The Demand for Resources In a SG / NG world Please listen to the audio as you work through the slides.

The Demand for Resources in a SG/NG world The pricing and employment of resources Relative to the circular flow model – top loop The Microeconomics of Resource Markets Learning Objectives: 1.The significance of resource pricing relative to resource allocation among firms and industries, the determination of income, and cost minimization for a firm. 2.The marginal productivity theory of resource demand 3.The determinants of resource demand 4.The determinants of the elasticity of resource demand. 5.The determination of the optimal combination of resources.

Significance of resource pricing Resource availability and therefore pricing, is a major factor in producing changes in our economy. How might a SG/NG future affect resource prices?

Resources Essential to Economic Growth Apply the concept of “Peak Oil” to other resources Water - Implications for food production Phosphorous rock (phosphate) - (food production) – 1989 peak The 17 Rare Earth Elements: 97% come from China – Indium – flat panel TV screens (known deposits exhausted by 2028) – Gallium – liquid crystal screens (known deposits exhausted by 2017) – Palladium Autocatalytic in auto exhaust systems Multilayer ceramic capacitors in computers & cell phones Stockpiles nearing depletion – Tantalum – cell phones – 1964 peak

Significance of Resource Pricing Issues based on resource pricing A firm’s Product mix – determined by resource pricing (Cell phones - Coltan, TV’s, soft drinks) Resource allocation (to firms) – determined by resource pricing (the rich and strong survive) Money Income Determination Resource prices translate into Income sources - - Wages, rents, interest, profit (the rich get richer)

Significance of resource pricing How does resource pricing impact Resource Allocation? 1.Product prices allocate finished goods and services to buyers (the rich get more) 2.Resource prices allocate resources among industries, firms, and countries. (interesting global north / global south impact – the rich get more) 3.Efficient allocation of resources over time calls for the continuing shift of resources from one use to another. (and from place to place) 4.But, how far can we push this?

Cost Minimization Resources are costs to the firm The profit maximizing firm seeks productive efficiency – find the least cost combination of resources What happens to an economy when firms drive down the cost of labor? Significance of resource pricing

Cost Minimization Consider the case of the bread company Inputs: Flour Water (for cooking, cleaning, etc.) Electricity Heat Labor Capital (ovens, etc.) Resource prices play a significant role in determining the quantities of resources to be combined in producing each good or service Significance of resource pricing

Cost Minimization Why should a firm care about what happens in another part of the world? Examples of a few resources Rare Earth Elements – China Palladium – (catalytic converters, fuel cells, electronics) South Africa, Canada, Russia, Montana Uranium – Canada 20%, Kazakstan 27%, Australia 15% Nickel – Canada (1/3 of worlds nickel), Russia Significance of resource pricing

Policy Issues Such as: How should we prepare for a SG/NG future? Should the government influence resource demand or allocation through taxes and subsidies – or is the government already doing that? How can we reduce resource demand? Significance of resource pricing

Marginal Productivity Theory of Resource Demand Resource Demand as a Derived Demand Objective: Focus on the Firm: 1.Find the least-cost combination of resources 2.Find the profit maximizing combination of resources What might be some implications of a SG/NG future?

Marginal Productivity Theory of Resource Demand Resource Demand as a Derived Demand Assumptions: Competitive product and resource markets Firm is a Price taker and wage taker (pure competition) Resource Demand - Derived from what? 1.Demand for the final product 2.Productivity of the resource 3.Price of the good or service 4.Marginal Productivity (MP) Remember diminishing marginal product? 5.Marginal Revenue Product (MRP)

Marginal Productivity Theory of Resource Demand Marginal Revenue Product (MRP) definition – The change in total revenue resulting from the use of each additional unit of a resource. MRP Schedule = firm’s demand schedule for the resource Important point!!!!: To maximize profit, a firm should hire additional units of a specific resource as long as each successive unit adds more to the firm’s revenue that it adds to total cost

Marginal Revenue Product = Change in Total Revenue Unit change in Resource Quantity Marginal Productivity Theory of Resource Demand

Marginal Resource Cost = Change in Total (Resource) Cost Unit change in Resource Quantity Marginal Productivity Theory of Resource Demand Marginal Resource Cost: The amount that each additional unit of a resource adds to the firm’s total (resource) cost. What do we mean by resource cost? Is it just the price of the resource? What are the implications of that?

Marginal Productivity Theory of Resource Demand Rule for Employing Resources: MRP = MRC It will be profitable for a firm to hire additional units of a resource up the point at which that resource’s MRP is equal to its MRC. This must apply for each resource used by the firm!

Units of Resource Total Product (Output) Marginal Product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) Q P Resource price (wage rate) Quantity of resource demanded Pure Competition MRP as a Demand Schedule ] ] ] ] ] ] ] ] ] ] ] ] 0 0$2$ 0 Consider the case of resource demand under Pure Competition Resource price = MRC

Units of Resource Total Product (Output) Marginal Product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] Q P Resource price (wage rate) Quantity of resource demanded Pure Competition MRP as a Demand Schedule ] ] ] ] ] ] $2 2 $ 0 14 $ 14

Units of Resource Total Product (Output) Marginal Product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] Q P Resource price (wage rate) Quantity of resource demanded Pure Competition MRP as a Demand Schedule ] ] ] ] ] ] $2 2 $ $ 14 12

Units of Resource Total Product (Output) Marginal Product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] Q P Resource price (wage rate) Quantity of resource demanded Pure Competition MRP as a Demand Schedule ] ] ] ] ] ] $2 2 $ $

