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Resource Demand

Resource Demand. The fun and excitement of the purchase of the factors of production. Keys to remember in the resource market. The firms are the demanders of resources The households are the suppliers of resources. Key questions to consider.

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Resource Demand

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  1. Resource Demand The fun and excitement of the purchase of the factors of production

  2. Keys to remember in the resource market • The firms are the demanders of resources • The households are the suppliers of resources

  3. Key questions to consider • Think like an economist, what would cause a firm to want to hire you? • A firm would hire you as long as…? • What would you call a market where a firm can hire all the labor it wants, at the exact same price, and all the workers are identical?

  4. Resource Demand • Resource demand is derived from product demand • The more a product is demanded; the more the resources for that product will be demanded • Remember, in this case the firm is the CONSUMER and has a DEMAND curve for labor • The demand for resources is predicated on 2 ideas: • The productivity of the resource • The value of the good that is produced

  5. Marginal Revenue Product/Marginal Resource Cost • Marginal Revenue Product (MRP) is the additional revenue that is generated by the addition of one more worker • We find MRP by dividing the change in total revenue by the change in resource input • MRP= TR/ Q • Marginal Resource Cost (MRC) is the additional cost associated with the addition of one more worker • We find MRC by dividing the change in Total Resource Cost by the change in resource input • MRC= TC/ Q Let’s re-examine one of our first questions in economics terms: A firm would be willing to hire you as long as …?

  6. MRC=MRP Rule • A firm will add an additional unit of a resource as long as the unit adds more to revenue than it does to cost • We use the MRC=MRP rule as a stop sign to let us know when to stop hiring additional resources

  7. MRP as the Demand Curve • MRC is the WAGE RATE for labor • We can say that the MRC is the PRICE of additional labor to the firm • At higher prices, firms employ less labor; at lower prices firm employ more labor. • This is for a PC market MRC MRP

  8. Determinants of Resource Demand • Change in Product Demand • An increase in demand for a product will increase the demand for the resources to make that product • A decrease in demand for a product will decrease the demand for the resources to make the product

  9. Determinants of Resource Demand • Change in Productivity • A change in productivity of a resource will change the demand for that resource in the same direction. • Quantities of other resources • The productivity of labor will increase with the addition of capital resources • Technological Progress • The improvement of technology will improve the quality of other resources • Quality of Variable Resources • Improvement in the quality of the resource itself will increase demand for the resource

  10. Determinants of Resource Demand • Change in the price of other resources • Substitute Resources • Substitution Effect- with the decline in the price of machinery, a firm will substitute machinery for labor • Output Effect- with the decline in cost form the substitution effect, the output will increase and increase the demand for labor • Net Effect- The Substitution Effect and the Output Effect work in opposite directions, the net effect is the combination of the two • Complementary Resources • A change in the price of a resource will cause the demand for a complementary resource in the opposite direction

  11. Elasticity of Resource Demand • The change in the quantity of a resource used compared to the change in the price of that resource • % change Q / % change in price • Factors that affect elasticity of resource demand • Rate of Marginal Product Decline • The faster the decline of MP, the more inelastic the demand for the resource • Ease of Substitutability • The larger the number of close substitutes the greater the elasticity • Elasticity of product demand • The greater the elasticity of product demand the greater the elasticity of resource demand • Ratio of resource to the total • The larger the proportion of costs a resource makes up, the greater the elasticity of demand for the resource

  12. Marginal Physical Product MPP is the change in the quantity of total product resulting from a unit change in a variable input

  13. Marginal Revenue Product • What am I worth to my employer? • MRPL (Marginal Revenue Product of Labor): a measure of whaht the next unit of a resource, such as labor, brings to the firm • In a PC market structure, the marginal revenue is simply the price of the product • MRP = Change in Total Revenue/Change is Resource Quantity= MR * MPL = P * MPL

  14. Molly’s Lemonade Stand

  15. Molly’s Lemonade Stand

  16. Marginal Resource Cost as a Wage • In the case of resource hiring, the marginal benefit is MRP • The cost of resource hiring is marginal resource cost (MRC) MRC= change in total resource cost/change in resource quantity = Wage

  17. The Least Cost Rule • As producers, we would like to find the best (cost minimizing) combination of 2 inputs, given the prices & production constraint • LEAST COST HIRING RULE 1. You must produce Q (quantity) units of output, now find the least-cost ($TC) way of doing so 2. You can only spend $TC, now find the highest level of output

