Transcript The Demand for Resourcesx

The Demand for Resources
In a SG / NG world
Please listen to the audio as you work through the slides.
The Microeconomics of Resource Markets
The Demand for Resources
in a SG/NG world
The pricing and employment of resources Relative to the circular flow model – top loop
Learning Objectives:
1. The significance of resource pricing relative to resource
allocation among firms and industries, the determination of
income, and cost minimization for a firm.
2. The marginal productivity theory of resource demand
3. The determinants of resource demand
4. The determinants of the elasticity of resource demand.
5. The determination of the optimal combination of resources.
Significance of resource pricing
Resource availability and therefore pricing, is a
major factor in producing changes in our economy.
How might a SG/NG future affect resource prices?
Resources Essential to Economic Growth
Apply the concept of “Peak Oil” to other resources
•Water - Implications for food production
•Phosphorous rock (phosphate) - (food production) – 1989 peak
•The 17 Rare Earth Elements: 97% come from China
– Indium – flat panel TV screens (known deposits exhausted by 2028)
– Gallium – liquid crystal screens (known deposits exhausted by 2017)
– Palladium
• Autocatalytic in auto exhaust systems
• Multilayer ceramic capacitors in computers & cell phones
• Stockpiles nearing depletion
– Tantalum – cell phones – 1964 peak
Significance of Resource Pricing
• Issues based on resource pricing
• A firm’s Product mix – determined by resource
pricing (Cell phones - Coltan , TV’s, soft drinks)
• Resource allocation (to firms) – determined by
resource pricing (the rich and strong survive)
• Money Income Determination
• Resource prices translate into Income sources
- - Wages, rents, interest, profit
•(the rich get richer)
Significance of resource pricing
How does resource pricing impact Resource Allocation?
1. Product prices allocate finished goods and services to buyers
(the rich get more)
2. Resource prices allocate resources among industries, firms,
and countries. (interesting global north / global south
impact – the rich get more)
3. Efficient allocation of resources over time calls for the
continuing shift of resources from one use to another. (and
from place to place)
4. But, how far can we push this?
Significance of resource pricing
Cost Minimization
• Resources are costs to the firm
• The profit maximizing firm seeks productive
efficiency – find the least cost combination of
resources
• What happens to an economy when firms drive down
the cost of labor?
Significance of resource pricing
Cost Minimization
• Consider the case of the bread company
•
Inputs:
• Flour
• Water (for cooking, cleaning, etc.)
• Electricity
• Heat
• Labor
• Capital (ovens, etc.)
• Resource prices play a significant role in
determining the quantities of resources to be
combined in producing each good or service
Significance of resource pricing
Cost Minimization
• Why should a firm care about what happens in
another part of the world?
• Examples of a few resources
• Rare Earth Elements – China
• Palladium – (catalytic converters, fuel cells,
electronics) South Africa, Canada, Russia, Montana
• Uranium – Canada 20%, Kazakstan 27%, Australia
15%
• Nickel – Canada (1/3 of worlds nickel), Russia
Significance of resource pricing
Policy Issues
Such as:
• How should we prepare for a SG/NG future?
• Should the government influence resource
demand or allocation through taxes and subsidies
– or is the government already doing that?
• How can we reduce resource demand?
Marginal Productivity Theory of Resource Demand
Resource Demand as a Derived Demand
Objective:
Focus on the Firm:
1. Find the least-cost combination of resources
2. Find the profit maximizing combination of resources
What might be some implications of a SG/NG future?
Marginal Productivity Theory of Resource Demand
Resource Demand as a Derived Demand
Assumptions:
• Competitive product and resource markets
• Firm is a Price taker and wage taker (pure competition)
Resource Demand - Derived from what?
1.
2.
3.
4.
Demand for the final product
Productivity of the resource
Price of the good or service
Marginal Productivity (MP)
• Remember diminishing marginal product?
5. Marginal Revenue Product (MRP)
Marginal Productivity Theory of Resource Demand
Marginal Revenue Product (MRP) definition –
The change in total revenue resulting from the use of each
additional unit of a resource.
MRP Schedule = firm’s demand schedule for the resource
Important point!!!!:
•To maximize profit, a firm should hire
additional units of a specific resource as long
as each successive unit adds more to the
firm’s revenue that it adds to total cost
Marginal Productivity Theory of Resource Demand
Marginal
Revenue
Product
=
Change in
Total Revenue
Unit change in
Resource Quantity
Marginal Productivity Theory of Resource Demand
Marginal Resource Cost:
The amount that each additional unit of a resource adds to the
firm’s total (resource) cost.
What do we mean by resource cost?
Is it just the price of the resource?
What are the implications of that?
Marginal
Resource =
Cost
Change in Total (Resource) Cost
Unit change in Resource Quantity
Marginal Productivity Theory
of Resource Demand
Rule for Employing Resources:
MRP = MRC
It will be profitable for a firm to hire
additional units of a resource up the point
at which that resource’s MRP is equal to its
MRC.
