See page 317, graph showing how product markets and resource markets are related.
Nonhuman Resources (Physical capital):
1) Physical Capital - Property, plant, equipment, machinery, computers, vehicles, etc. that help produce final products.
2) Land - e.g. for farming, golf courses, parks, etc
3) Natural resources - natural materials, e.g. oil, timber, minerals, plants, flowers, etc.
Investment can increase the stock of physical capital over time, increasing the productive capacity of the economy.
Human Resources (Human Capital) - human abilities, skills, know-how, creativity, entrepreneurship, knowledge, etc. that can contribute to output. "The Ultimate Resource - human spirit/human mind." Human potential is unlimited. Greatest resource of a country is self-interest.
The quality of human resources can be improved through training, education, development of skills, experience, etc. resulting in increased productivity: "Investment in human capital." Like physical capital, human capital can depreciate over time, wear out, become obsolete. Why?
Decisions to invest in human capital require a comparison of the costs vs. benefits of the increased earning potential vs. the costs of education/training. Example: MBA degree. Biggest cost?
In competitive markets, resource prices are determined
by market forces, S and D, just like product markets.
DEMAND FOR RESOURCES (INPUTS, FACTORS)
Derived Demand - Demand for resources/inputs is derived (or secondary) to the primary demand for final products. Because there is a demand for cars and GM tries to respond to this demand for a final product, GM has a derived demand for resources. GM demands labor, steel, parts, etc. to fill the demand for final goods.
Demand curve for resources slopes downward, just like demand for final products, see p. 319. Why?
1. Substitution in production, resulting from producers
being price sensititve.
Firms try to minimize cost, and can usually choose among various inputs: natural gas vs. oil vs. electric power, skilled vs. unskilled labor, labor vs. capital, foreign vs. domestic inputs, sugar vs. corn syrup, internal vs. external production, bar code vs. physical inventory, domestic vs. foreign production, full time vs. part time, permanent vs. temporary workers, downtown location vs. suburbs, copper vs. plastic pipe, wood vs. metal, Michigan location vs. Texas, etc.
When the price of a resource goes up, cost-conscious firms will switch turn to lower-cost substitutes and cut back on their use of the more expensive resource.
The more (fewer) good substitute resources are available, the more elastic (inelastic) the demand for that resource. Example: BMW is considering a factory in U.S., if it can consider locating in any of the 48 states, its demand will be very elastic (many good substitutes). If it wants to locate in a specific state for some reason, its demand will be more inelastic (few good substitutes).
2. Substitution in Consumption, resulting from consumers being price sensitive. Higher resource prices will increase product prices, causing consumers to reduce purchases and switch to substitutes. Since consumers buy less of the final product, producers reduce their demand for the resources needed to produce the final good - derived demand. If demand for a product falls, the derived demand for the resources needed to produce the product falls too.
Example: Autoworkers wages rose rapidly in the 1970s, raising the price of domestic cars. Consumers switched to foreign cars as close substitutes, demand fell for domestic cars, reducing the quantity of labor demanded (and employment) in the domestic auto industry, e.g. Flint MI. "Roger and Me"
Ceteris paribus, the more elastic the demand for
the final product, the more elastic the demand for the resources necessary
to make the product. Derived demand. Consumers' elasticity
is transmitted through producers to the resource market. Consumer
TIME AND THE DEMAND FOR RESOURCES
Like for product markets, the demand for resources is more elastic in the LR vs the SR (demand curve flattens). Given time to adjust, produces can make more changes in the LR than in the SR.
Example: page 321. Price for steel goes from
P1 to P2, Qd falls from Q1 to Q2 in SR. If high steel prices persist,
firms will alter production to use less steel and switch to cheaper substitutes.
Automakers will alter car designs to use less steel, architects will design
buildings to use less steel and more wood, plastic, aluminum, etc.
This will take time, maybe several years.
SHIFTS IN THE DEMAND FOR RESOURCES
What will cause the entire demand curve for a resource (labor, raw material, etc.) to shift?
1. Increased demand for the product will increase the demand for the resources necessary to make the product.
Examples: increased (decreased) demand for higher education increases (decreases) the demand for professors.
Decreased demand for domestic cars reduced the demand for autoworkers to build domestic cars.
2. Increases in the productivity of resource will increase the demand for it. What increases resource productivity, e.g. of labor?
a) MP of a resource (labor) depends on the other resources used to complement the input. Example: more or better capital will improve the productivity of labor, resulting in higher wages. Chain saw vs axe. Shovel vs. $200,000 road building machine. Wages of someone picking tomatoes vs. someone harvesting corn with a $200,000 combine. Airplane pilot vs. Greyhound busdriver. Carpenter or roofer with an automatic nail gun.
b) Technological advancements improve productivity of labor, raising wages. Improvements in word processing has increased the productivity of typists, journalists, lawyers, writers, professors, etc. Productivity has risen by an average of 2% per year in U.S. due partly to technological improvements.
c) Investment in human capital (education, training) results in higher productivity. Workers with a B.A. make more in general than those with a HS diploma, because they are more productive.
These factors explain why wages in U.S. are the highest in the world. Given the skill level of workers, the technology in the U.S. and the capital equipment available, U.S. workers produce more output per hour compared to workers in Cuba or India or Zimbabwe. The high productivity leads to an increase in demand, leading to higher wages. Greater productivity leads to higher wages.
