Resource Supply and Demand

In the study of input markets we separate resources, or factors of production, into four categories: (a) labor, which includes all forms of human work efforts except entrepreneurship and which receives wages as payment; (b) entrepreneurship, which visualizes needs and takes the necessary actions to initiate the process by which they will be met and which receives profit as payment; (c) natural resources, which are "gifts of nature" and which receive rent as payment; and (d) capital, which is made up of goods and skills used to further production and which receives interest payments.

Resources are actually not as easy to separate as the four-part classification implies. Production usually calls for certain combinations of resources, or "resource packages. " Capital is embodied in most usable resources. 

The supply of resources focuses not on the amount of resources in existence but rather on the quantity that is offered at various prices. Normally there is a positive relationship between the price of a resource and the quantity of it that is supplied. The supply of a resource defined in terms of a specific use is generally more price elastic than is the supply for all uses of a resource. 

The supply for all uses of labor depends on (a) population size, (b) age distribution, (c) labor force participation rate, (d) hours worked, and (e) working age. All of these factors are, in turn, more or less influenced by laws and customs.

The supply for all uses of entrepreneurship is to some degree dependent on the same variables that influence the supply of labor. However, some countries encourage entrepreneurship more than others do. The quantity supplied of entrepreneurship is influenced by expected profit, which is related to a country's patent, taxation, and antitrust policies.

Except for those natural resources that are defined in terms of particular locations, the supply for all uses of natural resources varies just as supplies of the other resource categories do. Many natural resources will not renew themselves. Others will, if properly cared for. At low rents there is atendency for the quantity supplied to dwindle. At high rents natural resources are cared for, exploration is encouraged, and technology is put to work to find new supplies of natural resources. s 311-312.)

The supply of capital is divided between capital goods and human capital. Since capital goods are themselves outputs of firms, the quantity supplied is expected to be greater at a high price than at a lower price, other things being equal. The supply for all uses of human capital is more complicated because human capital cannot be divorced from labor. The supply of the labor-human capital package depends on all the variables that influence labor plus those that influence society, firms, or individuals to invest in education and training. Higher expected earnings (interest payments) are expected to increase the quantity of human capital supplied. 

Resources have many alternative uses. If owners of a resource find all uses for that resource equally attractive, all owners of that resource will receive the same price. But, in fact, owners of resources do not find all uses equally attractive.

The price elasticity of supply of a resource depends on its mobility and the time it takes to switch from one use to another. The less specialized a resource, the more mobile it is and the greater its price elasticity of supply will be. The more time that is allowed for a resource to switch from one use to another in response to a price change, the more elastic its supply will be.

Consumers demand mixes of products that allow them to use their limited incomes to maximize their satisfaction. In contrast, because firms are profit maximizers, they demand mixes of resources that let them produce their chosen outputs at the lowest possible cost. It follows, then, that the demand for resources is a derived demand-the demand for a resource is derived from the demand for the products that this resource helps to produce.

The price elasticity of demand for a resource is positively related to: (a) the proportion of the total cost of producing a product that is accounted for by that resource; (b) the price elasticity of demand for the product that it helps to produce; (c) the amount of competition in the product's industry; and (d) how easy it is to substitute it for other resources and to substitute other resources for it.

The quantity of a resource that a firm demands depends on the contribution made by that resource to the value of the firm's output and on the cost that the firm must pay for that resource. A firm will want to continue to buy additional units of a certain resource as long as they will add more to its revenue (marginal revenue product, MRP) than to its cost (marginal factor cost, MFC) . A firm is in equilibrium in its purchasing of a resource when its marginal revenue product is equal to its marginal factor cost.

The interaction between resource supply and demand is much the same as the interaction between product supply and demand. Equilibrium price and equilibrium quantity are found where a positively sloped supply curve intersects a negatively sloped demand curve. 

The earnings of a resource may be divided into two parts: transfer earnings and economic earnings. Transfer earnings are what a resource can earn in its next-best use, and economic earnings are the rest.

In the extreme case where a resource has only a single use, its earnings are entirely economic since its transfer earnings are zero. In such a case, the supply curve of the resource is vertical. In the opposite extreme case where a resource has more than a single use and it earns an amount just barely above what it can earn in its next-best use, its economic earnings are almost zero, and practically all of its earnings are transfer earnings. In such a case, the supply curve of the resource for that specific use is horizontal. A slightly lower price causes all of the resource to switch to its next-best use.

In the normal case, where a resource has more than a single use but where a slightly lower price will not cause all of it to switch to its next-best use, its earnings are a mix of transfer earnings and - economic earnings. In such a case, the supply  curve of the resource is positively sloped. At lower prices some, but not all, of the resource would switch to its next-best use.

Resource allocation does not change ac cording to the amount of economic earnings that - owners of resources receive. For that reason some people have found economic earnings to be an excellent target for taxation.