14-1 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Chapter 14 The demand for economic resources

14-2 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Learning objectives Discuss the significance of resource pricing Introduce marginal productivity theory as a way of explaining the amounts of resources that firms use Examine the way the employment of resources may vary when there are many buyers of the resource and different forms of competition in the product market

14-3 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Learning objectives (cont.) Explain the demand for a resource, what determines changes to resource demand and what factors determine the elasticity of resource demand Introduce the concept of monopsony

14-4 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Significance and complexity of resource pricing? Resources are a major determinant of money incomes Resource pricing allocates resources among various industries and firms Cost minimisation –Firms must produce the profit-maximising output with the most efficient combination of resources

14-5 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Significance and complexity of resource pricing? (cont.) Ethical and public policy issues –Inequality in the personal distribution of income results from resource prices –Raises normative and equity issues surrounding the distribution of income

14-6 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Complexities of resource pricing Resource demand-and-supply determines pricing and employment However, exact nature depends on: –Type of resource –Type of market –Policies and practices of government –Complications added by firms and unions

14-7 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Marginal productivity theory Marginal analysis is applied to derive optimum hiring of resources Optimal employment of resources: MRP = MRC –To maximise profits, a firm should hire additional units of any given resource as long as each successive unit adds more to the firm’s total revenue than it does to its total costs Marginal revenue product (MRP) –Increase in total revenue resulting from the use of one additional unit of input

14-8 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Marginal productivity theory (cont.) Marginal resource cost (MRC) –The increase in total resource cost resulting from the use of one additional unit of input MRP = MRC rule –Explains the way demand for economic resource is formulated –Does not explain the exact derivation of demand curve

14-9 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Demand for a resource Depends on two types of markets: Product market in which the firm sells and produces goods Resource market –Many buyers? –Few buyers?

14-10 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Resource demand under perfect competition Assume perfect competition in resource market Derived demand for resource –Productivity of resource in producing the good –Market value of the good MRP schedule constitutes the firm’s demand for labour

14-11 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Marginal definitions Marginal product (MP) –Additional output resulting from the use of one additional unit of a resource, ceteris paribus Marginal revenue product (MRP) –The increase in total revenue resulting from the use of one additional unit of input MRP = MP × P

14-12 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia MRP as a demand schedule Units of resource Total product Marginal product MP Product price Total revenue Marginal revenue product MRP ] ] ] $ 1 1 $ $ ] ] ] ] ] ] ] ] ]

14-13 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia MRP curve DRDR DRDR Demand for resource: perfect competition Resource price (wage-rate) Quantity of resource demanded

14-14 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Resource demand under perfect competition Perfect competition in resource market Product demand curve is down-sloping –Firm must accept lower price in order to increase sales Comparison with perfect competition –MRP = MP × MR –MRP curve is less elastic than perfect competition –Imperfectly competitive firms less responsive to wage cuts in terms of workers employed

14-15 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Demand for resource: imperfect competition Units of resource Total product Marginal product MP Product price Total revenue Marginal revenue product MRP ] ] ] $ $ $ –1.30 ] ] ] ] ] ] ] ] ]

14-16 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Demand for resource: imperfect competition Quantity of resource demanded Resource price (wage-rate) D D MRP curve – 3– 3– 3– 3

14-17 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Market demand for a resource Derived by summing up the individual demand or MRP curves for all firms Complications –Decreased resource price may cause all firms in the industry to hire more of the resource and expand total output, thereby reducing product price –Product price falls as industry output expands, therefore true market demand curve will be less elastic than that based on constant product price

14-18 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Changes in resource demand and elasticity of demand Changes in product price Changes in productivity –Quantities of other inputs used –Technological progress –Labour quality

14-19 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Changes in resource demand (cont.) Prices of other resources Substitute resources –Substitution effect –Output effect Complementary resources –An increase (decrease) in the quantity of one resource that is needed in the production process will require an increase (decrease) in the amount of the other as well

14-20 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Elasticity of resource demand Rate of MP decline Ease of resource substitutability –The larger the number of good substitute resources available, the greater will be the elasticity of demand for a particular resource Elasticity of product demand –The greater the elasticity of product demand, the greater the elasticity of resource demand Resource cost–total cost ratio –The larger the contribution of a resource’s price to total costs, the greater the elasticity of demand for that resource

14-21 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Imperfect competition in resource market MRC will exceed the resource price under imperfectly competitive demand condition for a resource The firm must substitute MRC for resource price in its calculation of optimum input use when applying the MRP = MRC rule

14-22 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Imperfect competition in resource market Monopsony: one buyer of a resource –No well-defined demand curve for a resource Optimum hiring condition under varying degrees of competition: –Many producers in product market  MRP = MRC, MP × P = MRC –One producer in product market  MRP = MRC, MP × MR = MRC

14-23 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Next chapter: Wage determination