This must apply for each resource used by the firm!
Determinants of Resource Demand
1. Changes in Product Demand
An increase in product demand will increase the
demand for resources
What are some products with growing demand?
2. Changes in Productivity
An increase in the productivity of a resource will
cause an increase in its demand.
What are some resources with growing productivity?
Are there upper limits to productivity increases?
Determinants of Resource Demand
What could cause changes in productivity?
1. Quantities of Other Resources
• The MP of a resource will vary with the quantities of the other
resources used with it.
• Example: The greater the amount of capital and land used with
labor, the greater will be labor’s MP and thus demand for labor
2. Technological Advance
• The better the quality of capital, the greater the productivity of labor
used with it. Example - Dock workers, auto assembly workers,
knowledge workers.
3. Quality of the Variable Resource
• Improvements in the quality of labor will increase its MP and
therefore its demand.
Determinants of Resource Demand
What could cause changes in productivity?
4. Changes in the Prices of Other Resources may change the demand
for a specific resource.
• The direction of change in labor demand will depend on whether
labor & capital are substitutes or compliments.
Watch This!
The case of substitute resources
Assume two resources (capital and labor) are substitutable and the
price of capital falls relative to the price of labor. What will
happen to the demand for labor?
The impact on demand for labor will depend on the net effect of the:
• Substitution Effect
• Output Effect
Determinants of Resource Demand
A. Substitution Effect:
• Here the substitution effect decreases the demand for labor relative to capital
and lowers the cost of production.
• The fall in the price of machines prompts the firm to substitute machines
for labor
B. Output Effect
• With lower costs, the firm finds it profitable to produce and sell a higher level of
output.
• The higher level of output increases the demand for “all” resources, including labor.
C. Net Effect on the demand for labor depends on the relative sizes of these 2 effects
1. If the substitution effect > the output effect, a decrease in the price of capital decreases
the demand for labor
2. If the substitution effect < the output effect, a decrease in the price of capital will
increase the demand for labor
Determinants of Resource Demand
The Case of Complementary Resources
When labor and capital are complementary, a decline in the
price of capital increases the demand for labor through the
output effect.
Determinants of Resource Demand
Summary
The demand for labor will increase when:
1. The demand for the product produced by that labor
increases.
2. The productivity (MP) of labor increases.
3. The price of a substitute input decreases, provided the
substitution effect < output effect.
4. The price of a substitute input increases, provided the
substitution effect > the output effect.
5. The price of a complementary input decreases
Elasticity of Resource Demand
The sensitivity of producers to changes in resource prices
Erd =
Percentage change in resource quantity
Percentage change in resource price
Erd > 1 is Elastic
Erd = 1 is Unit-Elastic
Erd < 1 is Inelastic
Elasticity of Resource Demand
What determines the elasticity of resource demand?
1. Ease of Resource Substitutability
• The larger the number of satisfactory substitute resources available,
the greater the elasticity for a particular resource
• Examples: Water, oil, corn used to make ethanol
2. Elasticity of Product Demand
• The greater the elasticity of product demand, the greater the
elasticity of resource demand.
• Examples: Cell phones, insulin
3. Ratio of Resource Cost to Total Cost:
• The larger the proportion of total production costs accounted
for by a resource, the greater the elasticity of demand for that
resource.
Example: Oil used in production of pesticides.
Optimal Combination of Resources (long run)
Two questions a firm must consider:
1. What combination of resources will
minimize costs at a specific level of
output?
2. What combination of resources will
maximize profit?
Optimal Combination of Resources (long run)
Least-Cost Rule
A firm is producing a specific output with the least-cost combination
of resources when the last dollar spent on each resource yields the same
marginal product.
Least-Cost Combination of Resources
MP of Labor
MP of Capital
Price of Labor
Price of Capital
Minimizing cost is not sufficient for maximizing profit.
Optimal Combination of Resources (long run)
• In a purely competitive resource market, the marginal
resource cost (MRC) is equal to the resource price.
• For any competitive resource market our profit maximizing
equation transforms from MRP =MRC to
MRP of the resource = Price of the resource, or (MRP=P).
• This condition must hold for every variable resource!
• In competitive resource markets, a firm will achieve its
profit maximizing combination of resources when P=MRP
for each resource or restated as:
Optimal Combination of Resources (long run)
Profit-Maximizing Combination of Resources
MRPL
MRPC
PL
PC
1
For each resource used by the firm!
Marginal Productivity Theory of Income Distribution
The theory: Income gets distributed according
to contribution to society’s output.
However:
Inequality exists – physical and mental ability,
education and training, etc.
Market Imperfections – presence of labor unions,
discrimination, Externalities
Wage rates and other resource prices frequently are not based
solely on contribution to output!