Download Elasticity of Resource Demand

Elasticity of Resource Demand


Measure of sensitivity of producers to
changes in resource prices
Erd =
% ∆ in resource Q
% ∆ in resource P
 Erd > 1 = elastic
 Erd < 1 = inelastic
 Erd = 1 = unit elastic
Determinants of Elasticity of
Resource Demand

Ease of resource substitutability
 More easily substituted = more elastic demand
for the resource

Elasticity of product demand
 Product demand is elastic = more elastic
demand for the resource

Resource cost/total cost ratio
 The greater the proportion of total cost
determined by a resource the more elastic the
demand for that resource
 Any change in resource will be more noticeable
Resource cost/Total cost Ratio
Wages
Market for
Labor
Price
Market for Good
X
S1
S2
S=
MRC
S
W
W
P1
P2
P0
+20
%
D
D=
MRP
QL
Quantity of Labor
Q1 Q2 Qo
Quantity of X
If Wages are 100% of production costs =
20% increase in firms’ cost curves =
If Wages are 50% of production costs = 10% ELASTIC
increase in firms’ cost curves = LESS ELASTIC
Optimal Combination of
Resources

Two questions to consider:
1) What is the LEAST-COST combination of
resources to use in producing any given
output?
2) What combination of resources (and
output) will maximize a firm’s profits?
Least-Cost Rule

LEAST-COST RULE =


Costs are minimized where the marginal
product per dollar’s worth of each resource
is the same
Marginal Product and Price
MP(labor) =
MP(capital)
Price(labor)
Price(capital)
A firm can shift resources from labor to
capital and vice versa to achieve
equilibrium
Example
Product Price = $2
Labor = $8.00
Qty
Total
Product
0
0
1
12
2
Marginal
Product
Capital = $12
Qty
Total
Product
Marginal
Product
0
0
12/8 = 1.5
1
13
13/12 = 1.08
22
10/8 =1.25
2
22
9/12 = .75
3
28
6/8 =.75
3
28
6/12 = .5
4
33
5/8 =.625
4
32
4/12 = .33
5
37
4/8 =.5
5
35
3/12 = .25
6
40
3/8 = .375
6
37
2/12 =.167
7
42
2/8 = .25
7
38
1/12 = .08
Why not here???
MP(labor) = MP(capital)
Price(labor) Price(capital)
Profit Maximizing Rule

PROFIT MAXIMIZING RULE
 In a competitive market, the price of the
resource must equal it’s marginal revenue
product. This rule determines level of
employment of labor and capital

Marginal Revenue Product and Price
MRP (labor) = MRP(capital)
Price(labor)
Price(capital)
=1
Example
Product Price = $2
Labor = $8.00
Qty
Capital = $12
Total
Total
Marginal
Product Revenu Revenue
e
Product
(TP x
P)
0
0
0
1
12
24
2
22
3
Qty
Total
Total
Product Revenu
e
(TP x P)
Marginal
Revenue
Product
0
0
0
24/8 = 3.0
1
13
26
26/12 =2.17
44
20/8 = 2.5
2
22
44
18/12 =1.5
28
56
12/8 = 1.5
3
28
56
12/12= 1.0
4
33
66
10/8
=1.25
4
32
64
8/12 = .67
5
37
74
8/8 = 1.0
5
35
70
6/12 = 0.5
6
40
80
6/8 =0.75
6
37
74
4/12 = .33
7
42
84
4/8 = 0.5
7
38
76
2/12 = .167
Marginal Productivity Theory of
Income Distribution

The table show us evident of this theory
 Every factor of production that is sold in the factor
market is paid its equilibrium value of the marginal
product (a.k.a. MRP) or the additional value of employing
the last unit of that factor
 Example: All workers are paid the value of the final
worker and not based on their own individual value

Two concerns about this theory:
 Inequality – workers who produce more value of the
marginal product are paid the same as people who bring
less value of the marginal product
 Market imperfections – the most skilled/productive
factors of production are not always utilized.
Practice Problem #1
In the table below are the marginalproduct and marginal-revenue-product
schedules for resource A and resource
B.
 Both resources are variable and are
employed in purely competitive markets.
 The price of A is $2 and the price of B is
$4

Practice Problem #2
Qty of
Marginal
Resource product
A
of A
employed
1
2
3
4
5
6
7
40
32
24
20
16
8
4
Marginal
revenue
product
of A
$10
8
6
5
4
2
1
Qty of
Marginal
Resource product
B
of B
employed
1
2
3
4
5
6
7
40
36
32
24
16
12
8
Marginal
revenue
product
of B
$10
9
8
6
4
3
2
Practice Problem #1
1.
2.
3.
What is the least-cost combination of
resources A and B that would enable
the firm to produce 240 units of output
What is the profit-maximizing
combination of A and B?
What is the total output and profit when
the firm is employing the profitmaximizing combination of A and B?
Practice Problem #1 Answers
1.
Using the formula MPA/PA = MPB/PB.


2.
240 units can be produced by employing 5
units of A and 3 units of B (16/$2 = 32/$4).
The sum of the total products of 5A and 3B
equals 240
Use the formula MRPA/PA = MRPB/PB =
1. Profit is maximized by employing 6
units of A and 5 units of B.

($2.00/$2.00 = $4.00/$4.00 = 1)
Practice Problem #1 Answers
3.
As follows:
a. Total output is 288 units.
b. Total cost of resources is $32
[($2x6)+($4x5)].
c. Total revenue is $72 (288 x $.25).
d. Total profit is $40
Practice Problem #2
The table below summarizes the
marginal product and marginal revenue
product information for labor and capital.
 Both resources are variable and are
employed in purely competitive markets
 The price for labor is $1 and the price for
capital is $2

Practice Problem #2
QL
MPL MRP QK
MPK MRP
L
1
2
3
4
5
6
7
20
16
12
10
8
4
2
K
$5
4
3
2.5
2
1
.5
1
2
3
4
5
6
7
20
18
16
12
8
6
4
$5
4.5
4
3
2
1.5
1
Practice Problem #2
1.
2.
3.
What would be the least-cost combination of
labor and capital that would enable the firm
to produce 120 units?
What is the profit-maximizing combination of
labor and capital?
What is the total output and profit when the
firm is employing the profit-maximizing
combinations of labor and capital?
Practice Problem #2 Answers
1.
Use the formula MPL/PL – MPK/PK


2.
120 units can be produced by using 5 units
of labor and 3 units of capital
(8/$1) = (16/$2)
Use the formula MRPL/PL = MRPK/PK
=1


6 units of labor and 5 units of capital
($1/$1) = ($2/$2) = 1
Practice Problem #2 Answer
3.
As follows:




Total output is 144 units
Total cost of resources is $16 [($1x6) +
($2x5)]
Total revenue is $36 (144 x $.25)
Total profit is $20