5 Steps to a 5 AP Microeconomics, 2014-2015 Edition

What About Other Resources?

Labor is the resource with which most people identify because we have all been, or expect

to be, units of labor in a labor market. However, we can use the theory of resource demand

to predict how the market for capital (or any other resource) would behave. For example,

suppose that the market for capital is also perfectly competitive. If so, then each firm’s

demand for capital is also derived from the marginal revenue product of capital (MRPK)

MPRK= P ¥MPK

And because the marginal product of capital diminishes, the demand for capital is down-

ward sloping. In a competitive resource market, the firm can hire all of the capital it wants

at the marginal factor cost equal to the rental rate of capital (r*).

Each firm hires the profit-maximizing quantity of capital (K*) at the point where the

MRPKis equal to the rental rate (r*). We can see this hiring decision in Figure 10.4.

148 á Step 4. Review the Knowledge You Need to Score High

Rental

rate

K *

r*

MRPK

Quantity of capital

Figure 10.4

Rental

rate

Q*

r*

Quantity of capital

DK

D^1 K

SK

Figure 10.5

But where does this rental price of capital come from? With many firms hiring capital

in this competitive market, the market demand for capital is downward sloping. The

market supply curve for capital is upward sloping, and the market determines the compet-

itive price of capital (r*). This is seen in Figure 10.5.

Market forces, just as in the labor market, would cause the rental rate and quantity of

capital to change. For example, if the demand for capital increases, perhaps because of a

strong economy and positive corporate expectations, the equilibrium price and quantity of

capital in the market would be expected to increase.

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