2. 12 - 1 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources Unit 4 The Factor Market

3. 12 - 2 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources RESOURCE DEMAND Derived demand Resource demand is derived from product demand Demand depends on Productivity of resource (MP) Price of product (P)

4. 12 - 3 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources RESOURCE DEMAND Marginal Resource Cost (MRC) MRC = ΔTotal (Resource) Cost Δ Resource Quantity MRP = Δ Total Revenue Δ Resource Quantity Marginal Revenue Product (MRP)

5. 12 - 4 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources Rule for Employing Resources: MRP = MRC Resource Demand

6. 12 - 5 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources Resource Demand –For the firm, equal to MRP –Market demand equals summation of firm demands Downsloping because of DMR

7. 12 - 6 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources DETERMINANTS OF RESOURCE DEMAND Changes in Product Demand Changes in Productivity More Resources Better Resources Technology

8. 12 - 7 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources Changes in the price of substitute resources Substitution effect + Output effect = Net effect Changes in the price of complementary resources DETERMINANTS OF RESOURCE DEMAND

9. 12 - 8 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources The Least Cost Rule Minimize cost of producing a given output Last dollar spent on each resource yields the same marginal product Marginal Product Of Labor (MP L ) Price of Labor (P L ) Marginal Product Of Capital (MP C ) Price of Capital (P C ) =

10. 12 - 9 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources Profit Maximizing Rule MRP of each resource equals its price MRP L PLPL MRP C PCPC = = 1 MRP L PLPL = MRP C PCPC = and

11. 12 - 10 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources Labor Costs PURELY COMPETITIVE LABOR MARKET EQUILIBRIUM Labor Market S D = MRP (∑ mrp’s) WcWc (1000) Individual Firm S = MRC d = mrp WcWc Quantity of Labor Wage Rate (dollars) Quantity of Labor ($10) (5) $10

12. 12 - 11 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources Labor Costs Labor Market S D = MRP (  mrp’s) WcWc (1000) Individual Firm S = MRC d = mrp WcWc Quantity of Labor Wage Rate (dollars) Quantity of Labor ($10) (5) $10 Marginal Resource Cost (MRC) will be constant and equal to resource price (the wage rate) PURELY COMPETITIVE LABOR MARKET EQUILIBRIUM

13. 12 - 12 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources Wage Rate (dollars) MRP S WmWm Quantity of Labor MRC QmQm MONOPSONISTIC LABOR MARKET MRP = MRC Q m units of labor hired

14. 12 - 13 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources Wage Rate (dollars) MRP S WmWm Quantity of Labor MRC WcWc QmQm QcQc The competitive solution would result in a higher wage and greater employment. MONOPSONISTIC LABOR MARKET

15. 12 - 14 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources Rent Price paid for land and other natural resources Perfectly inelastic supply

16. 12 - 15 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources R1R1 Land Rent (dollars) Acres of Land S DETERMINATION OF LAND RENT Changes in the demand for land... Inelastic Supply... combines with demand... D1D1 to determine rent

17. 12 - 16 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources INTEREST The Price Paid for the Use of Money Money is NOT a Resource Rate Determination...

18. 12 - 17 Significance of Resource Pricing Marginal Productivity Theory of Resource Demand MRP as a Demand Schedule Determinants of Resource Demand Elasticity of Resource Demand Optimum Combination of Resources Interest Rate, (percent) Quantity of Loanable Funds LOANABLE FUNDS THEORY OF INTEREST i = 8% D F0F0 S