Chapter 27

Demand for Economic Resources


I. Resource (factor) pricing significance

II. Determining resource prices

III. Resource demand is "derived"

IV. Determining Resources demand

V. Determining factor allocations

VI. Factor relationships affect demand

VII. Elasticity of factor demand

VIII. Individual labor supply

IX. Resource Markets 25 min. Video

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I. Significance of resource (factor) pricing significance
   A. Factor allocation (land, labor, capital, enterprise) will be analyzed.
   B. The combination of "factors" used in production determines 
       1. economic efficiency 
       2. income distribution among factor owners (rent, wages, interest, and profit)

II. Determining resource prices
    A. Supply and demand is the key mechanism for determining resource prices.
    B. This chapter provides an overview of what determines resource demand. 
    C. Chapter 28 examines the supply and demand for labor.
    D. Chapter 29 examines the supply and demand for land, capital and enterprise.
    E. Monopoly interference will come from
        1. Big companies
        2. Big unions
        3. Big governments
        4. Big buying groups like American Association of Retired Persons 
    F. Check out
AP Microeconomics Review Material!
III. Resource demand is "derived" from
      A. Factor productivity
      B. Final product profitability (selling price)
      C. A highly productive resource making an expensive, highly profitable product,
           commands the highest factor price. The idea is to work for a successful 
           company in an expanding industry.

IV. Determining resources demand
      A. Demand for resources is called marginal revenue product (MRP)
          1. Marginal physical product (MPP) is the change in total production 
              which results from hiring one more unit of a resource.
          2. Marginal revenue product (MRP) is the change in total revenue 
              which results from hiring one more unit of a resource
      B. Economics in 60 seconds provides a preview.
          1. Video on Comparing Perfectly Competitive Product and Resource Markets Review
          2. Econ Concepts in 60 Seconds: Calculating MRP and MRC Review in purely competitive
              product and factor markets.
      C. Labor will be the variable resource examined.
      D. Both competitive and noncompetitive product markets will be analyzed.
          1. Perfectly competitive product market
Unit of Resource Purchased Total Product 
Marginal Physical Product of Labor Selling Price of
 Product Produced (P)
Total Revenue
 (TP x P)
Marginal Revenue Product of Labor
1 15 15 3 45 45
2 27 12 3 81 36
3 36 9 3 108 27

          2. Imperfectly competitive product market 
              a. Price of product produced must be lowered to sell more of the product.
              b. As a result resource demand is more inelastic.
              c. Inelastic demand for a resource means the purchaser of the resource can maximize profit by restricting output.

Unit of Resource Purchased Total Product 
Marginal Physical Product of Labor Selling Price of
 Product Produced (P)
Total Revenue
 (TP x P)
Marginal Revenue Product of Labor
1 15 15 3 45 45
2 27 12 2 54 9
3 36 9 1 36 -18
V. Determining factor allocations, which resources perform which tasks.
A. Because resources work together, the optimum proportion of resources to produce a
             product must be determined. 
          1. Optimum proportion is where the products produced by the factors divided by their
               price are equal.

Price of Labor is $8

Price of Capital is $14

Labor Purchased MPPL Labor Purchased MPPL 1 100
1 20 6 8 2 50
2 20 7 6 3 35
3 20 8 6 4 20
4 15 9 4 5 16
5 8 10 2 6 1
         2. Beginning with a labor intensive approach, we add capital until production per dollar of both resources is equal

Buy 1 machine & 10 people 
100/$14 > 2/$8 
so hire more machines and less people

Buy 2 machines & 5 people 
50/$14 > 8/$8 
so hire more machines and less people

Buy 3 machines & 3 people 
35/$14 = 20/$8
2.5 = 2.5

     B. Maximum profit is reached when the MRP of resources is equal to the price paid for
         said resources.  
     1. Hiring more of both will increase revenue by more than expenses but with MRP dropping, 
             eventually hiring more will lower profit.
         2. Hire 6 units of labor and 6 units of capital.


 VI. Factor relationships affect demand.
       A. When resources are substitutes for each other such as labor
            and capital, they compete for investment dollars.
            1. An increase in the productivity of capital will cause the MRP
                of capital to increase relative to the MRP per dollar of labor. 
            2. As a result, capital will be substituted for labor. 
            3. The process of substituting more efficient capital for less
                 efficient labor is called the substitution effect. It began
                 in the Stone Age, accelerated dramatically with the Industrial
                 Revolution and continues to accelerate today. 
            4. An automated welding machine replaces people making
                welders less valuable.
B. When resources are complements to each other such as labor and
     capital, their price and productivity affect each other.
     1. A decrease in the price of capital or an increase in its productivity
         will cause the MRP per dollar of capital to increase. 
     2. This increase in efficiency will cause total output to increase and
          with it the demand (MRP) for all resources including labor. 
     3. The process of increasing the MRP of labor by using capital is
          called the output effect. It began in the Stone Age, accelerated
          dramatically with the Industrial Revolution and continues to
          accelerate today. 
     4. A powered hammer makes carpenters more productive, less
          expensive, and increase the value of carpenters.
VII. Elasticity of factor demand

        B. Many factors affecting resource elasticity of demand
            1. Diminishing return as the faster diminishing returns
                begin, the quicker MPP decreases and the more inelastic
                is resource demand.
           2. High elasticity of product demand increases factor elasticity
               of demand
           3. Number and suitability of substitutes increase elasticity.
               If there are suitable resources available to switch to, 
               firms will switch rather than pay more for a given resource.

    4. Importance of the resource: resources that represent a high proportion
         of a product's total cost will have high elasticity of demand as the
         possible cost saving is substantial and the search for a substitute will
         be intensive.
     5. Time increases elasticity: given enough
C. 1. Read the American Production and Inventory Control Society (APICS)
         and learn how they true to increase the marginal physical product
         of resources and
     2. Read Who Did the Ethanol Tax Credit Benefit? An Event Analysis of
         Subsidy Incidence time, a substitute for expensive resources will be

VIII. Individual labor supply

People do not work at extremely low wages because the opportunity cost of leisure, i.e., wages, is low and it's not worth working. 

People begin to substitute work for leisure as wages are increased as the opportunity cost of leisure (wages) is greater and greater.

But leisure is a superior good and at some point the income effect causes people to increase leisure and work (supply) less even though wages are increased. 

As a result, the supply curve will eventually bend back toward the y-axis.

For more visit Backward bending supply curve of labor from Wikipedia

Why is productivity is up much more than wages?

Answer is in the next few chapters.

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