ECON 201

Macroeconomics
Chapter 25
THE DEMAND FOR RESOURCES
 Ch 25 Objectives
• The significance of resource pricing.
• How the marginal revenue productivity of a
resource relates to a firm’s demand for that
resource.
• The factors that increase or decrease resource
demand.
• The determinants of elasticity of resource
demand.
• How a competitive firm selects its optimal
combination of resources.
 Review
• Resource
– A natural, human, or manufactured item that
helps produce goods and services.
– A productive agent or factor of production.

• Derived Demand – demand for a resource

that depends on the demand for the product
it helps to produce
 Marginal Product -
• The additional output produced when 1
additional unit of a resource is employed (the
quantity of all other resources employed
remaining constant)
• Equal to the change in total product divided by
the change in the quantity of a resource
employed.
 Marginal revenue Product (MRP)

• The change in a firm’s total revenue when it

employs 1 additional unit of a resource (the
quantity of all other resources employed
remaining constant).
• Equal to the change in total revenue divided
by the change in the quantity of the resource
employed.
 Marginal resource cost (MRC)

• The amount the total cost of employing a

resource increases when a firm employs 1
additional unit of the resource (the quantity of
all other resources employed remaining
contstant).
• Equal to the change in the total cost of the
resource divided by the change in the quantity
of the resource employed.
 MRP=MRC Rule

• The principle that to maximize profit (or

minimize losses), a firm should employ the
quantity of a resource at which its marginal
revenue product (MRP) is equal to its marginal
resource cost (MRC), the latter being the wage
rate in pure competition.
 Substitution Effect

• Change in the quantity demanded of a

consumer good that results from a change in
its relative expensiveness caused by a change
in the product’s price
• The effect of a change in the price of a
resource on the quantity of the resource
employed by a firm, assuming no change in its
output.
 Output Effect

• The situation in which an increase in the price

of one input will increase a firm’s production
costs and reduce its level of output, thus
reducing the demand for other inputs;
conversely for a decrease in the price of the
input.
 Elasticity of resource demand

• A measure of the responsiveness of firms to a

change in the price of a particular resource
they employ or use
• The percentage change in the quantity of the
resource demanded divided by the percentage
change in its price.
 Least-cost combination of
resources
• The quantity of each resource a firm must
employ in order to produce a particular output
at the lowest total cost
• The combination at which the ratio of the
marginal product of a resource to its marginal
resource cost (to its price if the resource is
employed in a competitive market) is the same
for the last dollar spent on each of the
resources employed.
 Profit-maximizing combination of
resources
• The quantity of each resource a firm must
employ to maximize its profit or minimize its
loss
• The combination in which the marginal
revenue product of each resource is equal to
its marginal resource cost (to its price if the
resource is employed in a competitive
market).
 Marginal productivity theory of
income distribution
• The contention that the distribution of income
is equitable when each unit of each resource
receives a money payment equal to its
marginal contribution to the firm’s revenue
(its marginal revenue product).
 Resource Pricing
• Resources are used by firms in producing
goods & services; the prices of these
resources determine the costs of
production.
 4 Reasons to Study Resource Pricing

1. Money –Income determination

2. Cost Minimization
3. Resource allocation
4. Policy Issues
 Money –Income Determination

• Money incomes are determined by

resources supplied by the
households. In other words, firm
expenditures eventually flow back to
the household in the form of wages,
rent, and interest.
 Cost Minimization
• Resource prices are input costs.
• Firms try to minimize input costs to achieve
productive efficiency and maximize profit.
• Resource prices determine the
quantities of land, labor, capital and
entrepreneurial ability to produce each
good or service.
• Resource prices determine resource allocation.
 Resource Allocation

• In efficient allocation of resources over time

calls for the continuing shift of resources from
one use to another.
• Resource pricing is a major factor in producing
those shifts.
Policy Issues/Government involvement

• To what extent should government

redistribute income through taxes & transfers?
• Should govt. control wages to CEOs?
• Increase min wage?
• Do farmers receive enough subsidies?
• Labor unions?
 Derived Demand

• Resource demand is derived from demand for

products that the resources produce.
• Garden Tractors and tires
• Households want to consume food – but not
the tractor, land, labor/expertise of the
agriculturalist.
 Marginal Revenue Product (MRP)

• The change in a firm’s total revenue when it

employs 1 additional unit of a resource (the
quantity of all other resources employed
remaining constant).
• Equal to the change in total revenue divided
by the change in the quantity of the resource
employed.
 Marginal Revenue Product (MRP)
• Because the demand for a resource is derived
from the demand for the product produced
with it, the demand for the resource depends
on:
1. Productivity of the resource in helping
to create good or service.
2. Market Value or price of the good it
helps produce.
The demand for a resource is dependent upon:

1. The productivity of the resource

2. The market price of the product being
produced.

• No demand at all for a resource that is

efficient in producing something no one
wants to buy.
 MRP
• A highly productive resource will be in high
demand
• A non-productive resource will be in little
demand.
 Productivity
• Marginal Product – additional output, from 1
additional unit of labor.

