Download Factor Markets

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
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?
Resource Demand
 The demand for
 Resource demand is
derived from product
resources is predicated
demand
on 2 ideas:
 The more a product is
1. The productivity of the
demanded; the more the
resource
resources for that product
will be demanded
2. The value of the good
 Remember, in this case the
that is produced
firm is the CONSUMER
and has a DEMAND curve
for labor
Marginal Revenue
Product/Marginal Resource Cost
 Marginal Revenue Product
(MRP) is the additional
revenue that is generated
by the addition of one
more worker
 Marginal Resource Cost
(MRC) is the additional
cost associated with the
addition of one more
worker
 We find MRP by dividing
the change in total revenue
by the change in resource
input
 We find MRC by dividing
the change in Total
Resource Cost by the
change in resource input
 MRP=
 MRC=
TR/ Q
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 …?
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
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
16
14
12
10
8
6
MRC
4
2
MRP
0
0 1 2 3 4 5 6 7 8 9 10
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
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.
1.
Quantities of other resources
a.
2.
Technological Progress
a.
3.
The productivity of labor will increase with the addition of
capital resources
The improvement of technology will improve the quality of
other resources
Quality of Variable Resources
a.
Improvement in the quality of the resource itself will increase
demand for the resource
Determinants of Resource Demand

Change in the price of other resources
1.
Substitute Resources
a.
Substitution Effect- with the decline in the price of
machinery, a firm will substitute machinery for labor
b. Output Effect- with the decline in cost form the substitution
effect, the output will increase and increase the demand for
labor
c.
2.
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.
A change in the price of a resource will cause the demand for
a complementary resource in the opposite direction
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

1.
Rate of Marginal Product Decline

2.
Ease of Substitutability

3.
The larger the number of close substitutes the greater the elasticity
Elasticity of product demand

4.
The faster the decline of MP, the more inelastic the demand for the
resource
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
Marginal Physical Product
MPP is the change in the quantity of total
product resulting from a unit change in a
variable input
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
Molly’s Lemonade Stand
Labor
Input
(workers/
hour)
Total
Product
TPL
cups/hour
Marginal
Product
(MPL)
Marginal
Revenue
(MR=P)
0
0
1
25
$.50
2
45
$.50
3
60
$.50
4
70
$.50
-
Marginal Revenue
Product MRPL =
MPL * MR
Molly’s Lemonade Stand
Labor
Input
(workers/
hour)
Total
Product
TPL
cups/hour
0
0
1
25
2
Marginal
Product
(MPL)
Marginal
Revenue
(MR=P)
Marginal Revenue
Product MRPL =
MPL * MR
25
$.50
$12.50
45
20
$.50
$10.00
3
60
15
$.50
$7.50
4
70
10
$.50
$5.00
-
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
Labor
Input
(workers/
hour)
Total
Product
TPL
cups/hour
Marginal
Product
(MPL)
Marginal
Revenue
(MR=P)
Marginal
Revenue
Product MRPL
= MPL * MR
$.50
$12.50
Marginal
Resource
Cost (MRC=
Wage)
0
0
1
25
2
45
$.50
$7.50
3
60
$.50
$7.50
4
70
$.50
$7.50
5
75
$.50
$7.50
6
70
$.50
$7.50
7
60
$.50
$7.50
25
$7.50
Labor
Input
(workers/
hour)
Total
Product
TPL
cups/hour
Marginal
Product
(MPL)
Marginal
Revenue
(MR=P)
Marginal
Revenue
Product MRPL
= MPL * MR
Marginal
Resource
Cost (MRC=
Wage)
0
0
-
-
-
-
1
25
25
$.50
$12.50
$7.50
2
45
20
$.50
$10.00
$7.50
3
60
15
$.50
$7.50
$7.50
4
70
10
$.50
$5.00
$7.50
5
75
5
$.50
$2.50
$7.50
6
70
-5
$.50
-$2.50
$7.50
7
60
-10
$.50
-$5.00
$7.50
The Least Cost Rule
 As producers, we would like to find the best (cost
minimizing) combination of 2 inputs, given the
prices & production constraint
 LEAST COST HIRING RULE
1. You must produce Q (quantity) units of output,
now find the least-cost ($TC) way of doing so
2. You can only spend $TC, now find the highest
level of output
The Least Cost Rule
 You are using the Least Cost Production Method when the last dollar
spent on each resource yields the same marginal product per dollar
 In equation form:
• MPL/PL = MPk/Pk
• READ AS:
marginal productivity of labor/price of labor =
marginal productivity capital/price of capital
 We should shift resources to the resource that is giving us
MORE MP/$
 When they become equal we have reached the least
possible cost of production
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)
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
D
D1
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
What does labor demand look like for a monopoly vs
competitive market?
wage
MRPc
MRPm
Lm
Lc
M=monopoly
C= competitive market
L=labor
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
Labor supplied to
the firm
Necessary
hourly wage
Total
wage
(L*W)
Marginal Factor
Cost
0
0
1
$4
$4
$4
2
$5
$10
$6
3
$6
$18
$8
4
$7
$28
$10
5
$8
$40
$12
6
$9
$54
$14
-
What does this mean?
 Under monopsony, firms will hire where Lm <
Lc
 Monopsony firms will pay Wm < Wc =MRPL
MFC
S
Wc
Wm
MRPc
Lm
Lc
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.
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
Theory of Economic Rent
1. 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
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?
Example #2
A professional basketball player earns $850,000 a year. The nextbest 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?
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.
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.
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%