The Supply and Demand for Productive Resources

Two classes of productive resources:Non-human resources:

Physical capitalLand Natural resources

Human resources: (Human capital)Composed of the skills,

knowledge, and experience of workers.

HouseholdsBusinesses

Goods and Services Markets

Resource Markets Resources

Payments $$

. a. Businesses supply goods & services b. Receive sales revenue. c. Households, (investors, governments, and foreigners) demand goods. a. Business firms demand

resources b. Households supply labor and other resourcesc. in exchange for income.

Derived Demand for Resources

The demand for resources is derived from the demand for the products that the resources help produce.

A service station hires mechanics because of their customers’ demand for repair services.

Demand Inversely Related to PriceSubstitution in production:

•If one input becomes more expensive, producers will shift to lower-cost inputs.

•The better the substitute inputs, the more elastic the demand for the resource.

Substitution in consumption:•A high resource prices raises the product

price and consumers substitute other goods.

•The more elastic product’s demand, the more elastic is the demand for the resource.

• As a resource price increases, producers will:• use substitute resources, or• face higher costs

The Demand for Resources

These lead to higher prices and a reduction in consumption.• At the lower output, firms use less of the resource that increased in price.

• Both contribute to the inverse relationship between the price and quantity demanded of a resource.

D

P2

Q1

P1

A

Q2

Resource price

Quantity

B

Dsr

P2

Q1

P1

B

Q2

Resource price

Quantity

• the easier it is to switch to substitute inputs, and/or,• the more elastic the demand for the products the resource helps to produce.

• With time, the demand for a resource becomes more elastic (Dsr Dlr):

Q3

• The long-run demand for a resource is almost always more elastic than demand in the short-run.

Time and the Elasticity of Demand for Resources

Dlr

A

C

Shifting Resource Demand1. Changes in product demand

- cause the demand for its input resources to change in the same direction.

2. Changes in the productivity of a resource - If productivity rises, the demand rises.

3. Changes in the price of related inputs - The following increase resource demand:

• an increase in a substitute input price• a decrease in a complimentary input

price• The following decrease resource

demand:• a decrease in a substitute input price• an increase in a complimentary input

price

What effect would each of the following tend to have on a firm’s demand for a particular resource, increase (a) or decrease (b) a. An increase in the demand for the firm’s product ___b. A decrease in the amounts of all other resources the firm employs. ____c. An increase in the productivity of the resource ____d. An increase in the price of a substitute resource when the output effect is greater than the substitution effect. _____e. A decrease in the price of a complementary resource. ___f. A decrease in the price of a substitute resource when the substitution effect is greater than the output effect. ___

aaabbb

MRP = Marginalrevenue

Marginalproduct *

Hiring Resources• Hire up to where Marginal Revenue Product = Resource

Price

Marginal revenue product (MRP):Change in total revenue from the employment of an additional unit of a resource.

Marginal

product

=change in output

change in variable input

Marginal

revenue

=change in revenuechange in output

Remember –

Units of

Labor

Total Output

Marginal

Product

Product Price

Total Revenu

e

MRP

1 14 $5

2 26 $5

3 37 $5

4 46 $5

5 53 $5

6 58 $5

7 62 $5

Units of

Labor

Total Output

Marginal

Product

Product Price

Total Revenu

e

MRP

1 14 14 $5 70 70

2 26 12 $5 130 60

3 37 11 $5 185 55

4 46 9 $5 230 45

5 53 7 $5 265 35

6 58 5 $5 290 25

7 62 4 $5 310 20

Total Revenue

(5)

Marginal Product

(3)

Output(per week)

(2)

Variablefactor

(1)

Price (per unit)

(4)

0.0 5.0 9.0

12.014.0

15.516.517.0

5.0 $1,0004.0 $1,8003.0 $2,4002.0 $2,8001.5 $3,1001.0 $3,3000.5 $3,400

----- $ 0 0 1 2 3 4 5 6 7

$200$200$200$200$200$200$200$200

Numbers, Numbers, Numbers

MRP

(6)

1000 800 600 400 300 200 100

----

change in (2)change in (1)= (2) * (4)= (3) * (4)=

• A firm sells its product for $200 each (4).

• The marginal product (3) shows how output changes as workers (units of labor) are hired• The marginal revenue product (6) shows how hiring an additional worker affects the firm’s total revenue.

1000

MRP

1000 800 600 400 300 200 100

----

Variablefactor 0 1 2 3 4 5 6 7

800

600

400

200

1 2 3 4 5 6 7

Demand for ResourcesResource price

Quantity

• The MRP curve is the firm’s short run demand curve for the resource.

