Consumer surplus
6
S
4
P*
2
D
Producer surplus
1
2
Q* 3
4
Q
Economic Rent is producer surplus generated by a resource. Put differently, it is the price of the
resource minus the cost of extracting or using the resource. Economic rent is a very important
concept in resource economics. Another way of defining economic rent is:
Economic rent provided by a resource is the total value of the resource minus the
cost of extracting or using the resource.
Economic rent is sometimes also referred to as economic profit, resource rent, scarcity rent, or
just rent. It can be thought of as profit which the resource provides to society--value received
over and above the cost to society of production.
Economists originally used the term "rent" for this concept because it was first applied to land.
In a competitive market for land, economic rent represents the actual rent that the landowner
would receive for the land.
The concept of economic rent is easiest to understand for a resource which is costless to extract
or use, but which is in fixed supply--for which land is a good example. This means that the
supply curve is flat at first, running along the horizontal axis, up to the point of fixed supply,
after which it is vertical. In other words, it is possible to supply the resource for free up to the
available supply, but after that it’s impossible to supply any more no matter how high the price.
1The
actual calculation of consumer surplus and producer surplus raises a variety of theoretical and technical issues,
which are the subject of debate among economists, such as whether and how we should compensate for the "income
effects" associated with the difference between what consumers actually pay at equilibrium and what they would
hypothetically pay if the price were different.
Economics of Resources Lecture Notes: Supply and Demand, page 9
With this kind of resource, the price is zero as long as the demand is low enough (see the left
hand graph below). But after demand reaches a certain level, increases in demand have no effect
on quantity supplied--since the resource is fully utilized--but only serve to drive up the price (as
illustrated in the right-hand graph below). All of the value generated by the resource in this
example is pure economic rent.
P
S
P
S
P*
D
D
Q
Q
Economic rent = 0
because price is zero
Economic rent
Note that a resource generates economic rent only if it is scarce. In the left-hand graph above,
the resource is “abundant”--there is more than enough for everyone at a zero price. Scarcity
occurs when the marginal cost to society of resource use is not zero, or at the point when demand
exceeds the available supply at a price of zero, as illustrated in the right-hand graph. Note that
scarcity is an economic rather than a physical condition.
One reason why economic rent is so important is that in theory, economic rent can be taxed
with no effect on price or supply. In the example below (the same as the right-hand example
above), if the government taxes producers $1.50 per unit of the resource sold, this will have no
effect on the sales volume or the price. The price will still be $2, and consumers will notice no
difference, although the economic rent will now be shared between the government and the
resource owners.
P
S
3
P* 2
1
Owner's Profit
Tax Revenue
D
Q
Monopoly, Oligopoly, Cartels, Monopsony, and Oligopsony
If there is only a single supplier for a good the situation is known as a monopoly, and the supplier
is known as a monopolist. Through monopoly power, the monopolist can force the price of the
resource higher than it would be if the market were competitive, with many suppliers. The
Economics of Resources Lecture Notes: Supply and Demand, page 10
monopolist does this by constraining supply to a lower level than would have been supplied in a
competitive equilibrium.
P
Effect of reduction in supply by
a monopolist
Consumer surplus
Loss in net
benefits
(deadweight
loss)
S
P*
D
Producer surplus
Q*
Q
As illustrated in the graph above, by reducing supply the monopolist is able to gain a higher
price. His total revenues increase because he is able to increase the price by more than enough to
make up for the lower quantity that he is selling. As a result, his producer surplus increases.
However, total surplus or net benefits for society declines. This is known as "deadweight loss."
Note that monopolists have more to gain from artificially constraining supply, the more inelastic
the demand for the resource (the less price-flexible consumers are).
An oligopoly is similar to a monopoly except that there are more than one supplier. Another
word for an oligopoly is a cartel. There are many cartels which try to raise resource prices--and
producers’ profits--by restricting supply below that which would be supplied in a competitive
market. The most famous of these is OPEC, the Organization of Petroleum Exporting Countries.
