CHAPTER 14  
Demand for Resources

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CHAPTER OVERVIEW

This chapter and the next two chapters survey resource pricing.  The basic analytical tools involved in this survey are the demand and supply concepts of earlier chapters.  While the present chapter focuses on resource demand, the following two chapters couple resource demand with resource supply in explaining the prices of human and property resources.

The two most basic points made in this chapter are closely related.  First the MRP = MRC rule for resource demand is developed.  Most students will recognize that the rationale here is essentially the one underlying the MR = MC rule of previous chapters, but that the orientation now is in terms of units of input rather than units of output.  Second, the MRP = MRC rule is applied under the assumption that resources are being hired competitively to explain why the MRP curve is the resource demand curve.

Resource demand curves are developed for both purely competitive and imperfectly competitive sellers, but the emphasis is on the pure competition model in the hiring of resources.  Also covered are changes in resource demand and the elasticity of resource demand

LECTURE NOTES

I.          Review the circular flow model (Figure 2-6).

II.        Resource Pricing

A.  Resources must be used by all firms in producing their goods or services; the prices of these resources will determine the costs of production.

B.   Significance of resource pricing:

1.   Money incomes are determined by resources supplied by the households.  In other words, firm expenditures eventually flow back to the household in the form of wages, rent, and interest. (Figure 2-6)

2.   Resource prices determine resource allocation.

3.   Resource prices are input costs. Firms try to minimize these costs to achieve productive efficiency and profit maximization.

4.   There are ethical and policy issues concerning income distribution:

a.   Income distribution (Chapter 34);

b.   Income tax issues;

c.   Minimum wage law; and

d.   Agricultural subsidies.

III.       Marginal productivity theory of resource demand: assuming that a firm sells its product in a purely competitive product market and hires its resources in a purely competitive resource market.

A.  Resource demand is derived from demand for products that the resources produce.

B.   The demand for a resource is dependent upon:

      1.   The productivity of the resource;

      2.   The market price of the product being produced.

C.   Discussion of Table 27.1:

      1.   Review of the Law of Diminishing Returns;

      2.   Review the significance of the fixed product price;

      3.   Determination of Total Revenue (TR) and Marginal Revenue Product (MRP); MRP is the increase in total revenue that results from the use of each additional unit of a variable input.

4.   MRP depends on productivity of input (recall that marginal product of inputs falls beyond some point in production process due to law of diminishing marginal returns).

5.   MRP also depends on price of product being produced.

D.  Rule for employing resources is to produce where MRP = MRC.

1.   To maximize profits, a firm should hire additional units of a resource as long as each unit adds more to revenue than it does to costs.  (MRC is the marginal-resource cost or the cost of hiring the added resource unit.)  Equation form:

2.   Under conditions of pure competition in the labor market where the firm is a “wage taker,” the wage is equal to the MRC.

3.   MRP will be the firm’s resource (labor) demand schedule in a competitive resource market because the firm will hire (demand) the number of resource units where their MRC is equal to their MRP.  For example, the number of workers employed when the wage (MRC) is $12 will be 2; the number of workers hired when the wage (MRC) is $6 will be 5.  In each case, it is the point where the wage (MRC of worker) equals MRP of last worker (Figure 27.1).

IV.       Marginal productivity theory of resource demand: assuming that a firm sells its product in an imperfectly competitive product market and hires its resources in a purely competitive resource market.

A.  Discussion of Table 27.2:

      1.   Note that the product price decreases as more units of output are sold.

      2.   TR = output x product price.

B.   MRP of imperfectly competitive seller falls for two reasons: Marginal product diminishes as in pure competition, and product price falls as output increases.  Figure 27.2 illustrates this graphically.

