Resource Demand

The demand for resources is a derived demand - it is derived from the products or services which resources help produce.  For example, people do not demand acres of land or tractors, but they do demand the food products that are produced.

 

The strength of the demand for any resource depends on:

  • productivity of the resource in helping to produce goods

  1. A resource which is highly productive in producing a highly demanded product will be in great demand

  2. Unproductive resources will be in small demand

  3. Keep in mind productivity is affected by the law of diminishing returns

  •   the market value or price of the good

 

 

Marginal Revenue Product

  • marginal revenue product (MRP) is how much total revenue changes with each additional resource input.  This can be found by two ways:

    • finding change in total revenue at each level of resource input

    • multiplying product price by marginal product

  • MRP can be seen as a demand curve for a certain resource because each point on this schedule indicates the amount of the resource which the firm will hire at each point

The purely competitive seller's MRP curve is more elastic.  This is because individual firms cannot change product price no matter what quantity is bought/sold.  Impurely competitive sellers have to lower product price at higher quantities.  Therefore, changes in total revenue are more drastic, and the MRP curve is more steep (inelastic)

                       

 

Marginal Revenue Cost

  • Marginal revenue cost (MRC) is the amount which each additional unit of resource adds to a firm's total cost

  • MRC can be seen as a supply curve for a certain resource

 

 

The MRP = MRC Rule states: It will be profitable for a firm to produce up to the point at which that resource's MRP is equal to its MRC

 

 

Determinants of Resource Demand

  1. Changes in Product Demand

  • Because resource demand is derived from product demand, a shift in the demand for the product will shift the demand for resources in the same direction.

Productivity Changes - If the productivity of a resource increases, its demand will increase.  This can occur in many ways:

nonlabor inputs - the greater the amount of resources with which labor is combined, the greater the productivity

technological improvements

labor quality

 

Prices of Other Resources

Substitute Resources

  • Substitution Effect - if price of machine A declines, machine A will be demanded more, and the demand for labor declines

  • Output Effect - if the price of machinery declines, firms will find it profitable to produce more output, which in turn increases the demand for labor.

    • If the substitution effect outweighs the output effect, a change in the price of a substitute resource will change the demand for labor in the same direction.

    • If the output effect outweighs the substitution effect, a change in the price of a substitute resource will change the demand for labor in the opposite direction.

  • Complementary Goods - a change in the price of a complementary resource will cause the demand for a resource to change in the opposite direction.

 

Factors that Influence Elasticity of Resource Demand

  1. Rate of MP Decline - If the marginal product of labor declines slowly as it is added to a fixed amount of capital, the MRP, or demand curve for labor, will decline slowly and tend to be highly elastic.  This is pretty intuitive since marginal revenue product can be calculated by multiplying marginal product by product price.

  2. 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.

  3. Elasticity of Product Demand - The greater the elasticity of product demand, the greater the elasticity of resource demand.  This is pretty intuitive since resource demand is a derived demand (it is derived from product demand).

  4. Labor-Cost - Total-Cost Ratio - The larger the proportion of total production costs accounted for by a resource, the greater will be the elasticity of demand for that resource.

 

Optimal Combination of Resources:

  • Least-Cost Rule

  • the cost of any output is minimized when the marginal product per dollar's worth of each resource used is the same

  • Expressed mathematically, least cost is obtained when:

  • (MP of Labor / price of labor) = (MP of capital / price of capital)

    • The cost can always be lowered so long as MP1/price1 ? MP2/price2

    • When the firm is not producing at lowest possible costs, this is called X-inefficiency

 

Profit-Maximizing Rule

  • In competitive markets, a firm will realize the most profit maximizing combination when each input is employed up to the point at which its price equals its marginal revenue product:

Expressed mathematically:

  • P1 = MRP1

  • P2 = MRP2

Written another way:

  • (MRP1 / P1) = (MRP2 / P2) = 1

The profit maximizing rule assumes that firms are producing at the lowest cost possible at each level of input.

 


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