  18. The Least Cost Rule • You are using the Least Cost Production Method when the last dollar spent on each resource yields the same marginal product per dollar • In equation form: • MPL/PL = MPk/Pk • READ AS: marginal productivity of labor/price of labor = marginal productivity capital/price of capital • We should shift resources to the resource that is giving us MORE MP/$ • When they become equal we have reached the least possible cost of production

  19. Supply of Labor • If you have ever had a job, you have supplied labor • If the price of labor increases, more hours of labor should be supplied (just like the law of supply)

  20. Ex: The aging population in the US is giving a boost to the market for nurses. An increase in the demand for nurses increases both wage and employment of nurses as seen in the graph below. S Wages 2005 Wages 1995 D1 D

  21. Market Power in Product Markets • If a firm is a price maker, then MR > P • Monopoly markets produce less output (and charge higher prices), which in turn, a monopoly demands less resources, including labor

  22. What does labor demand look like for a monopoly vs competitive market? wage MRPc MRPm Lm Lc M=monopoly C= competitive market L=labor

  23. Market Power in Factor Markets • When a producer has extreme power in the factor market, we call them a wage-setting monopsonist & the wage is set below marginal factor cost • In a competitive labor market, the firm would employ all it wanted at the market determined wage • In a monopsony, the employer must increase the wage to increase the quantity of labor supplied • The labor supply of the firm is upward sloping • MFC (marginal factor cost) is now greater than the wage

  24. What does this mean? • Under monopsony, firms will hire where Lm < Lc • Monopsony firms will pay Wm < Wc =MRPL

  25. MFC S Wc Wm MRPc Lm Lc

  26. Economic Rent as a Factor of Production • Economic Rent: the minimum amount of money that some owner of a factor of production must receive in order to use an asset for a given purpose. • In labor terms, it is the minimum wage a person must receive in order to work. • In capital & land terms, economic rent is the amount of money needed to breakeven when either land or capital is used for any given purpose.

  27. Economic rent cont. • supply of land and other natural resources is inelastic • When the supply of a factor of production is perfectly inelastic, the price paid to the factor cannot provide an incentive to produce more • That factor is called a surplus or, economic rent • The amount of economic rent received by owners of land & other factors fixed in supply (dependent upon demand) is determined by the productivity of each factor

  28. Theory of Economic Rent • Since a tax on land or any other factor with a fixed supply doesn’t affect the amount of that factor available to society, all economic rent could be taxed away with no cost to society (Economist Henry George) Critics of this theory say, the supply of land for any use is not perfectly inelastic-users of land just as with other factors of production, must bid the land away from alternative uses, thus, rent is just a cost of production

  29. Example scenario: Agricultural land near a large city was selling for $3,000 an acre last year. Now a subdivision is being developed on this land, and it is selling for $50,000 an acre. Why did the price rise so dramatically? Do you think it is fair that the owners of this land reaped such a large and sudden return for no effort on their part?

  30. Example #2 A professional basketball player earns $850,000 a year. The next-best alternative for this player might be as a high school coach for $40,000 a year. Should $810,000 of his current salary be considered wages or rent (an economic surplus)? If a large part of the wages and salaries of many highly paid athletes, entertainers and others is considered as economic-surplus payments (not necessary to attract people into a particular line of work), does this suggest that such incomes should be taxed heavily?

  31. Role of Interest Rates A. Interest rates are the price paid for the use of money (loanable funds) B. Like other prices, the price of money (an interest rate) is determined by the supply of and demand for loanable funds. C. A real interest rate is the nominal rate of interest minus inflation. D. Real interest rates influence investment decisions.

  32. The Role of Profit in a Market Economy 1. Investment in Research & Development. This leads to better technology and dynamic efficiency. This profit is particularly important for some industries such as oil exploration and car manufacture. Without this investment the economy will stagnate and lose international competitiveness, leading to job losses in some sectors. 2. Reward for Shareholders: Shareholders are given dividends. Higher profit leads to higher dividends and encourages people to buy shares. Shareholders are an important source of finance for firms. Profit is important to be able to renumerate shareholders. 3. High Profit should Attract New Firms into the industry: For example, the high price of oil and hence profits for oil companies should encourage firms to develop new oil fields. This assumes the market is contestable and new firms can actually enter.

  33. Role of profit cont. 4. Risk Bearing Economies: Profit can be saved and provide insurance for an unexpected downturn, such as recession or rapid appreciation in the exchange rate. 5. Tax Revenues: Governments charge corporation tax on company profits and this provides several billion pound of tax revenue per year. In UK the corporation tax rate is 20%

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