Oligopolies or cartels commonly face the problem that there are strong incentives for individual
members of the cartel to “cheat” by supplying more, thus gaining the full benefit of the higher
prices which the other members have brought about by cutting back on production. If too many
members of the cartel cheat, then the cartel tends to fall apart because supply is not sufficiently
restricted.
Oligopolies or cartels are illegal in the United States and many other countries under anti-trust
laws, except in certain industries which are publicly regulated, such as transportation and
utilities.
A monopsony is a situation in which there is only one buyer, and an oligopsony is a situation in
which there is only one seller. In this situation, the monopsonist or oligopsonists may be able to
influence the market price downwards by holding off from buying in an effort to drive the price
down.
Factors Affecting Resource Supply
Many factors can affect resource supply. Some of the most important are listed below.
Economics of Resources Lecture Notes: Supply and Demand, page 11
Volume of resources in place. The more resources in place--the more coal reserves, or
underground oil fields, or forests, or streams which can be tapped for hydroelectric power--the
more which can be extracted or developed and offered for sale at any given price. For nonrenewable resources, as the volume in place declines, all else being equal we would expect the
supply curve to shift to the left.
Extraction costs. As the cost of extracting the resource (mining coal, cutting timber, catching
fish, etc.) rises, then the cost of producing a given quantity of the resource rises. A rise in
extraction costs causes the supply curve to shift to the left, indicating that for any given price,
less of the resource will be offered for sale.
One reason for which extraction costs may rise is a decline in the volume of the resources in
place. If all the cheap resources--the coal near the surface, the forests near the roads--have
already been extracted, the extraction costs for the resources will tend to rise. In contrast,
technological change may lower the extraction costs associated with any given volume of
resources in place.
Over time, technological change tends to shift the supply curve for non-renewable resources to
the right--we find cheaper ways of extracting resources--while declining resources in place tends
to shift the supply curve for non-renewable resources to the left. For this reasons, it is not
obvious whether the supply curve for non-renewable resources will shift to the right or to the left
over time.
Expected future prices. Remember that the supply curve for a resource represents the quantity
offered for sale within a given period of time. If the resource can be stored and sold at a later
period of time then the supplier has the option of holding it off the market and selling it for a
higher price later.
In general, for resources which can be stored for sale at a later date, if the expected future price
rises, more will be offered for sale in the future--causing the supply curve for the present period
to shift to the left. For the same reasons, if the interest rate falls, or if storage costs fall, the
option of selling in the future also becomes more attractive, causing the supply curve for the
present period to shift to the left.
Monopolistic or oligopolistic power. If supply is controlled by one firm (a monopoly) or just a
few firms (an oligopoly), they may offer less of the resource for sale at any given price than they
would if there were many competing firms. They would do this if they perceive that they could
maximize profits by restraining supply.
Factors Affecting Resource Demand
Many factors can affect resource demand. Some of the most important are listed below.
Prices of alternative resources. If other resources can be substituted for a resource (coal for oil,
bricks for wood, tuna for salmon, etc.) then the price that buyers are willing to pay for the
resource will also depend--crucially--on the prices of alternative resources. An increase in the
price of an alternative resource will cause the demand curve to shift to the right, because for any
Economics of Resources Lecture Notes: Supply and Demand, page 12
given price, buyers will wish to purchase more of the resource, which has become a relatively
better deal. For example, if the price of natural gas falls, this shifts the demand curve for oil to
the left (which tends to cause the price of oil to fall).
The extent to which alternative resources are substitutes for each other affects the extent to which
the prices of one may affect demand for the other. If products are very close substitutes (for
example, Alaska oil and Texas oil) then the demand curves will be very closely linked. If
products are not close substitutes (wood and steel) then demand may be linked to a lesser extent.
