2. Copyright 2008 The McGraw-Hill Companies 25-1 25 The Demand For Resources

3. Copyright 2008 The McGraw-Hill Companies 25-2 Chapter 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

4. Copyright 2008 The McGraw-Hill Companies 25-3 Turn from the product market to the resource (input or factor) market Roles of supply and demand are reversed: firms demand the resources, people supply them, as in the labor market Resource demand is a derived demand, that is, derived from the demand for the product being produced.

5. Copyright 2008 The McGraw-Hill Companies 25-4 Why study resource markets? Money-Income Determination: most household income comes from supplying resources such as labor. Cost Minimization: resource prices are costs to a firm, and firms have an incentive to use the least costly methods of production. Resource Allocation: resource prices affect what resources will be used and to what extent. Policy Issues: often involve resource prices and related issues, tax policy, minimum wage laws, union behavior, etc.

6. Copyright 2008 The McGraw-Hill Companies 25-5 As in product market, different kinds of resource markets Begin with a purely competitive resource market, price of the resource is determined by supply and demand for the resource What is the profit maximizing quantity of a resource that a firm should use?

7. Copyright 2008 The McGraw-Hill Companies 25-6 Here, we assume a purely competitive resource market (and a purely competitive product market) Many buyers and sellers of the resource. Homogenous units of the resource. Firm is a resource price taker: their actions do not affect the price of the resource.

8. Copyright 2008 The McGraw-Hill Companies 25-7 You already know a lot about resource markets. Use marginal analysis, hire the resource to the point where the added cost equals the added revenue

9. Copyright 2008 The McGraw-Hill Companies 25-8 Marginal Productivity Theory of Resource Demand Marginal Product (MP): MP is the change in output that results from adding one more unit of resource, such as labor, to production. Marginal Revenue Product (MRP) MRP is the change in total revenue that results from adding one more unit of a resource, such as labor, to production

10. Copyright 2008 The McGraw-Hill Companies 25-9 Marginal Productivity Theory of Resource Demand Rule for Employing Resources: MRP = MRC Marginal Revenue Product = Change in Total Revenue Unit Change in Resource Quantity Marginal Resource Cost = Change in Total (Resource) Cost Unit Change in Resource Quantity Marginal Revenue Product (MRP) Marginal Resource Cost (MRC)

11. Copyright 2008 The McGraw-Hill Companies 25-10 MRP as Resource Demand MRP as Resource Demand Schedule (1) Units of Resource (2) Total Product (Output) (3) Marginal Product (MP) (4) Product Price (5) Total Revenue, (2) X (4) (6) Marginal Revenue Product (MRP) 0123456701234567 0 7 13 18 22 25 27 28 76543217654321 $2 2 $ 0 14 26 36 44 50 54 56 $14 12 10 8 6 4 2 ] ] ] ] ] ] ] ] ] ] ] ] ] ] 1234567 0 -2 2 4 6 8 10 12 14 16 $18 Resource Wage (Wage Rate) Quantity of Resource Demanded D=MRP Purely Competitive Seller’s Demand for A Resource

12. Copyright 2008 The McGraw-Hill Companies 25-11 What is MRC equal to in a purely competitive labor market? The same as the market wage rate, that is, MRC = W (wage): recall in pure competition, the firm is a wage taker and hires a small fraction of the available labor, thus it can hire the labor it wants at the current market wage.

13. Copyright 2008 The McGraw-Hill Companies 25-12 Resource markets In the previous example, if this is a labor market and the wage is $9, how many units of labor should this firm hire? Now make a slight change: assume a purely competition labor or resource market, but an IMPERFECTLY competitive product market (such as oligopoly, monopoly, etc) Cannot use a constant price as in previous example.

14. Copyright 2008 The McGraw-Hill Companies 25-13 MRP as Resource Demand MRP as Resource Demand Schedule (1) Units of Resource (2) Total Product (Output) (3) Marginal Product (MP) (4) Product Price (5) Total Revenue, (2) X (4) (6) Marginal Revenue Product (MRP) 0123456701234567 0 7 13 18 22 25 27 28 76543217654321 $2.80 2.60 2.40 2.20 2.00 1.87 1.75 1.65 $ 0.00 18.20 31.20 39.60 44.00 46.25 47.25 46.20 $18.20 13.00 8.40 4.40 2.25 1.00 -1.05 ] ] ] ] ] ] ] ] ] ] ] ] ] ] 1234567 0 -2 2 4 6 8 10 12 14 16 $18 Resource Wage (Wage Rate) Quantity of Resource Demanded D=MRP (Pure Competition) Imperfectly Competitive Seller’s Demand for A Resource D=MRP (Imperfect Competition) W 25.1

