14-1Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Chapter 14

The demand for economic resources

14-2Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Learning objectives• Discuss the significance of resource pricing• Introduce marginal productivity theory as

a way of explaining the amounts of resources that firms use

• Examine the way the employment of resources may vary when there are many buyers of the resource and different forms of competition in the product market

14-3Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Learning objectives (cont.)• Explain the demand for a resource, what

determines changes to resource demand and what factors determine the elasticity of resource demand

• Introduce the concept of monopsony

14-4Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Significance and complexity of resource pricing?• Resources are a major determinant of money

incomes• Resource pricing allocates resources among

various industries and firms• Cost minimisation

– Firms must produce the profit-maximising output with the most efficient combination of resources

14-5Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Significance and complexity of resource pricing? (cont.)Ethical and public policy issues

– Inequality in the personal distribution of income results from resource prices

– Raises normative and equity issues surrounding the distribution of income

14-6Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Complexities of resource pricing

• Resource demand-and-supply determines pricing and employment

• However, exact nature depends on:– Type of resource– Type of market– Policies and practices of government– Complications added by firms and unions

14-7Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Marginal productivity theory• Marginal analysis is applied to derive optimum

hiring of resources• Optimal employment of resources: MRP = MRC

– To maximise profits, a firm should hire additional units of any given resource as long as each successive unit adds more to the firm’s total revenue than it does to its total costs

• Marginal revenue product (MRP)– Increase in total revenue resulting from the use

of one additional unit of input

14-8Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Marginal productivity theory (cont.)• Marginal resource cost (MRC)

– The increase in total resource cost resulting from the use of one additional unit of input

• MRP = MRC rule– Explains the way demand for economic resource

is formulated– Does not explain the exact derivation of demand curve

14-9Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Demand for a resourceDepends on two types of markets:• Product market in which the firm sells

and produces goods• Resource market

– Many buyers?– Few buyers?

14-10Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Resource demand under perfect competitionAssume perfect competition in resource market• Derived demand for resource

– Productivity of resource in producing the good– Market value of the good

• MRP schedule constitutes the firm’s demand for labour

14-11Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Marginal definitions• Marginal product (MP)

– Additional output resulting from the use of one additional unit of a resource, ceteris paribus

• Marginal revenue product (MRP)– The increase in total revenue resulting from

the use of one additional unit of input

• MRP = MP × P

14-12Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

MRP as a demand schedule

Units ofresource

Totalproduct

Marginalproduct

MP

Productprice

Totalrevenue

Marginalrevenue

product MRP

]]

]0123456

0152736424546

1512 9 6 3 1

$1 1 1 1 1 1

$ 0 15 27 36 42 45 46

$ 15 12 9 6 3 1

]

]

]

]

]]

]

]

]

14-13Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

MRP curve

DR

DR

Demand for resource: perfect competition

1 2 3 4 5 6 7 8 9 10 0

Res

ou

rce

pri

ce (

wag

e-ra

te)

Quantity of resource demanded

33

66

99

1212

1515

1818

14-14Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Resource demand under perfect competition• Perfect competition in resource market• Product demand curve is down-sloping

– Firm must accept lower price in order to increase sales

• Comparison with perfect competition– MRP = MP × MR– MRP curve is less elastic than perfect competition– Imperfectly competitive firms less responsive

to wage cuts in terms of workers employed

14-15Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Demand for resource: imperfect competition

Units ofresource

Totalproduct

Marginalproduct

MP

Productprice

Totalrevenue

Marginalrevenue

product MRP

]]

]

0123456

152736424546

1512 9 6 3 1

$1.30 1.20 1.10 1.05 1.00 0.95

$ 0 19.50 32.40 39.60 44.10 45.00 43.70

$ 19.50 12.90 7.20 4.50 0.90 –1.30

]

]

]

]

]]

]

]

]

14-16Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Demand for resource: imperfect competition

Quantity of resource demanded

1 2 3 4 5 6 7 8 9 10 0

Res

ou

rce

pri

ce (

wag

e-ra

te)

D

D

MRP curve

33

66

99

1212

1515

1818

2121

–– 33

14-17Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Market demand for a resource• Derived by summing up the individual demand

or MRP curves for all firms• Complications

– Decreased resource price may cause all firms in the industry to hire more of the resource and expand total output, thereby reducing product price

– Product price falls as industry output expands, therefore true market demand curve will be less elastic than that based on constant product price

14-18Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Changes in resource demand and elasticity of demand

• Changes in product price• Changes in productivity

– Quantities of other inputs used– Technological progress– Labour quality

14-19Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Changes in resource demand (cont.)

Prices of other resources• Substitute resources

– Substitution effect– Output effect

• Complementary resources– An increase (decrease) in the quantity of one resource

that is needed in the production process will require an increase (decrease) in the amount of the other as well

14-20Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Elasticity of resource demand• Rate of MP decline• Ease of resource substitutability

– The larger the number of good substitute resources available, the greater will be the elasticity of demand for a particular resource

• Elasticity of product demand– The greater the elasticity of product demand,

the greater the elasticity of resource demand

Resource cost–total cost ratio– The larger the contribution of a resource’s price

to total costs, the greater the elasticity of demand for that resource

14-21Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Imperfect competition in resource market• MRC will exceed the resource price under

imperfectly competitive demand condition for a resource

• The firm must substitute MRC for resource price in its calculation of optimum input use when applying the MRP = MRC rule

14-22Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Imperfect competition in resource market• Monopsony: one buyer of a resource

– No well-defined demand curve for a resource

• Optimum hiring condition under varying degrees of competition:

– Many producers in product market MRP = MRC, MP × P = MRC

– One producer in product market MRP = MRC, MP × MR = MRC

14-23Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Next chapter:

Wage determination