V.         Market demand for a resource will be the sum of the individual firm demand curves for that resource.

VI.       Determinants of Resource Demand:

A.  Changes in product demand will shift the demand for the resources that produce it (in the same direction).

B.   Productivity (output per resource unit) changes will shift the demand in same direction.  The productivity of any resource can be altered in several ways:

1.   Quantities of other resources

2.   Technical progress

3.   Quality of variable resource.

C.   Prices of other resources will affect resource demand.

1.   A change in price of a substitute resource has two opposite effects.

a.   Substitution effect example: Lower machine prices decrease demand for labor.

b.   Output effect example: Lower machine prices lower output costs, raise equilibrium output, and increase demand for labor.

c.   These two effects work in opposite directions—the net effect depends on magnitude of each effect.

2.   Change in the price of complementary resource (e.g., where a machine is not a substitute for a worker, but machine and worker work together) causes a change in the demand for the current resource in the opposite direction.  (Rise in price of a complement leads to a decrease in the demand for the related resource; a fall in price of a complement leads to an increase in the demand for related resource).  (See Table 27.3 for summary)

D.  Occupational Employment Trends:

1.   Changes in labor demand will affect occupational wage rates and employment. (Wage rates will be discussed in Chapter 28.)

 2.  Discussion of fastest growing occupations.  (Table 27.5)

 3.  Discussion of occupations with the greatest absolute job growth.  (Table 27.6)

VII.      Elasticity of resource demand is affected by several factors.

A.  Formula of elasticity of resource demand: measures the sensitivity of producers to changes in resource prices.

B.   If Erd > 1, the demand is elastic; if Erd < 1, the demand is inelastic; and if Erd = 1, demand is unit-elastic.

C.   Determinants of elasticity of demand:

1.   Rate of decline in marginal product: If MRP changes slowly as units of resource are added, the demand for resource will be elastic, because a small decline in price of resource will lead to a big increase in the quantity demanded; a small increase in resource cost will lead to a big decrease in quantity demanded.

2.   Ease of resource substitutability: The easier it is to substitute, the more elastic the demand for a specific resource

3.   Elasticity of product demand: The more elastic the product demand, the more elastic the demand for its productive resources.

4.   Resource-cost/total-cost ratio: The greater the proportion of total cost determined by a resource, the more elastic its demand, because any change in resource cost will be more noticeable.

VIII.    Optimal Combination of Resources

A.  Two questions are considered.

1.   What is the least-cost combination of resources to use in producing any given output?

2.   What combination of resources (and output) will maximize a firm’s profits?

B.   The least‑cost rule states that costs are minimized where the marginal product per dollar’s worth of each resource used is the same.  Example: MP of labor/labor price = MP of capital/capital price.  (Key Questions 4 and 5)

1.   Long-run cost curves assume that each level of output is being produced with the least-cost combination of inputs.

2.   The least-cost production rule is analogous to Chapter 21’s utility-maximizing collection of goods.

C.   The profit‑maximizing rule states that in a competitive market, the price of the resource must equal its marginal revenue product.  This rule determines level of employment MRP(labor) / Price(labor) = MRP(capital) / Price(capital) = 1.

D.  See examples of both rules in Table 27.7.

IX.       Marginal Productivity Theory of Income Distribution

A.  “To each according to what one creates” is the rule.

B.   There are criticisms of the theory.

1.   It leads to much inequality, and many resources are distributed unequally in the first place.

2.   Monopsony and monopoly interfere with competitive market results with regard to prices of products and resources.

X.         LAST WORD: Input Substitution: The Case of ATMs

A.  Theoretically, firms achieve the least‑cost combination of inputs when the last dollar spent on each makes the same contribution to total output; rule implies that firms will change inputs in response to technological change or changes in input prices.

B.   A recent real-world example of firms using the least cost combination of inputs is in the banking industry, in which ATMs are replacing human bank tellers.

1.   Between 1990-2000, 80,000 human tellers lost their jobs, and more positions will be eliminated in the coming decade.

2.   ATMs are highly productive:  A single machine can handle hundreds of transactions daily, millions over the course of several years.

3.         The more productive, lower-priced ATMs have reduced the demand for a substitute in production

 

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