Chapter 25: Pricing in Resource
Markets
• Resource markets
• Resource demand
• The labor market
Factor/Resource markets
• Factors of production:
•
 land
 labor
 capital
 entrepreneurship
factor prices determined in resource
markets
resources markets
• same concepts of demand and
supply
 now applied to factors of
production
resource demand
• producer will demand an additional
unit of resource if
MR of
resource
>
MC of
resource
example: 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
example: 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
terms
• 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 demand
• firm hires additional resources until
 MRC = MRP
cost of the extra resource =
extra revenue from the resource
resource 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…..
The Market for Resources
• 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
examples
• 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 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
examples
• 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
example
• bank
 ATMs vs bank tellers
 ATM costs falls
-- demand for bank tellers falls
example
• 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
example
• price of trucks (18-wheeler) fall
 increase demand for truck drivers
note
• 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
example
• 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
P res.
S
P*
D
Q*
Q res.
resource 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
The Labor Market
• Labor supply
• Labor demand
• Earnings differences
Labor Supply
• time is a scarce resource
 market work (for pay)
 nonmarket work (not for pay)
(cleaning, studying)
 leisure (for fun)
work and utility
• 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
implications
• 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
Effect of a wage increase
• two effects:
 substitution effect
 income effect
substitution effect
• as wage rises
•
 opp. cost of other time uses rises
 spend more time on market work
Qs of labor rises as wages rise
income effect
• 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?
labor supply
• economists observe
•
 upward sloping for most wages
 downward sloping at very high
wages
backward-bending supply curve
S
wage
subst. < inc.
effect
subst. > inc.
effect
Q labor
Changes in market labor supply
• 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
• 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
Labor 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
example: car wash
•
•
price of car wash = $3
car washes per hour
Q labor
TP
0
1
0
5
2
3
4
5
9
12
14
15
MP
MRP
5
4
3
2
1
15
12
9
6
3
how 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
• 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
15
if wage = $9
hire 3 units labor
12
9
6
3
LD
1
2
3
4
5
Q labor
wage
15
wage = $12,
hire 2
12
9
wage = $6,
hire 4
6
3
LD
1
2
3
4
5
Q labor
Earnings differences
• based on both demand-side and
supply side factors
Human 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
ability/talent
• Human capital, but hard to measure
• the best athletes, most popular
movies stars, CEOs command HUGE
salary premium over others
Efficiency 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
Non-wage job characteristics
• Risk/danger
• Working conditions
• Work is meaningful or glamorous
Holding all else constant,
• dangerous jobs pay more
• jobs with higher layoff probability
pay more
geography
• wages higher in U.S.
•
•
 encourages immigration
teacher’s salaries vary significantly
by state
wages lower in South than Northeast
discrimination
• age, race, gender
• wage differentials remain EVEN after
controlling for other factors
 occupation
 education/experience
 risk
unionization
• union workers earn more than
nonunion workers doing the same
jobs
 janitors
 auto workers
 teachers
26. Markets for Capital and Natural
Resources
• Financial markets
• Natural Resource markets
Financial Markets
• Demand for financial capital
• Supply of financial capital
• interest rate
• financial capital = loanable funds
Demand for Financial capital
• firms demand funds to finance
•
capital purchases
higher interest rate, more expensive
to borrow
 lower Q demanded of funds
interest rate
D
Q funds
Shifts in 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
• Government borrowing
 Federal gov’t deficits shift demand
to the right
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
Shifts in supply of funds
• 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
Financial market equilbrium
interest rate
S
i*
D
Q*
Q funds
Natural Resource markets
• renewable resources
•
 land, forests, livestock
nonrenewable resources
 fossil fuels, metals
Market for land
• supply is fixed for type or location
 perfectly inelastic
rent
S
r*
D
Q*
Q land
economic 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
S
economic rent
r*
D
Q*
Q land
• Pure economic rent
 Income earned by resource with a
perfectly inelastic supply
Economic Rent
• amount of resource earnings ABOVE
opportunity cost
• or
resource earnings – minimum
required earnings
• “gravy”! “bonus”!
example: 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
when do resources earn rent?
• less elastic (more inelastic) the
supply,
 more rent as a % of total earnings
Differential rent
• Rents earned to superior units of a
•
resource
 Where quality of resource affects
productivity
Examples
 Highly fertile farmland
 Highly skilled trial lawyer
Inframarginal rent
• Total rent when units of resource
•
differ in their opportunity costs
What causes differences?
 Differences in objectives
 Differences in constraints
examples
• Nursing
•
 Find the work rewarding
 Other constraints in the job market
Teaching summer school
 Presence of small children
 Children in college
upward-sloping supply
earnings split
P res.
S
P*
rent
opp.
cost
D
Q*
Q res.
Supply 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
example: metals
• nonrenewable resource
• discover new sources
• use substitutes (plastic)
• Recycling technology
Market-guided conservation
• 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
Problems with markets &
nonrenewable 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
Doomsday scenarios
• Aka
• “We are running out of everything
and we are all going to die”
Paul Ehrlich
The Population Bomb,
1968
•
•
"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 Growth
1974
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:
• Julian Simon
• The Ultimate Resource (1983)
• Hoodwinking the Nation (1999)
• Doomsayers underestimate human
ingenuity
Simon 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
Real concerns about resources
today:
• 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