Capital and Natural Resource Markets

3. Marginal Productivity and Resource Demand

Firms will demand more of a resource if the marginal product of the resource is greater than the marginal cost.

Learning Objectives

Explain the relationship between marginal productivity and resource demand

Key Takeaways

Key Points

• When firms have positive net marginal products of resources, the demand for the resource will increase.
• Some resources are subject to the typical market constraints of supply and demand.
• Some resources are public goods, which means that they could be depleted if firms that have positive net marginal products from the resource are not regulated.
  

Key Terms

• marginal productivity: The extra output that can be produced by using one more unit of the input
  

The marginal product of a given resource is the additional revenue generated by employing one more unit of the resource. In the case of labor, for example, the marginal product of labor is the additional value generated for the company by hiring one additional worker. A firm will continue to employ more of the resource until the marginal revenue equals the marginal cost to the firm. The same concept applies to all resources that can be used in production, whether its labor or wood or land.

Since firms will seek to use additional resources if the net marginal product is positive, they can affect the demand for the resources. For many resources, the increased demand has the same effects as if it were any other input: an increase in demand will lead to an increase in price.

Oil Rig: Oil is a natural resource that is traded in markets. When firms have positive net marginal productivity from using more oil, demand for oil will rise.

Some resources, though, are public goods and therefore are not regulated by normal market forces. Take, for example, a body of water that multiple firms all use. If each firm has a positive marginal productivity of using more water in their manufacturing process, they will use more water since it's free (there is no, or limited, marginal cost). If each firm individually chooses to use more water, the lake will eventually be damaged. This is known as the tragedy of the commons.

Governments have an incentive to attempt to correct such market failures. There are often regulations on the use of public goods to prevent the tragedy of the common, and there may be regulations on private goods as well (e.g. companies are required to get permits to mine on land they own).