Chapter 25 the demand for resources ECON 201 Macroeconomics Chapter 25 the demand for resources

Ch 25 Objectives The significance of resource pricing. How the marginal revenue productivity of a resource relates to a firm’s demand for that resource. The factors that increase or decrease resource demand. The determinants of elasticity of resource demand. How a competitive firm selects its optimal combination of resources.

Review Resource A natural, human, or manufactured item that helps produce goods and services. A productive agent or factor of production. Derived Demand – demand for a resource that depends on the demand for the product it helps to produce

Marginal Product - The additional output produced when 1 additional unit of a resource is employed (the quantity of all other resources employed remaining constant) Equal to the change in total product divided by the change in the quantity of a resource employed.

Marginal revenue Product (MRP) The change in a firm’s total revenue when it employs 1 additional unit of a resource (the quantity of all other resources employed remaining constant). Equal to the change in total revenue divided by the change in the quantity of the resource employed.

Marginal resource cost (MRC) The amount the total cost of employing a resource increases when a firm employs 1 additional unit of the resource (the quantity of all other resources employed remaining contstant). Equal to the change in the total cost of the resource divided by the change in the quantity of the resource employed.

MRP=MRC Rule The principle that to maximize profit (or minimize losses), a firm should employ the quantity of a resource at which its marginal revenue product (MRP) is equal to its marginal resource cost (MRC), the latter being the wage rate in pure competition.

Substitution Effect Change in the quantity demanded of a consumer good that results from a change in its relative expensiveness caused by a change in the product’s price The effect of a change in the price of a resource on the quantity of the resource employed by a firm, assuming no change in its output.

Output Effect The situation in which an increase in the price of one input will increase a firm’s production costs and reduce its level of output, thus reducing the demand for other inputs; conversely for a decrease in the price of the input.

Elasticity of resource demand A measure of the responsiveness of firms to a change in the price of a particular resource they employ or use The percentage change in the quantity of the resource demanded divided by the percentage change in its price.

Least-cost combination of resources The quantity of each resource a firm must employ in order to produce a particular output at the lowest total cost The combination at which the ratio of the marginal product of a resource to its marginal resource cost (to its price if the resource is employed in a competitive market) is the same for the last dollar spent on each of the resources employed.

Profit-maximizing combination of resources The quantity of each resource a firm must employ to maximize its profit or minimize its loss The combination in which the marginal revenue product of each resource is equal to its marginal resource cost (to its price if the resource is employed in a competitive market).

Marginal productivity theory of income distribution The contention that the distribution of income is equitable when each unit of each resource receives a money payment equal to its marginal contribution to the firm’s revenue (its marginal revenue product).

Resource Pricing Resources are used by firms in producing goods & services; the prices of these resources determine the costs of production.

4 Reasons to Study Resource Pricing Money –Income determination Cost Minimization Resource allocation Policy Issues

Money –Income Determination 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.

Cost Minimization Resource prices are input costs. Firms try to minimize input costs to achieve productive efficiency and maximize profit. Resource prices determine the quantities of land, labor, capital and entrepreneurial ability to produce each good or service. Resource prices determine resource allocation.

Resource Allocation In efficient allocation of resources over time calls for the continuing shift of resources from one use to another. Resource pricing is a major factor in producing those shifts.

Policy Issues/Government involvement To what extent should government redistribute income through taxes & transfers? Should govt. control wages to CEOs? Increase min wage? Do farmers receive enough subsidies? Labor unions?

Derived Demand Resource demand is derived from demand for products that the resources produce. Garden Tractors and tires Households want to consume food – but not the tractor, land, labor/expertise of the agriculturalist.

Marginal Revenue Product (MRP) The change in a firm’s total revenue when it employs 1 additional unit of a resource (the quantity of all other resources employed remaining constant). Equal to the change in total revenue divided by the change in the quantity of the resource employed.

Marginal Revenue Product (MRP) Because the demand for a resource is derived from the demand for the product produced with it, the demand for the resource depends on: 1. Productivity of the resource in helping to create good or service. 2. Market Value or price of the good it helps produce.

The demand for a resource is dependent upon: The productivity of the resource The market price of the product being produced. No demand at all for a resource that is efficient in producing something no one wants to buy.

MRP A highly productive resource will be in high demand A non-productive resource will be in little demand.

Productivity Marginal Product – additional output, from 1 additional unit of labor. (i.e. How much will be produced if you employ one more person)

First, find total Revenue 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. MRP=Change in Total Revenue/Change in Resource Quantity MRP depends on productivity of input. MRP also depends on price of product being produced.

Find MRP

Find MRC MRC is the mount that each additional unit of resource used adds to the firm’s total or “resource” cost.

Rule for Hiring resources is to produce where: MRP = MRC. 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: MRC = Change in Total Resource Cost Change in Resource Quantitiy

To Hire or not to Hire… IF the MRP of the last worker (“that much labor”) exceeds his/her MRC, the firm CAN PROFIT by hiring one more worker. IF the MRC of the last worker exceeds his/her MRP, the firm is hiring workers who aren’t paying their way (firm could increase profits by canning someone).