(i.e. How much will be produced if you employ

one more person)
 First, find total Revenue
• Determination of Total Revenue (TR) and Marginal
Revenue Product (MRP); MRP is the increase in total
revenue that results from the use of each additional
unit of a variable input.

• MRP=Change in Total Revenue/Change in Resource

Quantity
• MRP depends on productivity of input.
• MRP also depends on price of product being produced.
Find MRP
 Find MRC
MRC is the mount that each additional unit of
resource used adds to the firm’s total or
“resource” cost.
 Rule for Hiring resources is to produce where:
MRP = MRC.

• To maximize profits, a firm should hire

additional units of a resource as long as each
unit adds more to revenue than it does to
costs. (MRC is the marginal-resource cost or
the cost of hiring the added resource unit.)

• Equation form:
MRC = Change in Total Resource Cost
Change in Resource Quantitiy
 To Hire or not to Hire…
• IF the MRP of the last worker (“that much
labor”) exceeds his/her MRC, the firm CAN
PROFIT by hiring one more worker.

• IF the MRC of the last worker exceeds his/her

MRP, the firm is hiring workers who aren’t
paying their way (firm could increase profits
by canning someone).
 MRP=MRC Rule
• Similar to Marginal Revenue (MR) = Marginal
cost (MC) profit maximizing rule.

• Rationale is the same, but now we are looking

at inputs not outputs.
 MRP Schedule
• Columns 1 & 6 on table 25.1
• Is the firm’s demand schedule for labor.

• To maximize profits, the firm needs to hire

additional units of a resource as long as each
additional unit adds more to the firm’s total
revenue that it adds to cost.
 MRP as Resource Demand Schedule
• Market Supply & Market Demand establish
the wage rate (in a purely competitive labor
market).

• Each firm hires a small % of market supply, it

can’t influence the market wage rate.

• SO –The Firm is a wage taker.

 Marginal productivity theory of resource demand

• In the competitive resource market, the firm is

a “wage taker”

• It hires such a small amount of the total

supply of the resource that its hiring decisions
do not influence the resource price.
 Firm is a wage taker
• Total resource cost increases by exactly the
amount of the constant market wage rate.
• Example – shoe maker
• MRC of labor (extra cost of input) equals the
Market Wage rate.
• Example (Mkt. wage rate) – table 25.1 “again”
• Under conditions of pure competition in the
labor market where the firm is a “wage taker,”
the wage is equal to the MRC.

• MRP will be the firm’s resource (labor)

demand schedule in a competitive resource
market because the firm will hire (demand)
the number of resource units where their
MRC is equal to their MRP.
 MRP schedule is the firm’s demand for labor

• Each point on the schedule (curve) is the # of

workers the firm would hire at each possible
wage rate.
• Fig 25.1
• Downward
sloping.
• Marginal productivity theory of
resource demand: assuming that a
firm sells its product in an
imperfectly competitive product
market and hires its resources in a
purely competitive resource market.
• Marginal productivity theory of resource demand -
assuming that a firm sells its product in a purely
competitive product market and hires its resources
in a purely competitive resource market.

• In a competitive product market – the firm is a “price

taker” and can dispose of as little or as much output
as it chooses at the market price.

• Firm sells such a small fraction of the total output

that its output decisions do not influence product
price.
 Por Hemplo
• The number of workers employed when the
wage (MRC) is $12 will be 2; the number of
workers hired when the wage (MRC) is $6 will
be 5. In each case, it is the point where the
wage (MRC of worker) equals MRP of last
worker (Figure 27-1).
 Resource Demand Under Imperfect Market Competition

• Firm is selling its products in an imperfectly

competitive market
• i.e firm is “price maker”
• Must lower price to sell the Marginal product
of each additional worker.
• Example (satellite TV).
 Imperfectly competitive Producer
• Less responsive to resource price cuts than the
purely competitive producer.

• i.e. cable co and agiculture

 Consider This … “Winner takes all”
• Some markets are what economist Robert Frank calls “winner-take-all-
markets,” where a few of the top performers in the market receive
extraordinary incomes, and the vast majority earn very little.

