The Supply of and Demand for Productive Resources

Productive assets are bought and sold in resource markets, which determine what is produced, how it's produced, and the income distribution.

Product markets involve households demanding goods and services supplied by firms.
Resource markets involve firms demanding factors of production supplied by households in exchange for income.
In resource markets, firms are buyers, and households are sellers, the reverse of product markets.

Two classes of productive resources:
- Non-human resources:
- Physical capital
- Land
- Natural resources
- Human resources:
- Skills, knowledge, and experience of workers
Investment in human capital increases the human capital and productivity of individuals through education, training, and experience.
Human resources differ from non-human resources:
- Human capital is embodied in the individual.
- Human resources can’t be bought or sold, only their labor services.

The demand for resources is derived from the demand for the products they help produce.
- Example: A repair shop hires mechanics because customers demand maintenance and repair services.
The quantity demanded of a resource is negatively related to its price due to:
- Substitution in production:
- If a resource becomes more expensive, producers shift to lower-cost substitutes. The better the substitutes, the more elastic the demand for the resource.
- Substitution in consumption:
- A higher resource price raises the product price, leading consumers to substitute toward other goods. The more elastic the product’s demand, the more elastic the demand for the resource.
As a resource price increases, producers that use the resource intensely will:
- Use substitute resources and/or face higher costs, leading to higher prices and a reduction in output.
At a lower output rate, firms use less of the resource that increased in price.
Both factors contribute to the inverse relationship between price and quantity demanded.

In the long run, firms are better able to switch to substitute inputs.
In the long run, product demand is more elastic; hence, the demand for resources is also more elastic.
Thus, resource demand is almost always more elastic in the long run than in the short run.

A change in product demand causes the demand for resources to change in the same direction.
A change in resource productivity alters resource demand (higher productivity increases demand).
A change in the price of related inputs alters demand for a resource:
- Increase in substitute input price increases resource demand.
- Decrease in complementary input price increases resource demand.
- Decrease in substitute input price decreases resource demand.
- Increase in complementary input price decreases resource demand.

Profit-maximizing firms hire additional resource units until the marginal revenue product (MRP) equals its price.
Marginal revenue product (MRP): Change in total revenue from employing an additional resource unit.
- $MRP = Marginal\ revenue \times Marginal\ product$
- $Marginal \ product = \frac{change \ in \ output}{change \ in \ variable \ input}$
- $Marginal \ revenue = \frac{change \ in \ revenue}{change \ in \ output}$

A firm will use an additional input unit only if it adds more to revenues than to costs.
The MRP curve is the firm’s short-run demand curve for the resource.
In the short run, it slopes downward because the marginal product of the resource falls as more is used with a fixed amount of other resources.
The MRP curve’s location depends on:
- The product’s price
- The resource’s productivity
- The quantity of other factors working with the resource

With multiple inputs, firms expand their usage until the marginal product divided by price is equal across inputs.
- $\frac{MP \ of \ skilled \ labor}{Price \ of \ skilled \ labor} = \frac{MP \ of \ unskilled \ labor}{Price \ of \ unskilled \ labor} = \frac{MP \ of \ machine}{Price \ (rental \ value) \ of \ machine}$
Wage differentials reflect skill differentials.
If a high-skill worker is twice as productive as a low-skill worker, the high-skill worker will have twice the wage rate.

The amount of a resource supplied in the market is positively related to its price.
The short-run supply elasticity of a resource is determined by resource mobility (how easily it can be transferred).
Highly mobile resources have elastic supply curves, even in the short run.
Resource supply is more elastic in the long run due to investment in physical and human resources.

The long-run supply of a resource is almost always more elastic than the short-run supply.
Example: Certified Public Accountant (CPA) services
- An increase in CPA wages from P1 to P2 results in a short-run increase in CPA services from Q1 to Q2.
- In time, the supply of CPAs becomes more elastic (Ssr to Slr) as more individuals train to become CPAs.

Resource prices are determined by supply and demand.
Changes in market resource prices influence decisions of users and suppliers.
Higher resource prices incentivize users to turn to substitute inputs and suppliers to provide more of the resource.

The market demand for a resource, such as engineering services, is a downward-sloping curve, reflecting the declining MRP of the resource.
The market supply of a resource slopes upward as higher resource prices (wages) induce individuals to supply more.
The equilibrium price P1 brings the choices of buyers and sellers into harmony, where the quantity demanded equals the quantity supplied.

An increase in demand for housing leads to increased demand for electricians.
In the product market, equilibrium price and output of houses both rise.
In the resource market, the equilibrium price and output of electrician services also increase.
The significant price increase and modest output increase reflect the highly inelastic short-run supply of skilled electricians.
The higher resource price attracts new human capital investments, and over time, the resource’s supply curve becomes more elastic, moderating the resource price and increasing the quantity supplied.

Changes in resource prices are essential for efficient resource allocation.
Profit is a reward for entrepreneurs who can identify and capitalize on opportunities to put resources to higher-valued uses.