Units of Resource Total Product (Output) Marginal Product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] Q P Resource price (wage rate) Quantity of resource demanded Pure Competition MRP as a Demand Schedule ] ] ] ] ] ] $2 2 $ $ The purely competitive seller’s demand for a resource. Downward sloping due to decreasing MP

Units of Resource Total Product (Output) Marginal Product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] Q P Resource price (wage rate) Quantity of resource demanded Pure Competition MRP as a Demand Schedule ] ] ] ] ] ] $2 2 $ $ The purely competitive seller’s demand for a resource Now, consider the case of resource demand under Imperfect Competition Firm is price maker MRP falls because 1.MP diminishes & 2.Price falls as output rises

Units of Resource Total Product (Output) Marginal Product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] Q P Resource price (wage rate) Quantity of resource demanded Imperfect Competition MRP as a Demand Schedule ] ] ] ] ] ] $ $ $ The imperfectly Competitive seller’s demand for a resource Less elastic than the competitive seller

Determinants of Resource Demand 1. Changes in Product Demand An increase in product demand will increase the demand for resources What are some products with growing demand? 2. Changes in Productivity An increase in the productivity of a resource will cause an increase in its demand. What are some resources with growing productivity? Are there upper limits to productivity increases?

Determinants of Resource Demand What could cause changes in productivity? 1. Quantities of Other Resources The MP of a resource will vary with the quantities of the other resources used with it. Example: The greater the amount of capital and land used with labor, the greater will be labor’s MP and thus demand for labor 2. Technological Advance The better the quality of capital, the greater the productivity of labor used with it. Example - Dock workers, auto assembly workers, knowledge workers. 3. Quality of the Variable Resource Improvements in the quality of labor will increase its MP and therefore its demand.

Determinants of Resource Demand What could cause changes in productivity? 4. Changes in the Prices of Other Resources may change the demand for a specific resource. The direction of change in labor demand will depend on whether labor & capital are substitutes or compliments. Watch This! The case of substitute resources Assume two resources (capital and labor) are substitutable and the price of capital falls relative to the price of labor. What will happen to the demand for labor? The impact on demand for labor will depend on the net effect of the: Substitution Effect Output Effect

Determinants of Resource Demand A. Substitution Effect: Here the substitution effect decreases the demand for labor relative to capital and lowers the cost of production. The fall in the price of machines prompts the firm to substitute machines for labor B. Output Effect With lower costs, the firm finds it profitable to produce and sell a higher level of output. The higher level of output increases the demand for “all” resources, including labor. C. Net Effect on the demand for labor depends on the relative sizes of these 2 effects 1.If the substitution effect > the output effect, a decrease in the price of capital decreases the demand for labor 2.If the substitution effect < the output effect, a decrease in the price of capital will increase the demand for labor

Determinants of Resource Demand The Case of Complementary Resources When labor and capital are complementary, a decline in the price of capital increases the demand for labor through the output effect.

Determinants of Resource Demand Summary The demand for labor will increase when: 1.The demand for the product produced by that labor increases. 2.The productivity (MP) of labor increases. 3.The price of a substitute input decreases, provided the substitution effect < output effect. 4.The price of a substitute input increases, provided the substitution effect > the output effect. 5.The price of a complementary input decreases

Elasticity of Resource Demand E rd = Percentage change in resource price Percentage change in resource quantity E rd > 1 is Elastic E rd = 1 is Unit-Elastic E rd < 1 is Inelastic The sensitivity of producers to changes in resource prices

Elasticity of Resource Demand What determines the elasticity of resource demand? 1. Ease of Resource Substitutability The larger the number of satisfactory substitute resources available, the greater the elasticity for a particular resource Examples: Water, oil, corn used to make ethanol 2. Elasticity of Product Demand The greater the elasticity of product demand, the greater the elasticity of resource demand. Examples: Cell phones, insulin 3. Ratio of Resource Cost to Total Cost: The larger the proportion of total production costs accounted for by a resource, the greater the elasticity of demand for that resource. Example: Oil used in production of pesticides.

Optimal Combination of Resources (long run) Two questions a firm must consider: 1.What combination of resources will minimize costs at a specific level of output? 2.What combination of resources will maximize profit?

Least-Cost Rule A firm is producing a specific output with the least-cost combination of resources when the last dollar spent on each resource yields the same marginal product. MP of Labor MP of Capital Price of Labor Price of Capital Least-Cost Combination of Resources Optimal Combination of Resources (long run) Minimizing cost is not sufficient for maximizing profit.

Optimal Combination of Resources (long run) In a purely competitive resource market, the marginal resource cost (MRC) is equal to the resource price. For any competitive resource market our profit maximizing equation transforms from MRP =MRC to MRP of the resource = Price of the resource, or (MRP=P). This condition must hold for every variable resource! In competitive resource markets, a firm will achieve its profit maximizing combination of resources when P=MRP for each resource or restated as:

Profit-Maximizing Combination of Resources MRP L PLPL MRP C PCPC 1 Optimal Combination of Resources (long run) For each resource used by the firm!

Marginal Productivity Theory of Income Distribution The theory: Income gets distributed according to contribution to society’s output. However: Inequality exists – physical and mental ability, education and training, etc. Market Imperfections – presence of labor unions, discrimination, Externalities Wage rates and other resource prices frequently are not based solely on contribution to output!