Week13 Inputs Demand

Input Demand:

The Labor and Land Markets

AQS 2141 Economics for Quantity Surveyors 1

Input Markets: Basic Concepts

Demand for Inputs: A Derived Demand

The demand for resources (inputs) that is

dependent on the demand for the outputs

those resources can be used to produce.

Inputs are demanded by a firm if and only if

households demand the good or service

produced by that firm.



(Cont’d)

Inputs: Complementary and Substitutable

Inputs can be complementary or substitutable.

Diminishing Returns

Marginal product of variable inputs declines.



(Cont’d)

Marginal Revenue Product (MRP)

The additional revenue a firm earns by

employing one additional unit of the input.


Labor Markets

A profit-maximising firm will add inputs – in the

case of labor, it will hire workers – as long as

the marginal revenue product of that inputs

exceeds the market price of that input – in the

case of labor, the wage.


Labor Markets (Cont’d)

For a perfectly competitive firm employing one

variable factor of production, labor, the

condition W = MRPL is exactly the same as the

condition P = MC.

Firms weigh the value of outputs as reflected

in output price against the value of inputs as

reflected in marginal cost.



For a firm employs two variable factors of

production, a change in factor price has both a

factor substitution effect and an output effect.

Factor substitution effect:

The tendency of firms to substitute away from

a factor whose price has risen and toward a

factor whose price has fallen.



Output effect of a factor price increase:

When a firm faces higher costs, it is likely to

produce less in the short run. When a firm

decides to decrease output, its demand for all

factors declines.



Output effect of a factor price decrease:

A decrease in the price of a factor of

production, in contrast, means lower costs of

production. If their output price remains

unchanged, firms will increase output. This, in

turn, means that demand for all factors of

production will increase.


Land Markets

Land is in strictly fixed supply, its price is

demand determined – that is, its price is

determined exclusively by what households

and firms are willing to pay for it.

A firm will pay for and use land as long as the

revenue earned from selling the product

produced on that land is sufficient to cover the

price of that land. The firm will use land up to

the point at which MRPA = PA where A is land.


Firm’s Profit-maximization

Condition in Input Markets

Every firm has an incentive to use variable

inputs as long as the revenue generated by

those inputs covers the costs of those inputs

at the margin.

Firms will employ each input up to the point

that its price equals its marginal revenue

product.


Input Demand Curves

A shift in a firm’s demand curve for a factor of

production can be influenced by the demand

for the firm’s product, the quantity of

complementary and substitutable inputs, the

prices of other inputs, and changes in

technology.


Reference:

Case, K.E. & Fair, R.C. (2007) Principles of Economics (8th Edition).

New Jersey: Pearson Education, Inc. Chapter 10.


Input Demand:

The Capital Markets and the Investment Decision


Capital

Those goods produced by the economic

system that are used as inputs to produce

other goods and services in the future.


Physical, or Tangible Capital

Materials things used as inputs in the

production of future goods and services.

Social Capital, or Infrastructure

Capital that provides services to the public.

Intangible Capital

Nonmaterial things that contribute to the

output of future goods and services.


Human Capital

A form of intangible capital that includes the

skills and other knowledge that workers have

or acquire through education and training and

that yields valuable services to a firm over

time.


Measuring Capital

Capital Stock

For a single firm, the current market value of

the firm’s plant, equipment, inventories, and

intangible assets.


Investment and Depreciation

Investment

New capital additions to a firm’s capital stock.

Depreciation

The decline in an asset’s economic value over

time.


Capital Market

The market in which households supply their

savings to firms that demand funds to buy

capital goods.


Capital Income: Interest and

Profits

Capital income: income earned on savings that

have been put to use through financial

markets.

Interest: The payments made for the use of

money.

Interest Rate: Interest payments expressed as

a percentage of the loan.


Capital Income: Interest and

Profits (Cont’d)

Profit: The excess of revenues over cost in a

given period.

Functions of Interest and Profit

1. Interest may function as an incentive to

postpone gratification.

2. Profit serves as a reward for innovation and

risk taking.


The Demand for New Capital and

The Investment Decision

Forming Expectation

The Expected Benefits of Investment

The investment process requires that the

potential investor evaluate the expected flow of

future productive services that an investment

project will yield.


The Demand for New Capital and

The Investment Decision (Cont’d)

Forming Expectation (Cont’d)

The Expected Costs of Investments

The ability to lend at the market rate of interest

means that there is an opportunity cost

associated with every investment project.


Comparing Cost and Expected

Return

Expected Rate of Return

The annual rate of return that a firm expects to

obtain through a capital investment.

The expected rate of return on an investment

project depends on the price of the investment,

the expected length of time the project

provides additional cost savings or revenue,

and the expected amount of revenue

attributable each year to the project.



Return (Cont’d)

Expected Rate of Return (Cont’d)

Only those investment projects in the economy

that are expected to yield a rate of return

higher than the market interest rate will be

funded. At lower market interest rates, more

investment projects are undertaken.



Return (Cont’d)

The Expected Rate of Return and the Marginal

Revenue Product of Capital

A perfect competitive profit-maximizing firm

will keep investing in new capital up to the

point at which the expected rate of return is

equal to the interest rate.



Return (Cont’d)

The Expected Rate of Return and the Marginal

Revenue Product of Capital (Cont’d)

The firm will continue investing up to the point

at which the marginal revenue product of

capital is equal to the price or capital, or

MRPK = PK .


Reference:

Case, K.E. & Fair, R.C. (2007) Principles of Economics (8th Edition).

New Jersey: Pearson Education, Inc. Chapter 11.


Week13 Inputs Demand

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