The Supply and Demand for Productive Resources

Factor markets, Where productive resources and services are bought and sold, help to determine what is produced, how it is produced, and how the distribution of income (output) is accomplished. There are two broad classes of productive resources-nonhuman capital and human capital. Both are durable in the sense that they will last into the future, thereby enhancing future productive capabilities. Both yield income to their owners. Investment can expand the future supply of both.

The demand for resources is derived from demand for products that the resources help to produce. The quantity of a resource demanded is inversely related to its price. There are two reasons why if the price of a resource increases, less of it will be used. First, producers will substitute other resources for the now more expensive input (substitution in production). Second, the higher resource price will lead to higher prices for products that the resource helps to make, inducing consumers to reduce their purchases of those goods (substitution in consumption). 

The short-run market demand curve will be more inelastic than the long-run curve. It will take time for producers to adjust their production process to use more of the less expensive resources and less of the more expensive resources.

The demand curve for a resource, like the demand of a product, may shift. The major factors that can increase the demand for a resource are (a) an increase in demand for products that use the resource, (b) an increase in the productivity of the resource, and (c) an increase in the price of substitute resources.

Profit-maximizing firms will hire additional units of a resource as long as the marginal revenue product of the resource exceeds its hiring cost, usually the price of the resource. If resources are perfectly divisible, firms will expand their usage of each resource until the marginal revenue product of each resource is just equal to its price.

When a firm is minimizing its costs, it will employ each factor of production up to the point at which the marginal product per last dollar spent on the factor is equal for all factors. This condition implies that the marginal product of labor divided by the price of labor must equal the marginal product of capital (machines) divided by the price of capital, and that this ratio (MP;/P;) must be the same for all other inputs used by the firm. When real-world decision-makers minimize per unit costs, the outcome will be as if they had followed these mathematical procedures, even though they may not consciously do so.

Resource owners will use their factors of production in the manner that they consider most personally advantageous. Many resources will be relatively immobile in the short-run. The less mobile a resource, the more inelastic its short-run supply. There will be a positive relationship between amount supplied and resource price even in the short-run.

In the long-run, investment and depreciation will alter resource supply.  Resource owners will shift factors of production toward areas in which resource prices have risen and away from areas in which resource prices have fallen. Thus, the long-run supply will be more elastic than the short-run supply.

The prices of resources will be determined by both supply and demand.  The demand for a resource will reflect the demand for products that it helps make. The supply of resources will reflect the human and physical capital investment decisions of individuals and firms.

Changing resource prices will influence the decisions of users and sup pliers alike. Higher resource prices give users a greater incentive to turn to substitutes and stimulate suppliers to provide more of the re source. Since these adjustments take time, when the demand for a resource expands, the price will usually rise more in the short-run than in the long-run. Similarly, when there is a fall in resource demand, price will decline more in the short-run than in the long-run.