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Factor Markets: Demand for Resources

Factor Markets: Demand for Resources. Resource Pricing. 1) Money-income distribution: wage, rent, interest, profit 2) Resource allocation: product prices indirectly affect; resource prices directly affect allocative and productive 3) Cost minimization: profit maximization

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Factor Markets: Demand for Resources

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  1. Factor Markets: Demand for Resources

  2. Resource Pricing • 1) Money-income distribution: wage, rent, interest, profit • 2) Resource allocation: product prices indirectly affect; resource prices directly affect allocative and productive • 3) Cost minimization: profit maximization • 4) Policy issues: min. wage, profit tax, etc.

  3. Derived Demand • Who wants a gallon of crude oil? • Indirect satisfaction needs and wants • KEY: firms/employers demand resources, households/workers supply them

  4. Marginal Revenue Product (MRP) • 1) Productivity (marginal product) • 2) Market value/price of good produced (revenue) • MRP= ΔTR/ ΔResource Q

  5. Marginal Resource Cost (MRC) • MRC= Δtotal resource cost/ Δresource Q • MRP=MRC rule: “it will be profitable for a firm to hire additional units of a resource up to the point at which that resource’s MRP is equal to its MRC.” • Inputs rather than outputs • MRP=D

  6. Perfect vs. Imperfect • PC firm’s D for resources is downsloping solely because MP diminishes fixed price • Imperfect competitor’s MRP is downsloping because of DMR and price falls as output increases (less elastic D curve) • IC firms produce less, therefore demand fewer resources • EXCEPT if oligopoly tech progressive greater production + more resources: offsets monopoly power restriction

  7. Determinants Resource Demand • MRP derived from product demand and resource productivity: 2 shifters • Δ Product Demand: Ceteris paribus,“a change in the demand for a product that uses a particular resource will change the demand for the resource in the same direction”

  8. Δ Productivity • Ceteris paribus, “a change in the productivity of a resource will change the demand for the resource in the same direction” • 1) Quantities of other resources: capital intensity • 2) Technological progress: quality of capital • 2) Quality of the variable resource: more skilled labor •  advanced workers paid better: productivity major determinant of wages (except for last decade in US30%+ increase prod, 10% increase wages)

  9. Changes Prices Other Resources • Substitute Resources • 1) Substitution effect: “a firm will purchase more of an input whose relative price has declined” and vice versa • 2) Output effect: lower costs greater output increase D all resources: “the firm will purchase more of one particular input when the price of the other input falls” and vice versa • 3) Net effect: sub and output effects work in opposite directions • Depends on which is stronger

  10. Complementary Resources • No substitution effect: fixed proportions • Output effect: “A change in the price of a resource will cause the demand for a complementary resource to change in the opposite direction.”

  11. Demand for labor will increase when • 1) demand for product increases • 2) Productivity (MP) of labor increases • 3) Price of substitute input decreases; provided output>sub • 4) Price of substitute input increases; provided sub>output • 5) Price of complementary input decreases • (Reverse the effects to explain decrease labor demand)

  12. Elasticity of Resource Demand • Erd= %ΔRQ/% ΔRP • Erd>1 elastic; <1 inelastic; =1 unit • Determinants: • 1) Rate of MP decline (just like MU) • 2) Ease of substitutability (“shiftability”) • 3) Elasticity of product demand: go together • 4) Ratio of resource cost to total cost: larger proportion greater elasticity

  13. Optimal Combination Resources • 1)What combination minimizes cost? • 2) What combination maximizes profit? • 1) Least-Cost Rule: “when last dollar spent on each resource yields the same marginal product”; assume two inputs, labor and capital • MPl/Pl = MPc/Pc • Basically balancing margins • Able produce larger output specific cost = specific output smaller cost • “All the long-run cost curves…assume that the least-cost combination of inputs has been realized at each level of output”; if not x-inefficiency

  14. 2) Profit-Maximizing Combo • “When each resource is employed to the point at which its marginal revenue product equals its price” • We need both PL=MRPL and PC=MRPC • MRPL/PL = MRPC/PC = 1 • If profit-maximizing must be cost-minimizing; reverse not necessarily true

  15. Marginal Productivity Theory of Income Distribution • Resources paid according to contribution to society’s output: Ethically “To each according to what he or she creates” • But • 1) Inequality: unequal distribution to begin with: genetics + social inequality; property resources unequally distributed (inheritance) gov’t intervention • 2) Market imperfections

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