• Both the product and resource markets connected with the “winner-take-
all-markets” would be characterized as imperfectly competitive, although
the high earnings for the top performers do attract a large number of
competitors to the resource market.

• Top music performers such as Shania Twain receive high earnings that
reflect their high MRPs from selling millions of CDs and drawing
thousands to concerts.

• i.e. Hannah Montanan & Ricki Lake

 What determines resource demand?

• What shifts the demand curve?

• Assume all other things equal
• Resource demand is derived form product
demand.
 Determinants of Resource Demand:
• Changes in product demand will shift the demand for
the resources that produce it (in the same direction).

• Productivity (output per resource unit) changes will

shift the demand in same direction. The productivity
of any resource can be altered in several ways:
– Quantities of other resources
– Technical progress
– Quality of variable resource.
 Prices of other resources will affect resource demand.
• A change in price of a substitute resource has
two opposite effects.
– Substitution effect example: Lower machine prices
decrease demand for labor.
– Output effect example: Lower machine prices lower
output costs, raise equilibrium output, and increase
demand for labor.
– These two effects work in opposite directions—the net
effect depends on magnitude of each effect.
• Change in the price of complementary resource
(e.g., where a machine is not a substitute for a
worker, but machine and worker work together)
causes a change in the demand for the current
resource in the opposite direction. (Rise in
price of a complement leads to a decrease in
the demand for the related resource; a fall in
price of a complement leads to an increase in
the demand for related resource).
 Occupational Employment Trends:

• Changes in labor demand will affect occupational

wage rates and employment. (Wage rates will be
discussed in Chapter 26.)
• Discussion of fastest growing occupations. (Table
25.5) (your homework)
• Discussion of most rapidly declining occupations.
(Table 25.6)
 Elasticity of resource demand is affected
by several factors.
• Formula of elasticity of resource demand
measures the sensitivity of producers to
changes in resource prices.
• If Erd > 1, the demand is elastic; if Erd < 1, the
demand is inelastic; and if Erd = 1, demand is
unit-elastic.
 If…………..
• If Erd > 1, the demand is elastic
• If Erd < 1, the demand is inelastic
• If Erd = 1, demand is unit-elastic.
 Determinants of elasticity of demand:

• Ease of resource substitutability: The easier it is to

substitute, the more elastic the demand for a specific
resource
• Elasticity of product demand: The more elastic the
product demand, the more elastic the demand for its
productive resources.
• Resource-cost/total-cost ratio: The greater the
proportion of total cost determined by a resource,
the more elastic its demand, because any change in
resource cost will be more noticeable.
 Optimal Combination of Resources

Two questions are considered:

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?
 The least‑cost rule
• States that costs are minimized where the
marginal product per dollar’s worth of each
resource used is the same. (Example: MP of
labor/labor price = MP of capital/capital price).
– Long-run cost curves assume that each level of
output is being produced with the least-cost
combination of inputs.
– The least-cost production rule is comparable to
Chapter 19’s utility-maximizing combination of goods.
• The profit‑maximizing rule states:
– that in a competitive market, the price
of the resource must equal its
marginal revenue product.
–This rule determines level of
employment MRP(labor) / Price(labor)
= MRP(capital) / Price(capital) = 1.
 Marginal Productivity Theory of Income
Distribution
• To each according to what he or she creates is
the rule.

B.There are criticisms of the theory.

– 1. It leads to much inequality, and many resources
are distributed unequally in the first place.
– 2. Monopsony and monopoly interfere with
competitive market results with regard to prices of
products and resources.
 LAST WORD: Input Substitution: The Case of ATMs
• Theoretically, firms achieve the least‑cost combination of inputs
when the last dollar spent on each makes the same contribution
to total output; the rule implies that firms will change inputs in
response to technological change or changes in input prices.
• A recent real-world example of firms using the least cost
combination of inputs is in the banking industry, in which ATMs
are replacing human bank tellers.
– Between 1990-2000, 80,000 human tellers lost their jobs, and more positions will be
eliminated in the coming decade.
– ATMs are highly productive: A single machine can handle hundreds of transactions
daily, millions over the course of several years.
– The more productive, lower-priced ATMs have reduced
the demand for a substitute in production.
 End of chapter questions
• What is the significance of resource pricing?
• Explain how the factors determining resource
demand differ from those determining product
demand.
• Explain the meaning and significance of the fact that
the demand for a resource is a derived demand.
• Why do resource demand curves slope downward?
End chapter 25