Supply of Resources
The third task of
the firm is to obtain resources needed to produce a
product. For each resource, a supply curve shows limitations
that the firm faces. These supply curves are based on the
preferences of sellers and on the actions of other firms
that use the resource.
Because a market demand curve can be derived
from utility curves and a budget line, it may seem
surprising that a supply curve can also be derived from the
same procedure. To see that it can, consider the graph below
that shows indifference curves for income and leisure.
Income is desirable because one can obtain other desirable
things with it, and leisure is desirable because it lets one
enjoy income.
In the world we live in, greater amounts of income must
be purchased with more work--which means less leisure. The
tradeoff between leisure and income, shown by the budget
line, depends on the wage rate. If the wage rate is $10,
options open to an individual include 24 hours of leisure
and no income, or 20 hours of leisure and $40 of income, or
10 hours of leisure and $140 of income.
To get a supply curve for labor, one must see what
happens if the wage rate changes. Two wage rates are shown
in the graph above. At the higher wage rate, the individual
wants less leisure (which means he will work more as wages
rise), but one could as easily draw indifference curves that
show the amount of leisure rising as wages rise (which means
he will work less as wages rise). Higher wages have two
effects on the leisure-work decision, and these two effects
pull in opposite directions. A higher wage rate increases
the benefits of working, causing people to substitute work
for leisure. This is called the substitution effect
and is caused by changes in the slope of the budget line.
Higher wages also increase income, and people want more
leisure with a higher income. This is called the income
effect of a price change and is caused by changes in the
distance of the budget line from the origin.
Usually the substitution and income effects reinforce
each other, but they pull in opposite directions and almost
cancel each other out in the case of labor. Most economists
believe that the market supply curve for labor (found by
adding up all the supply curves of individuals) is close to
a vertical line.
Supply curves for other resources can be obtained in
similar ways. The supply curve for capital, for example,
depends on decisions of people to consume now or to consume
in the future. People who prefer to consume in the future
will save and make funds available to finance capital. Their
"time preference" determines the shape of indifference
curves. The slope of the budget line depends on the interest
rates. The budget line tells how much one can get in the
future if one sacrifices consumption now.
Although the overall market supply curve for labor may be
almost vertical, no firm sees this supply curve. Firms hire
not general labor, but specific kinds of labor--accountants,
electricians, truck driver, etc.--and because people can
shift from one occupation to another, the supplies of
specific kinds of labor are more elastic than that for labor
in general. Also, because there are other many firms buying
labor, what one firm does may have little effect on the
overall market. If the firm is so small in the market that
it can see no effects at all on the wage from its hiring
decisions, it is a price
taker. If it has some effect on wages, so that when it
wants to hire more, it finds that wages rise, the firm is a
price maker or what economists usually call a price
searcher. The extreme case of a price maker is a
monopsonist, the case of only one buyer in the
market. The supply curve for a resource that a monopsonist
sees is the same as the market supply curve for that
specific resource.
The supply curve for a resource is a constraint or
boundary on the firm because it shows the minimum that the
firm can pay for a level of the resource. If the firm is a
price taker in the resource market, it will face a
horizontal supply curve such as that in the graph below.
This curve indicates that any number can be bought at
P1 with no effect on price. There is no way the firm
can attain point a even though it might prefer to pay
less than P1 because no one will sell at less than
P1. Sellers will not sell because we assumed that
there were a great many other buyers of the resource who
will pay P1. Point c is possible, but a waste
of money because the same amount of the resource could be
bought for less.
If the firm is one of a few buyers or the only buyer of a
resource, it may face a supply curve that slopes upward,
making it a price searcher. It can obtain quantity Q1
if it pays P1, but it must pay more than P1 if
it wants quantity Q2.
You should have noticed that there are
similarities between a supply curve for a resource and a
demand curve for output. Both are boundaries, and the curve
the firm faces may differ from the market curve. The
similarity goes further, because there is a counterpart for
marginal revenue called "marginal resource cost"
that measures the extra cost to the firm of hiring one
more unit of the resource.
When a firm is a price taker, marginal resource cost is
the same as the price of the resource. If the firm can hire
as many workers as it wants at $10 per hour, then hiring one
more hour of labor adds $10 to costs. Marginal resource cost
and the supply of labor are both horizontal lines in this
case.
When a firm is a price searcher facing an upward-sloping
supply curve, the extra cost of hiring another unit of the
resource is different from the price of the extra unit. The
table below illustrates the reason for this difference. If
the firm wants to buy two units, it cannot pay $1.00 and get
two. It must be willing to pay $2.00 for each. However, the
added cost of the second unit is not $2.00, but $3.00. This
can be shown by comparing the total cost of two units and
one unit, or $4.00 less $1.00. The added cost of the second
unit is not only the two dollars that must be paid for it,
but an added dollar for the first one. By the same logic,
the added cost of a third unit is $5.00.
Computing Marginal
Resource Cost
|
Quantity
|
Price
|
Marginal Resource
Cost
|
1 (first)
|
$1.00
|
$1.00
|
2 (second)
|
$2.00
|
2.00 + 1.00
|
3 (third)
|
$3.00
|
3.00+2.00
|
The marginal resource cost curve lies above an
upward-sloping supply curve because of the assumption that
the firm can pay only one price. This is often a realistic
assumption. If the firm hires two clerks who do exactly the
same work, and pays one $4.00 per hour and the other $6.00
per hour, the lower-paid one will be unhappy and may refuse
to work for the lower pay. On the other hand, many firms do
not publicly disclose what they pay various people, and
discourage employees from discussing salaries. To the extent
that people are unaware of what others are earning, the firm
may be able to pay different prices for the same resource,
or in economists' jargon, to price discriminate. Price
discrimination will pull down the MRC curve in the graph
closer to, or perhaps even onto, the supply curve.
Copyright
Robert Schenk
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