Determinants of Resource Demand Changes in Product Demand

Determinants of Resource Demand
Changes in product demand:

[Remember: resource demand is a 'derived demand' from its product]
 Condition: other things equal

 Product demand ↑, D for resource involved ↑ (direct relationship)
 higher product price increase MRP of resources.
 E.g. The demand for new houses drive up house prices, causing more demand for
construction workers and an increase in their wages.
Changes in productivity
 Condition: other things equal

 Resource productivity ↑, demand ↑ (direct relationship)
 3 ways of altering resource productivity:
o Quantities of other resources
 Q of capital + land used w/ labor ↑, MP ↑, productivity of labor ↑
o Technological advances
 Quality of capital + land used w/ labor ↑, MP ↑, productivity of
labor ↑
o Quality of variable resource
 e.g. training, education
 Quality of labor ↑, MP ↑, productivity of labor ↑
Changes in the prices of other resources

[Depends on whether labor and capital are substitutes/complements in production]
 Substitute Resources
o E.g. a receptionist (labor) is substitutable for an answering machine

(capital)
o Substitute Effect
 Firm buy more of input whose P relatively low + buy less of input
whose P has relatively high
o Output Effect
 The output effect means that the firm will purchase more of one
particular input when the price of the other input falls and less of
that particular input when the price of the other input rises.
 – PCAPITAL ↓ → costs ↓ → output ↑ → DALL RESOURCES ↑
→ DLABOR ↑
o Net Effect:
 If substitute effect>output effect, decrease in price for capital
decreases demand for laborI
 If output effect>substitute effect, decrease in price for capital
increases demand for labor
 Complementary Resources
o Labor and capital must be used in fixed proportions e.g. one man operates
one machine
o Output effect
In general, the demand for labor will increase when:
 The demand for the product produced by that labor increases

 The productivity of labor increases
 The price of a substitute input decreases, provided the output effect exceeds the
substitution effect
 The price of a substitute input increases, provided the substitution effect exceeds
the output effect
 The price of a complementary input decreases
Elasticity of Resource Demand Optimal Combination of Resources
Elasticity of Resource Demand refers to the relative change of resource demand caused
by changes in resource price.
Erd= (percentage change in resource quantity) / (percentage change in resource price)
* Elasticity of Resource Demand 3 main determinants:

 Ease of Resource Substitutability
High # of substitutes = ELASTIC resource demand

Low # or no substitutes = INELASTIC resource demand
TIME: more time, more elastic
 Elasticity of Product Demand
DERIVED resource elasticity from product

High product elasticity = high resource elasticity
Low product elasticity = low resource elasticity
 Ratio of Resource Cost to Total Cost
Large proportion of total cost = High elasticity

Small proportion of total cost = Low elasticity
Optimal Combination of Resources:

Least-Cost Rule:
 Marginal Product of labor/Price of Labor = Marginal Porduct of capital/Price of
capital. More simply: MP(L) / P(L) = MP(C) / P(L).
 A firm produces using this rule when the last dollar spent on each resource yields
the same marginal product.
 If the equation is not balanced, the firm should produce more (either capital or
labor) of the larger number, so that the equation becomes true.
Profit Maximizing Rule:

 Marginal Revenue Product of Labor/Price of Labor = Marginal Revenue Product
of Capital/Price of Captial = 1. Simplified: MRP(L) / P(L) = MRP(C) / P(C) = 1.
 Minimizing cost does not necessarily maximize profit, but maximizing profit
always minimizes costs.
Wage determination in perfectly competitive labour markets

An explanation of how wages are determined in a perfectly competitive labour market.
A perfectly competitive labour market will have the following features
 Many firms
 Perfect information about wages and job conditions.
 Firms are offering identical jobs
 Many workers with the same skills
Diagram of wage determination
 The equilibrium wage rate in the industry is set by the meeting point of the
industry supply and industry demand curves.
 In a competitive market, firms are wage takers because if they set lower wages,
workers would not accept the wage.
 Therefore they have to set the equilibrium wage We.
 Because firms are wage takers, the supply curve of labour is perfectly elastic
therefore AC = MC.
 The firm will maximise profits by employing at Q1 where MRP of Labour = MC
of Labour
Comparing wage of lawyers and McDonalds workers
Lawyers get higher pay for two reasons.
1. Supply of lawyers is inelastic because of the qualifications required.
2. The Marginal Revenue Product (MRP) of lawyers is high. If they are successful
they can make firms a lot of revenue.
McDonald’s workers, however, get lower pay because:
1. Supply of cleaners is elastic because there are many thousands of people who are
suitable fo
2. working, qualifications are not really required.
3. The MRP of a McDonald’s worker is much lower because there is a limited profit
to be made from selling Big Macs.
Diagram of wage determination for lawyers and McDonald’s workers
The wage rate on the right is higher because supply is more inelastic and demand is
higher.
Good luck

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Determinants of Resource Demand

Changes in product demand:

 Condition: other things equal

 Condition: other things equal

Changes in the prices of other resources

o E.g. a receptionist (labor) is substitutable for an answering machine

In general, the demand for labor will increase when:

 The demand for the product produced by that labor increases

Elasticity of Resource Demand Optimal Combination of Resources

Erd= (percentage change in resource quantity) / (percentage change in resource price)

* Elasticity of Resource Demand 3 main determinants:

High # of substitutes = ELASTIC resource demand

 Elasticity of Product Demand

DERIVED resource elasticity from product

 Ratio of Resource Cost to Total Cost

Large proportion of total cost = High elasticity

Optimal Combination of Resources:

Profit Maximizing Rule:

Wage determination in perfectly competitive labour markets

A perfectly competitive labour market will have the following features

Diagram of wage determination

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