John Petroff's "Microeconomics, Chapter 8: Economic Resources"
Study this brief chapter on economic resources. You will likely find the examples in the above material useful to understanding the concepts in this subunit.
The purpose of this topic is to outline how much and at what
price will firms use resources: labor, land, capital and
entrepreneurial ability. The demand for resources is shown to be
derived from the demand for the goods produced with them. Causes
for demand changes and demand elasticity are listed. The optimum
combination of resources is set out to be based on the equality
of marginal revenue product and marginal resource cost.
The demand for any resource is said to be derived from the
demand for the product for which the resource is used.
| A restaurant will hire employees if it needs to serve more meals. No demand for meals, no demand for employees. The two go together. |
The marginal revenue product is the increase in revenue
generated by one more unit of a resource used in production.
The marginal revenue product can be calculated by multiplying
the marginal physical product by the price of the product sold
by the firm.
| If a restaurant hires one more cook or any other type of employee, that restaurant could not possibly pay the cook or employee more than what he/she generates in additional revenues. Otherwise, the restaurant would obviously go out of business. |
The marginal physical product is the additional quantity of
output which can be produced by using one more unit of a
resource used in production.
| Suppose a restaurant serves 1000 meals a day with the existing staff of waiters. If the number of meals the restaurant can serve increases to 1050 by adding one more waiter, the marginal physical product of the employee is 50 meals. |
The optimum quantity of any resource a firm should use is
determined by the intersection of the marginal resource cost
and the marginal revenue product. Should one less unit of the
resource be used, the firm would forego an opportunity for
more profit. Should one more unit of resource be used, the
additional cost would exceed the additional revenue and
profits would be smaller.
| Suppose a restaurant needs to hire a few more waiters. It will keep on adding one more waiter to its staff as long as the additional (or marginal) revenue generated by that new waiter exceeds the additional (or marginal) cost of having that new employee. If the additional cost exceed the additional revenue, the restaurant should not keep that last employee. |
The marginal resource cost is the additional cost resulting
from one more unit of a resource used in production. If the
resource market is in perfect competition, the marginal
resource cost is equal to supply and price of the resource.
If a monopsony (i.e. a firm that has the power to pay less than the going price for a resource by limiting how much it uses of that resource) is present, the marginal resource cost of the
monopsonist is higher that the supply curve.
| If a firm is able to pay a lower wage for fewer employees, but has to increase the wage it offers to attract more employees, it is in a monopsonistic position. The monopsonist face a supply of labor that is upsloping (see Graph G-MIC9.2 in Chapter 9). If the supply line can be written as W=aH+b (where W is wage, H is hours worked, a and b are coefficients), its total labor cost is WxH, or (aH+b)H, and its marginal cost of labor is MRC=2aH+b. Marginal resource cost is twice as steep as supply. |
The demand for a resource is the marginal revenue product for
that resource. This can be verified by noting that the optimum
quantity of resource is given by the intersection of marginal
resource cost and marginal revenue product.
| The fact that the demand for a resource is the marginal revenue product can be seen in professional sport organizations. A team can hire many good players for a moderate salary, but it can hire only one or very few superstars at an extremely high salary. The reason why the superstar receives the millions of dollars in salary is because he/she attracts fans and generates additional revenues. |
If the firm has some amount of monopolistic power in the product
market, the price will decrease as output increases. Thus, the
demand for resources of such a firm is steeper than that of a
comparable firm which would be in a competitive product market.
Changes in the demand for a resource may be attributed to a(n)
- change in demand for the product,
- improvement in productivity (for instance from better skills),
- change in price of other resources causing an output effect
or a substitution effect,
- change in the availability of complementary resources.
RESOURCE DEMAND SUBSTITUTION EFFECT
The decrease in the price of a resource may cause that resource to
be used more commonly as a substitute for another resource. For
instance, the lower cost of capital results in more automation
with less need for labor. But this substitution effect may be in
part offset by an output effect. The lower cost of automation
may lead to an expanded output requiring more labor to be used.
| Accountants work faster since the advent of the hand calculators. One may think that because accountants are faster fewer are needed (i.e. substitution effect). But, in fact, fast working accountants are in ever greater demand because new tasks are given to them, such as tax preparation. The output effect is larger than the substitution effect. |
The elasticity of demand for a resource is affected by
- the elasticity of the product sold by the firm,
- the rate of decline of the marginal physical product due,
for instance, to differences in skills,
- the availability of substitute resources, and
- the proportion of that resource in total costs.
| Fish canning is especially sensitive to wage rates because of the amount of manual work required. The industry shifts its productive location according to labor cost. Thus, because of the high labor cost in the United States, there is virtually no more fish canning here. |
A firm will maximize its profits by combining resources in such
a manner that the last dollar spent on any resource is just
equal to the revenue generated by that or any other resource.
More specifically, the ratio of marginal physical product over
marginal resource cost must be equal for all resources. In the
special case of perfect competition in a resource market,
the ratios of marginal physical product over price of the
resources are also equal.
| A freight and delivery company may use a variety of vehicles: jet airplanes, trucks, vans, motorcycles and even messenger bicycles. How many of each will be used will depend on each contribution to marginal revenue compared to its cost. |