Economic rent vs. opportunity costs

Economic rent
The difference between what an owner of a factor of production (such as land, capital or labor) receives and the opportunity cost for that owner.

Opportunity cost
The benefits the owner could have received by taking an alternative action.

Size of economic rent and opportunity cost
Determined by the elasticity of supply for that particular good or service.

Tips:
Economic rent is different from rent.

Renewable and Non-renewable Resources

Renewable natural resources

• A form of physical capital that tend to be replenished by nature.
• Supply is perfectly inelastic
• Demand is determined by price

Examples: water or solar energy.

Non-renewable natural resources

• Not available (for practical purposes) once they are used.
• Supply is perfectly elastic (horizontal)
• Quantity supplied is determined by demand
• Current price = Present value of the next period’s expected price, expected to increase at a rate equal to the interest rate essentially.
• Technological changes and political uncertainties are some of the many factors that make forecasting price changes difficult.

Examples: natural gas, oil, and coal.

Demand and Supply for Capital

Demand for capital:
The demand for capital will increase if:

• Lower interest rate
• Expect poor future business conditions => less investment

Supply for capital
The supply for capital will increase if

• Higher interest rate => more savings
• Higher current income => more savings
• Lower expected future income => more savings

Other factors affect demand and/or supply for capital

• Population changes
• Technological changes
• Expectations

Physical vs. Financial Capital

Physical capitial refer to the firm’s physical assets e.g. plants, equipment, raw materials, inventory. Greater demand for physical capital leads to greater demand for financial capital to purchase it. A firm will continue to employ physical capital until:

MRP of physical product = cost of financial capital

Demand and Supply for Labour

Labor Demand
Demand for labor will increase if:

• The price of the output increase
• The price of a factor of production that is substitute to labor increase
• The price of a factor of production that is complement to labor decrease

Demand of labor is more elastic in long run. A firm when continue to hire labor until MRP of labour = Price of labour.

Factors that shift demand curve
Change in:

• Demand for the goods
• Productivity of the resource
• Price of related resources

Labor Supply

• Supply curve: depend of the working-aged population
• Quantity of labor supplied : depend on the wage rates
  
  Increase in wage rates => consume less leisure => substitution effect
  Increase in wage rates => more income to consume leisure => income effect

Relationship Between MRP and Demand

Due to the law of diminishing returns, both the marginal product and the marginal revenue product for an input will decline as more of the input is deployed.

To maximize firm’s profit, both price takers and price searchers will follow the rule below:
Increase the input unitl MRP=P, where P - cost of last unit of resource input

As the price of an input goes up, fewer units of that resource will generate the MRP needed to entice the firm to employ that resource. The demand curve for a resource will be downward sloping.

Values for the demand curve will depend upon the price of the good being produced, the productivity of the resource in question, and the amount of other resources used by the firm.

A profit-maximizing firm will continue to employ units of a resource as long as the MRP associated with the unit exceeds the firm's cost. If we assume the units of each resource are perfectly divisible, then the following conditions will apply to a firm with 3 production inputs (A, B, and C).

MRPa=Pa

MRPb =Pb

MRPc= Pc

Where:
Pa - price (or wage rate) of resource A,
Pb - price (or wage rate) of resource B,
Pc - price (or wage rate) of resource C.

Expenses can always be reduced by substituting resources with relatively high marginal product per dollar spent for resources that have a relatively low marginal product per dollar. This substitution will continue to occur if per unit costs are to be minimized unit:

MRPa/Pa = MRPb/Pb = MRPc/Pc

In a competitive environment, firms will continue to identify opportunities that generate more value from a given resource. Drives their prices ever higher.

Marginal Revenue Product (MRP)

Marginal revenue product (MRP):
Increase in revenue from employing one more unit of a resource.

Marginal product (MP):
Increase in output from employing one more unit of a resource. (last unit of resources)

Marginal revenue (MR):
Increase in revenue from one unit increase in output.

For price taker,
MRP = MP x MR.

For non-price taker, more complicated computation.

Demand for the factors of production

Demand for a resource is a derivative of demand for the goods that can be produced with it.

Demand curve for a resource is downward sloping due to:

• Substitution of the resource with other resources in the production of the good.
• Substitution of the good with other goods.

Factors that shift demand curve:
Change in:

• demand for the goods
• productivity of the resource
• price of related resources.