•It slopes downward because the marginal product of the resource falls as more of it is used with a fixed amount of other resources.

• How will they decide how many to hire?

Choosing Between Resources1. Maximize Profits – find the output level

where profits are maximized.

• Deal with each resource independently.• Hire until:

- MRP labor = Price of labor- MRP capital = Price of capital

MP of skilled labor

Price of skilled labor= MP of unskilled labor

Price of unskilled labor=

MP of machine

Price ( ) of machinerentalvalue

Choosing Between Resources2. Minimizing the Cost of Production

-check the Marginal Productivity per $ -choose the greater up to desired output.

• If MP labor = 15 and Price = $5, then MP/P = 3• If MP capital = 20 and Price = $5, then MP/P = 4 • use capital

Units of Capital

MP of Capital

Units of Labor

MP of Labor

1 24 1 11

2 21 2 9

3 18 3 8

4 15 4 7

5 9 5 6

6 6 6 4

7 3 7 1

8 1 8 .5

a. What is the least-cost combination of labor and capital to employ in producing 80 units of output? ____ C and _____ Lb. What is the profit-maximizing combination of capital and labor for the firm to employ? ___ C ___ L Total output: __

Quan. Total Product

Marginal Product

Total Revenue

MRP Quan. Total Product

Marginal Product

Total Revenue

MRP

0 0 0 $0 $0 0 0 0 $0 $0

1 12 12 24 24 1 13 13 26 26

2 22 10 44 20 2 22 9 44 18

3 28 6 56 12 3 28 6 56 12

4 33 5 66 10 4 32 4 64 8

5 37 4 74 8 5 35 3 70 6

6 40 3 80 6 6 37 2 74 4

7 42 2 84 4 7 38 1 76 2

Labor (price = $8)Capital (price = $12)

Minimize cost of 50 units of output Maximize profits

To maximize profits would you: (a) increase Capital (b) increase Labor (c) keep both the same (d) increase both (e) decrease one or both in the following cases:

a. MRPL = $8; PL = $4; MRPC = $8, PC = $4.

b. MRPL= $10; PL = $12; MRPC = $14, PC = $9.

c. MRPL = $6; PL = $6; MRPC = $12, PC = $12.

d. MRPL = $22; PL = $26; MRPC = $16, PC = $19

• The short-run supply elasticity is determined by how easily the resource can be transferred from one use to another, or resource mobility. • If resources are highly mobile then the

supply curve will be elastic even in the short run.

• The supply of a resource will be more elastic in the long run than the short run.

• In the long run, investment can increase the supply of both physical and human resources.

Supply Positively Related to Price

S

P2

Q1

P1

Q2

B

A

Resource SupplyResource price

Quantity

• As a resource’s price increases, individuals have a greater incentive to supply it.• Thus, a positive relationship will exist between a resource’s price and the quantity supplied in the market.

Time and Resource Supply Elasticity

S

P2

Q1

P1

Q2

Resource price

Quantity

• The supply of CPA services for example

• If CPA wages increase from P1 to P2, the short-run response will be an increase in CPA services from Q1 to Q2. Some CPAs work more and some come out of retirement.

• At the higher wage P2, Q3 CPA services are supplied to the market.

• The long-run supply of a resource is almost always more elastic than short-run supply.

• Given time, supply of the resource (CPAs) becomes more elastic. (Ssr Slr) as more individuals choose this field of training.

Q3

Slr

C

A

B

Supply Demand

andand

Resource Prices

Resources Prices• Determined by supply and demand.• Changes in the market prices influence the

decisions of both users and suppliers.• Higher resource prices - more substitutes

used.• Higher resource prices - more of the

resource supplied.

Q1

P1

D

S

A

EquilibriumWage(resource price)

Quantity

•market demand is downward sloping, reflecting declining MRP • market supply slopes upward as higher prices (wages) induce individuals to supply more.

•price P1 brings the choices of buyers and sellers into harmony.

• At equilibrium price P1, the quantity demanded will just equal the quantity supplied.

The Coordinating Function of Resource Prices

• Changes in resource prices in response to changing market conditions are essential for efficient allocation of resources.

• Profit is a reward for entrepreneurs who are able to see and act on opportunities to put resources to higher valued uses.

leads

to an increase in demand for electricians (resource market).

Adjusting to Dynamic Change• An increase in demand for housing (product market) …

• In the product market, the equilibrium price and output of houses both rise (to P2 and Q2).• In the resource market, the equilibrium price and

output of electrician services will increase substantially (to P2 and Q2).

