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
o

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

(capital)
Substitute Effect
Firm buy more of input whose P relatively low + buy less of input
whose P has relatively high
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 whent he price of the other inut rises.
PCAPITAL costs output DALL RESOURCES
DLABOR
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
o

Labor and capital must be used in fixed proportions e.g. one man operates
one machine
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.