Chapter 16 - Significance of Resource Pricing PDF

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Significance of Resource Pricing...

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Chapter 16 The demand for resources, mainly labor, is the focus of this chapter. Resource prices and their implications on money income, cost minimization, resource allocation, and policies are examined. Then, the resource demand curve is derived in purely competitive and imperfectly competitive markets. The optimal combination of resources and the least cost rule and profit maximization are looked at as well. The Last Word is about how ATMs at first replaced human labor in the banking industry but now are considered a complement to labor.

Significance of Resource Pricing

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Determines money income for the household

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Cost minimization

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Resource allocation

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Policy issues

Studying resource pricing aids in the understanding of economic activity in several ways. Resource prices are a major factor in determining the income of households. To firms, resource prices represent costs. To make the most money, firms must produce at the profit-maximizing output with the least costly combination of resources. Resource prices help in the allocation of resources among the various industries and firms that need them. And finally, many policy issues like CEO pay, labor unions, and minimum wage increases are based on resource pricing. While the focus in this chapter is on the labor resource, the principles apply just as well to the other economic resources: land, capital, and entrepreneurial ability.

Derived Demand for Resources

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Assume perfect competition •

Product markets

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Resource markets

Derived demand for resources depends on •

Marginal product of the resource (MP)

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Price of the product it produces (P)

To keep the example simple, assume that resources are bought and sold in perfectly competitive markets and that the products produced by the resources are also bought and sold in perfectly competitive markets. Note that there is a derived demand for resources since we do not consume resources directly but indirectly through the consumption of the goods and services produced with the resources. The strength of the demand depends on the productivity of that resource in helping to create a good or service and the market value or price of the good or service it helps produce.

Marginal Revenue Product

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Marginal revenue product (MRP)

Change in total revenue resulting from unit change in resource input (labor)

The marginal revenue product represents the change in total revenue resulting from the use of each additional unit of a resource.

Marginal Productivity Theory of Resource Demand

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MRP = MRC rule

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To maximize profit, hire additional resources as long as the additional product produced adds more to revenues than to costs

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MRP schedule equals the firm’s demand for labor

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MRC exactly equal to wage rate

A firm will maximize profits at the point at which marginal revenue product equals marginal resource cost.

Determinants of Resource Demand

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Changes in product demand

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Changes in productivity

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Quantities of other resources

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Technological advance

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Quality of the variable resource

Other things equal, an increase in the demand for a product will increase the demand for a resource used in its production. Changes in productivity can be brought about by changes in quantities of other resources, technological advances, or the quality of the variable resources.

Determinants of Resource Demand Continued

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Changes in price of substitute resources •

Substitution effect

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Output effect

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Net effect

Changes in the price of complementary resources

Changes in the prices of substitute resources may affect the demand for a specific resource. The substitution effect tells us that a firm will purchase more of an input whose relative price has declined and, conversely, use less of an input whose relative price has increased. The output

effect indicates 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. Netting the two together will determine the final total change. With complementary resources the changes in demand for each resource will be directly related, meaning they will rise and fall together.

Substitute and Complement Resources

This table provides a summary of how an increase in the price of capital will affect the demand for labor depending on whether they are substitutes or complements in production.

Determinants of Labor Demand

This table provides a summary of the determinants that impact the demand for labor and how this demand shifts when the determinants change.

Occupational Employment Trends

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Rising employment in health services •

Personal care aides

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Home health aides

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Biomedical engineers

Declining employment •

Shoe machine operators

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Postal service mail sorters

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Postal service clerks

There is rising employment in health services due to rising demand for health care. Use of insurance has allowed people to buy more health care than they could have without it.

Declining employment in shoe manufacturing and the US Postal Service is occurring because of imports and due to labor saving technological change.

Growing Employment Trends

This table lists the ten fastest growing U.S. occupations for the years 2014 through 2024 as projected by the Bureau of Labor Statistics. You may notice that service occupations dominate the list and seven of them are related to the health field.

Declining Employment Trends

This table lists the ten most rapidly declining U.S. occupations for the years 2014 through 2024 as projected by the Bureau of Labor Statistics. The list is composed of occupations being affected by labor saving technology with automated or computerized equipment and with the US demand for these goods increasingly being filled by imports.

Elasticity of Resource Demand

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Ease of resource substitutability

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Elasticity of product demand

Ratio of resource cost to total cost

A change in the demand of a resource must be distinguished from a change in the quantity demanded of a resource. The sensitivity of resource quantity to changes in resource prices along a fixed resource demand curve is measured in the elasticity of resource demand which is measured as the percentage change in the resource quantity divided by the percentage change in the resource price. Several factors determine the elasticity of resource demand. The ease of the resource substitutability is one. The greater the substitutability of other resources, the more elastic the

demand will be for a particular resource. Since the demand for labor is a derived demand, the elasticity of the demand for the output product will also influence the elasticity of the demand of labor. And finally, the ratio of the resource cost to total cost is also a factor. The larger the proportion of total production costs accounted for by a resource, the greater the elasticity of demand will be for that resource.

Optimal Combination of Resources

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What combination of resources will minimize costs at a specific output level?

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Least-cost combination of resources

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Least cost rule

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What combination of resources will maximize profit?

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Profit-maximizing combination of resources

Profit maximizing rule

In the long run, all resource inputs are variable, and so one must consider what combinations of resources a firm should choose when all its inputs are variable. A firm will produce a specific output with the least-cost combination of resources in order to maximize profit.

Least-Cost Rule

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Minimize cost of producing a given output

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Last dollar spent on each resource yields the same marginal product

The least-cost rule states that a firm will seek to minimize the cost of producing a given output in order to maximize profits. A producer’s least-cost rule is analogous to the consumer’s utilitymaximizing rule described in Chapter 7. In achieving the cost-minimizing combination of resources, the producer considers both the marginal product data and the prices (costs) of the various resources.

Profit-Maximizing Rule

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Each resource is employed to the point where its MRP is equal to its price

Just minimizing costs is not enough for maximizing profit. There is only one unique level of output that will maximize profit. Profit maximization occurs where marginal revenue equals marginal cost. A firm will achieve its profit-maximizing combination of resources when each resource is employed to the point at which its marginal revenue product equals its resource price.

Income Distribution

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Marginal productivity theory of income distribution

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Paid according to value of service

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Workers

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Resource owners

Inequality •

Productive resources unequally distributed

Market imperfections

Income is distributed according to how the resource contributed to creating society’s output. Income payments based on marginal revenue product provide a fair and equitable distribution of society’s income. It is not a perfect system, however, as it can result in a highly unequal distribution. This may be because production resources were unequally distributed in the first place. Market imperfections can also result in unequal distributions. In some labor markets, employers are able to exert their wage-setting power to pay less-than-competitive wages.

Substitutes or Complements?

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Banks will use the least cost combination of resources

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Before ATMs, tellers would handle cash for customers (labor)

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ATMs arrived in 1980s and they can handle cash for customers (capital)

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At first, tellers were displaced but today there are more ATMs and more tellers

Labor and capital are now complements

What happens when a technological advance makes a capital good with a MP/P that is greater than for other inputs? The firm will change their resource mix. If the new good is a substitute for a particular type of labor, the firm will replace labor with the new capital. If the new good is a complement of a particular type of labor, then the firm will add additional amounts of that labor. At first, ATMs displaced bank tellers but now data shows that the number of bank tellers have increased over time. Since ATMs have freed up tellers from cash handling, the tellers can do other banking tasks, such as selling financial products....