15. Copyright 2008 The McGraw-Hill Companies 25-14 Market Demand for a Resource The market demand for a resource is the horizontal sum of the MRP curves for all the firms using that resource. What causes this demand curve to shift? 1. Changes in Product Demand and product price 2. Changes in Productivity of the resource, which is affected by Quantities of Other Resources Technological Advance Quality of Variable Resources

16. Copyright 2008 The McGraw-Hill Companies 25-15 Market Demand for a Resource 3. Changes in the Prices of Other Resources –Substitute Resources Substitution Effect: the lower price of one resource encourages firms to use more of that resource and less of others Output Effect: the lower price of one resource lowers overall costs, which encourages the firm to produce more output, which requires more of all resources. Net Effect: combines both the substitution and output effects. –Complementary Resources

17. Copyright 2008 The McGraw-Hill Companies 25-16 Occupational Employment Trends 10 Fastest Growing U.S. Occupations In Percentage Terms, 2004 - 2014 Home Health Aides Data Communications Analysts Medical Assistants Physician Assistants Software Engineers, Applications Physical Therapist Assistants Dental Hygienists Software Engineers, Systems Dental Assistants Personal Home Care Aides Occupation Employment Thousands of Jobs 20042014 Percentage Increase 624 231 387 62 460 59 158 340 267 701 974 357 589 93 682 85 226 486 382 988 56% 55% 52% 50% 48% 44% 43% 41% 10 Most Rapidly Declining U.S. Occupations In Percentage Terms, 2004 - 2014 Meter Readers, Utilities Textile Machine Operators Credit Authorizers, Checkers, & Clerks Railroad Brake, Signal, & Switch Operators Mailing Clerks Sewing Machine Operators Telephone Operators File Clerks Computer Operators Photographic Pro- cessing Machine Operators Occupation Employment Thousands of Jobs 20042014 Percentage Increase 50 148 67 17 160 256 39 255 149 54 27 81 39 11 101 163 25 163 101 38 -45% -41% -39% -37% -36% -33% -31% Source: Bureau of Labor Statistics

18. Copyright 2008 The McGraw-Hill Companies 25-17 Elasticity of Resource Demand What factors affect Erd? 1. Ease of Resource Substitutability 2. Elasticity of Product Demand 3. Ratio of Resource Cost to Total Cost E rd = Percentage Change in Resource Quantity Percentage Change in Resource Price O 25.1

19. Copyright 2008 The McGraw-Hill Companies 25-18 Optimal Combination of Resources The Least-Cost Rule –Least-Cost Combination of Resources Marginal Product Of Labor (MP L ) Price of Labor (P L ) Marginal Product Of Capital (MP C ) Price of Capital (P C ) =

20. Copyright 2008 The McGraw-Hill Companies 25-19 Optimal Combination of Resources The Profit-Maximizing Rule MRP (Resource) = P (Resource) Profit Maximizing Combination of Resources MRP L PLPL MRP C PCPC = = 1 MRP L PLPL = MRP C PCPC = and W 25.2

21. Copyright 2008 The McGraw-Hill Companies 25-20 Marginal Productivity Theory of Income Distribution Inequality Market Imperfections O 25.2

22. Copyright 2008 The McGraw-Hill Companies 25-21 Input Substitution: Banks Using More ATMs at the Expense of Human Teller Jobs Consistency With Least-Cost Combination of Resources ATMs Debut About 35 Years Ago Today Nearly 400,000 Perform About 11 Billion U.S. Transactions 80,000 Human Tellers Eliminated Between 1990 and 2000 Bank Customers Gain Convenience of More Locations While Labor is “Freed-Up” for Other Possibly Better Positions Since Teller Turnover is about 50% Last Word The Case of ATMs

23. Copyright 2008 The McGraw-Hill Companies 25-22 Key Terms derived demand marginal product (MP) marginal revenue product (MRP) marginal resource cost (MRC) substitution effect output effect elasticity of resource demand least-cost combination of resources profit maximizing combination of resourcesprofit maximizing combination of resources marginal productivity theory of income distributionmarginal productivity theory of income distribution

24. Copyright 2008 The McGraw-Hill Companies 25-23 Next Chapter Preview… Wage Determination