Chapter 10: Pricing in Resource Chapter 10: Pricing in Resource MarketsMarketsChapter 10: Pricing in Resource Chapter 10: 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