Demand for final products. Many--indeed most--resources are not consumed in the form in
which they are extracted. Instead, they are used as raw materials or inputs in the production of
other products. It is the demand for these end products which ultimately drives resource demand.
For example, timber is used as a raw material in the production of lumber, which is used in part
as a raw material in the production of furniture and other wood products. The demand for timber
is derived from the demand for lumber and other wood products. All else equal, If the demand
for the end products declines, the demand for the resource in turn declines.
Conceptually, we may think of supply and demand curves not only for the resource, but also for
each intermediate or final product made from the resource. These demand and supply curves are
closely linked. In using supply and demand analysis, it is important to carefully identify at what
level you are discussing supply and demand.
For example, we may talk about supply and demand for crude oil, or supply and demand for
aviation fuel, or supply and demand for air transportation. Demand for all three are closely
linked. An increase in demand for air transportation (for example due to higher consumer
incomes) will tend to increase the demand for aviation fuel which in turn tends to increase the
demand for crude oil. Similarly, an increase in supply for crude oil (for example, due to the
discovery of a huge new oil field) may increase the supply of aviation fuel which may increase
the supply of air transportation (remember, this means increase the amount of air transportation
which airlines are willing to offer at any given price.)
Conceptually, it is easy to think of linked demand or supply for these different product levels.
Empirically (numerically) it can be extremely difficult to measure these curves, or how different
factors affect them--because there are so many different factors which affect demand or supply.
Resource use technology. Even if final (consumer) demand remains unchanged, demand for
resources may shift if the technology of resource use changes. For example, if a cheaper way of
making plywood is developed, this may increase the demand for lumber, because plywood mills
expect to be able to make more money from selling plywood, for any given amount of timber
used.
Consumer incomes and the distribution of income. How much income consumers have, and
which consumers have income, has a major effect on demand for resources. For example, we
might expect demand for food to be greater in a country where income is evenly distributed than
in a country where a small rich population has most of the wealth. However, demand for
expensive diamonds might be smaller in a country where income is evenly distributed.
Economics of Resources Lecture Notes: Supply and Demand, page 13
Consumer tastes. If consumers tastes for end products changes, then derived demand for the
resources used to make the products change. When corsets went out of style, demand for whale
baleen used to manufacture corsets declined.
Expected future prices. If people expect that the price of a resource will increase, then they
may wish to buy resources now in anticipation of being able to sell the resources later at a higher
price, or alternatively because it is cheaper for them to acquire resources now and store them for
future use, rather than to purchase them in the future. For example, if I anticipate that prices will
be higher for gasoline after the government imposes a tax next month, I may try to buy and store
a lot of gasoline now. Thus anticipated higher taxes of gasoline in the future may increase the
current demand for gasoline (and the derived demand for crude oil).
Volatility of Resource Prices
The prices of many resources are highly volatile. It is not uncommon for prices of resources such
as oil, timber, minerals, or fish to double in a single year, or for prices to fall by more than half.
The prices of end products made from these resources, such as gasoline, furniture, metal
products, or restaurant meals, are nowhere near as volatile. We would be shocked if the price of
furniture or restaurant meals doubled in a single year.
Why are resource prices so much more volatile than the prices of end products made from these
resources? It is because resources prices are derived from the prices of end products. Because
resource prices are lower, the same absolute change in the prices of end products and resource
prices will be relatively much more dramatic for the resource prices.
The prices of the end products reflect far more than the prices of the resources. They reflect, for
example, the costs of transportation of the resources to the place of manufacture, manufacturing
costs in producing the end product (including the costs of other raw materials), distribution costs,
and retail sales costs (which are often quite significant). In simple terms, the derived demand for
the resource--expressed as the price which buyers are willing to pay for any given amount of the
resource--may be thought of as the demand for the end product minus all these other costs of
manufacture and distribution. Thus, in simple terms, if the price which end users are willing to
pay for a given quantity of the end product declines by $1, then the price which the purchasers of
the resource are willing to pay for a given quantity of the resource will also decline by $1. (For
most resources, this relationship is not exact, but for many resources it is approximately valid).