MRP=MRC Rule Similar to Marginal Revenue (MR) = Marginal cost (MC) profit maximizing rule. Rationale is the same, but now we are looking at inputs not outputs.

MRP Schedule Columns 1 & 6 on table 25.1 Is the firm’s demand schedule for labor. To maximize profits, the firm needs to hire additional units of a resource as long as each additional unit adds more to the firm’s total revenue that it adds to cost.

MRP as Resource Demand Schedule Market Supply & Market Demand establish the wage rate (in a purely competitive labor market). Each firm hires a small % of market supply, it can’t influence the market wage rate. SO –The Firm is a wage taker.

Marginal productivity theory of resource demand In the competitive resource market, the firm is a “wage taker” It hires such a small amount of the total supply of the resource that its hiring decisions do not influence the resource price.

Firm is a wage taker Total resource cost increases by exactly the amount of the constant market wage rate. Example – shoe maker MRC of labor (extra cost of input) equals the Market Wage rate. Example (Mkt. wage rate) – table 25.1 “again”

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

MRP schedule is the firm’s demand for labor Each point on the schedule (curve) is the # of workers the firm would hire at each possible wage rate. Fig 25.1 Downward sloping.

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.

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. In a competitive product market – the firm is a “price taker” and can dispose of as little or as much output as it chooses at the market price. Firm sells such a small fraction of the total output that its output decisions do not influence product price.

Por Hemplo 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).

Resource Demand Under Imperfect Market Competition Firm is selling its products in an imperfectly competitive market i.e firm is “price maker” Must lower price to sell the Marginal product of each additional worker. Example (satellite TV).

Imperfectly competitive Producer Less responsive to resource price cuts than the purely competitive producer. i.e. cable co and agiculture

Consider This … “Winner takes all” Some markets are what economist Robert Frank calls “winner-take-all-markets,” where a few of the top performers in the market receive extraordinary incomes, and the vast majority earn very little. Both the product and resource markets connected with the “winner-take-all-markets” would be characterized as imperfectly competitive, although the high earnings for the top performers do attract a large number of competitors to the resource market. Top music performers such as Shania Twain receive high earnings that reflect their high MRPs from selling millions of CDs and drawing thousands to concerts. i.e. Hannah Montanan & Ricki Lake

What determines resource demand? What shifts the demand curve? Assume all other things equal Resource demand is derived form product demand.

Determinants of Resource Demand: Changes in product demand will shift the demand for the resources that produce it (in the same direction). Productivity (output per resource unit) changes will shift the demand in same direction. The productivity of any resource can be altered in several ways: Quantities of other resources Technical progress Quality of variable resource.

Prices of other resources will affect resource demand. A change in price of a substitute resource has two opposite effects. Substitution effect example: Lower machine prices decrease demand for labor. Output effect example: Lower machine prices lower output costs, raise equilibrium output, and increase demand for labor. These two effects work in opposite directions—the net effect depends on magnitude of each effect.

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).

Occupational Employment Trends: Changes in labor demand will affect occupational wage rates and employment. (Wage rates will be discussed in Chapter 26.) Discussion of fastest growing occupations. (Table 25.5) (your homework) Discussion of most rapidly declining occupations. (Table 25.6)

Elasticity of resource demand is affected by several factors. Formula of elasticity of resource demand measures the sensitivity of producers to changes in resource prices. If Erd > 1, the demand is elastic; if Erd < 1, the demand is inelastic; and if Erd = 1, demand is unit-elastic.

If………….. If Erd > 1, the demand is elastic If Erd < 1, the demand is inelastic If Erd = 1, demand is unit-elastic.

Determinants of elasticity of demand: Ease of resource substitutability: The easier it is to substitute, the more elastic the demand for a specific resource Elasticity of product demand: The more elastic the product demand, the more elastic the demand for its productive resources. 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.

Optimal Combination of Resources 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?

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). Long-run cost curves assume that each level of output is being produced with the least-cost combination of inputs. The least-cost production rule is comparable to Chapter 19’s utility-maximizing combination of goods.

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.

Marginal Productivity Theory of Income Distribution To each according to what he or she 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.

LAST WORD: Input Substitution: The Case of ATMs Theoretically, firms achieve the least‑cost combination of inputs when the last dollar spent on each makes the same contribution to total output; the rule implies that firms will change inputs in response to technological change or changes in input prices. 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. Between 1990-2000, 80,000 human tellers lost their jobs, and more positions will be eliminated in the coming decade. ATMs are highly productive: A single machine can handle hundreds of transactions daily, millions over the course of several years. The more productive, lower-priced ATMs have reduced the demand for a substitute in production.

End of chapter questions What is the significance of resource pricing? Explain how the factors determining resource demand differ from those determining product demand. Explain the meaning and significance of the fact that the demand for a resource is a derived demand. Why do resource demand curves slope downward?

End chapter 25