When economists introduce the concept of markets and supply and demand, these terms usually describe markets for goods and services. Resource markets, on the other hand, are markets for the inputs to production rather than the outputs of production, but they share many of the same features. For example, resource markets have a supply side and a demand side, but individuals are the suppliers and firms are the demanders. This contrasts with goods markets, where firms are the suppliers and consumers are the demanders. In labor markets, firms decide how much labor to hire by comparing what is known as the marginal revenue product of labor to the wage. Individuals decide how much labor to supply by comparing the going wage to their preferences for leisure. This labor and demand come together to determine an equilibrium wage and level of employment in a labor market. There are identifiable factors that shift the supply and demand of labor and, as a result, the equilibrium wage and employment. Resource markets also exist for financial capital, known as a market for loanable funds. This type of market determines an equilibrium interest rate, or a return on savings. This interest rate in turn helps determine which of a firm's potential projects are worth undertaking from a financial perspective using what is known as the present value formula.
At A Glance
Resource markets are markets for the inputs to production, and they function largely the same as markets for goods and services but with the roles of individuals and firms reversed. Individuals, in this case, are the suppliers and firms are the demanders.
- The marginal revenue product of labor is the incremental revenue generated by one additional unit of labor. The marginal revenue product of labor generally has the same characteristics as the marginal product of labor.
- The demand for labor is the amount of labor that firms want to hire at each wage.
- The supply of labor is the amount that individuals want to work at each wage. The supply of labor is determined by the trade-off between labor and leisure (i.e., not working).
- As in other competitive markets, equilibrium in the perfectly competitive labor market is at the intersection of supply and demand.
- Factors such as changes in output prices, changes in technology, and changes in the supply of other inputs to production cause labor demand curves to shift, resulting in changes in the equilibrium wage and number of workers employed.
- Factors such as changes in tastes for leisure, changes in alternative labor opportunities, and immigration cause labor supply curves to shift, resulting in changes in the equilibrium wage and number of workers employed.
- The market for loanable funds brings together individual savers and firms trying to borrow in order to purchase capital. The market for loanable funds can be thought of as a market for financial capital, which in turn funds the physical capital used in production.
- The interest rate can be thought of as either the return on savings, the cost of borrowing, or the price of money borrowed. The market for loanable funds determines the equilibrium interest rate in an economy.
- The present value formula gives the value today of a series of future payments and costs. When interest rates increase, present values decrease, and vice versa.