While the absolute decline in prices may be $1 for both the end product and the resource, the
relative decline in prices represented by a $1 drop is much higher for the resource.
The volatility of resource prices tends to be aggravated by the fact that for many resources, either
short-run supply or short-run demand is inelastic. As a result, small changes in demand or supply
can lead to large changes in price.
The volatility of resource prices can be aggravated by speculation. As long as everyone thinks
that resource prices are going to go up, this tends to become a self-fulfilling prophesy because
Economics of Resources Lecture Notes: Supply and Demand, page 14
people buy the resource either because they expect to make money selling it later or because they
need to use it in the future and they figure it’s cheaper to buy now and store it rather than to have
to buy at a higher price in the future. As everyone tries to buy, the demand curve shifts outward,
driving the price higher. The same thing happens in reverse when the price is falling.
Economics of Resources Lecture Notes: Supply and Demand, page 15
Some Key Insights
Simple supply and demand analysis may be used to derive or illustrate some of the most
important themes in resource economics, relating to the value of resources. We will introduce
these themes here in reference to resource prices, and we will return to them later when we
discuss resource value . (As we will discuss later, value and price are often, but not necessarily
always, the same).
Resource prices vary. They vary depending upon time and place and circumstances, reflecting
differences in the supply and demand for the resource. In the past, before gasoline engines, there
was no demand for gasoline. In the future, when solar power makes energy nearly free, there
may once again be no demand for gasoline. When large oak trees were abundant, on the frontier,
large oak beams were cheap. Now that large oak trees are no longer abundant, large oak beams
are no longer cheap.
Resource prices reflect marginal costs of production and marginal benefits from
consumption. Marginal refers to the last or final unit. At any quantity, the demand curve
shows the price which buyers would pay for one more unit. At any quantity, the supply curve
shows the price at which suppliers are willing to supply one more unit.
Resource demand and supply curves are usually not horizontal. As suppliers produce more, the
marginal costs of production increase, which is what makes the supply curve upward sloping. As
consumers consumer more, the marginal benefits (marginal utility) of consumption declines,
which is what makes the demand curve downward sloping.
The end result is that the actual price usually ends up being very different from what it might
have been is supply were much lower, or demand were much greater.
Diamonds command a high price primarily because there are so few of them (and, partly, because
an international cartel tries to hold down supply). If diamonds were as plentiful as pebbles, they
would not command such a high price.
Food commands a high price only because it costs something to produce and there isn't as much
of it as we would like. If apples and watermelons grew in profusion in the wild, and there were
more than we could eat, they would not command a high price at the market. If salmon ran in
huge numbers in every stream across America, salmon would not command as high a price as
they do.
There is no inherent price which a resource will or should command. If market forces are
left to operate freely--if governments do not interfere and regulate prices--then prices may (and
many economists would add "should") fluctuate as demand and supply fluctuate. This means
that neither gold, nor diamonds, nor food, nor energy, nor wood, nor water, nor any other
resource will necessarily, in all circumstances, command any particular price in the market.
Production will only occur if the marginal benefit exceeds the marginal cost. Put differently,
resource production occurs as long as the price which buyers are willing to pay exceeds the price
at which suppliers are willing to supply. In a supply and demand perspective, it is easy to see
Economics of Resources Lecture Notes: Supply and Demand, page 16
why society does not seek to maximize resource production. Production ceases, instead, at the
point at which the demand curve crosses (falls below) the supply curve.
If extraction costs are zero, and there is more of the resource available than would be
demanded at a zero price, then the price of the resource will be zero. In supply and demand
terms, if the demand curve intersects the supply curve when it is horizontal along the X axis--if
as much can be supplied as is demanded at a zero price--then the price will be zero.
Economics of Resources Lecture Notes: Supply and Demand, page 17