D2

PriceProductMarket

ResourceMarket

P1

Q1

D1

Q2

P2

D2

Quantity

P1

P2

S

D1

SsrPrice(wage)

Q1 Q2

Quantity

D2

PriceProductMarket

ResourceMarket

P1

Q1

D1

Q2

P2

D2

Quantity

P1

P2

S

D1

SsrPrice(wage)

Q1 Q2

Quantity

Adjusting to Dynamic Change

Slr

P3

Q3

• This significant increase in price and modest increase in

output is a characteristic of the highly inelastic nature of the short-run supply of the skilled electrician’s labor.• The higher resource price will attract new human capital investments and, with time, the resource supply curve will become more elastic, moderating the resource price (to P3) and increasing its quantity supplied (to Q3).

Occupation Thousand Jobs Percentage2000 2010 Increase

Computer software engineer, applications

380 760 100%

Computer support specialists 506 996 97Computer software engineers, systems

317 601 90

Computer systems administrators 229 416 82Data communication analysts 119 211 77Desktop publishers 38 63 66Database administrators 106 176 66Personal and home care aides 414 672 62Computer system analysts 431 689 60Medical assistants 329 516 57

The 10 Fastest Growing US Occupations in Percentage Terms, 2000-2010

Thousand Jobs PercentageOccupation 2000 2010 Increase

Railroad brake, signal, and switch operators

22 9 -59%

Shoe machine operators 9 4 -56Telephone operators 54 35 -35Radio mechanics 7 5 -29Loan interviewers 139 101 -27Motion picture projectionists 11 8 -27Meter readers 49 36 -27Rail track layers 12 9 -25Farmers and ranchers 1294 965 -25Shoe and leather workers 19 15 -21

The 10 Most Rapidly Declining US Occupations in Percentage Terms,

2000-2010

1. The demand curve for a human resource will be more elastic thea.more and better substitutes are available for it. b.more difficult it is to substitute other resources for it. c. more inelastic the demand for the product the resource is used to produce.d.shorter the time period under consideration.

2. If skilled labor is three times the cost of unskilled labor, a profit-maximizing firm will vary the quantity of each type of labor until thea. marginal product of each is the same.b. amount of unskilled labor used is three times the quantity of skilled labor used.c. amount of unskilled labor used is one-third the quantity of skilled labor used.d. marginal product of unskilled labor is one-third that of skilled labor.

3.The notion that the demand for inputs depends on the demand for outputs is termeda. inverse demand. b. derived demand.c. proportional demand. d. complementary demand.4.What concept implies that a firm’s MRP curve for labor will slope downward in the short run?a.diminishing marginal returns b. the law of supplyc. the law of decreasing cost d. the price equalization

principle5.Which one of the following labor resources will likely have the most inelastic supply schedule in the short run?a.filling station attendants b. sales clerksc. construction laborers d. dentists

6. Suppose the United Auto Workers’ Union succeeded in obtaining a 10 percent increase in the wages of its workers and that the wage increase caused automobile prices to rise. Employment in the auto industry would be most likely to decline significantly if a. the demand for American-made automobiles was highly elastic.b. the supply of foreign-produced automobiles was highly inelastic.c. American consumers considered foreign automobiles a poor substitute for American automobiles.d. the demand for American automobiles was relatively constant and highly inelastic.7. If the demand for a consumer good decreases, the demand for resources required to make the good willa. increase.b. remain the same, but the quantity demanded will increase.c. decrease.d. increase or decrease depending on whether the demand for the product is elastic or inelastic.

The following chart indicates the reductions in total losses due to theft if a jewelry store hires additional security guards.

Number Dollar Value ofof Guards Thefts Prevented

1 1502 2503 3404 4205 4906 540

8. If the security guards can be hired for $75 per day, how many guards should the shop hire?a. 2 b. 3 c. 4 d. 5 e. 6

9.An increase in the demand for a product will cause

a. both the demand for and prices of the resources used to produce the product to decline. b. both the demand for and prices of the resources used to produce the product to increase.c. the demand for the resources used to produce the product to increase and their prices to decline. d. the demand for the resources used to produce the product to decline and their prices to increase.

10. If the demand for workers with doctorate degrees in economics increases, we would expecta. the wages of economists to increase in the short run and the number of economists employed to increase in the long run.b. the supply of economists to increase in the short run and their wages to rise in the long run.c. a rapid increase in the supply of economists, causing wages to remain constant.d. the wages of economists to decrease in the short run and the number of economists employed to increase in the long run.