3. When two resources are substitutes, a rise in the
price of one resource will lead to an increase in demand for the other.
If brick and wood are substitutes for construction, and increase in the
price of wood will lead to an increase in the demand for brick. If
skilled and unskilled labor are substitutes, an increase in the price of
unskilled labor will lead to an increase in the demand for skilled labor.
Why would skilled labors support increase in min wage???
MARGINAL PRODUCTIVITY AND DEMAND FOR RESOURCES
How does a profit-maximizing producer decide how much of a resource to use (how many workers to hire)? By comparing MRP (marginal revenue product) to the price of the resource (wage).
MRP = change in TR / change in input (labor, x1)
MR = change in TR / change in ouput (Q)
MRP = MP (change in TP, # units) x MR ($)
MRP = increase (change) in firm's revenue from one additional unit of input
MRP = increase in revenue from hiring one more person (carpenter). If a construction company hires one more carpenter, what is the change in revenue (MRP)?
Most firms are price-takers in the resource markets since their demand is too small to affect the market price. Therefore, firms' marginal cost for a resource is the price of the resource. If I wanted to hire a carpenter, I would pay the market price, as a price-taker. Profit-max rule (for price-takers, price-searcher, monopolists): Expand employment of each resource (input) until the MRP of the resource is just equal to the price of the resource.
Example: page 324. Accounting firm. Variable inputs (resources) are computers (capital) and data-entry operators (labor). We look at holding capital (computers) fixed and increasing labor, from 0 - 7 workers. Total Output (Q) is accounting statements per week, and the firm charges $200 per statement. Column 3 is MP (dQ/dx1) and column 4 is MR = P = $200. TR = P x Q = $200 x Q.
MRP = d TR / d labor = d TR or
MRP = MP x MR Column (3) x (4)
MRP is the same as the firm's demand for labor curve, page 325.
Question 3, page 335. How many workers would firm
hire @ $250? Continue to hire data-entry operators as long as MRP
> P (wage), stop hiring when MRP = P. Additional workers would cost
more than they would contribute to firm's revenue.
For a profit-max firm, MRP = P (wage), or Wages = MRP.
The location of the MRP (demand for labor) curve would
depend on 1) price of the product, 2) productivity of the resource and
3) the amount of other resources with which the resource is working.
Changes in any of these factors would cause the MRP (D for labor) to shift.
Examples: if sales price/statement increased to $300, the MRP would increase.
If data-entry operators' productivity increased, the MRP would increase.
If new, better, or more computer equipment was purchased by the firm, the
MRP would increase.
EMPLOYMENT LEVELS WHEN THERE ARE NUMEROUS INPUTS
Firms use many resources for production - labor vs. capital,
skilled vs. unskilled labor, internal vs external production, full-time
vs part time labor, domestic vs foreign supplies or production, raw materials,
parts, supplies, etc. How should a firm decide to combine resources
to max profits or min costs of production?
PROFIT MAXIMIZATION WHEN MULTIPLE RESOURCES ARE USED
Profit max firms will continue to expand use of all inputs as long as MRP > Cost (price or wage) of the resource. In equilibrium, the MRP = P of the resource, just like MR = MC. Difference: to determine the profit max level of output (Q*), firms will produce until MR = MC. To determine the profit max use on an input (x1*), the firm will expand use of the resource until MRP = P (of x1).
In equilibrium, with firm's trying to max profits (and competing against each in both the input and output markets), the following conditions will exist:
MRP of someone with BA = P (wage for BA)
MRP of someone with MBA = P (wages for manager w/MBA)
MRP of Machine A = P (rental rate of machine), and so on for all factors of production
COST MINIMIZATION FOR MULTIPLE INPUTS
In an attempt to minimize the overall costs of production, firms will use various inputs in such a way that the MP per dollar spent is the same for all factors, meaning that:
MP of Skilled Labor =
MP of Unskilled Labor = MP of Machine A
P of Skilled Labor P of Unskilled Labor P (rent) on Machine A
Example: Suppose that a construction company can hire either skilled workers to hang doors or unskilled workers. The skilled workers are twice as productive and get paid twice as much, e.g. skilled workers can hang 4 doors per hour and get $40/hour, and the unskilled workers can hang 2 doors per hour and get $20/hour. This situation would be in equilibrium because:
4 Doors = 2 Doors
which is same as MP-skilled =
MP - unskilled
$40 $20 Wage-Sk Wage - Unsk
Wage differences reflect productivity. If skilled workers are twice as productive, they get paid twice as much. Profit-max firms trying to achieve cost min will compete with each other in the labor market and the equilibrium outcome will be as described above. In the case above, the cost per door installed is $10 whether the company uses skilled or unskilled workers. Suppose that the market is out of equilibrium, or a given firm is not in equilibrium, e.g. suppose that skilled workers could hang 5 doors per hour. In that case:
5 Doors >
Now skilled workers are a better deal for the company, it only costs them $8 for skilled vs. $10 for unskilled. This firm and other firms would use more skilled and less unskilled workers causing two results: a) The MP of skilled work would fall as more skilled workers are used and b) the price of skilled workers would go up. Suppose that MP fell to 4.5 doors/hour and the wage went up to $45, the price is now $10/door for the company again.
Important point: Low wages do not necessarily mean
low cost for companies, it does not always make sense to hire the lowest
wage workers. It is not just wages, but wages relative to productivity
that really matters. Companies want value in labor, not necessarily
the lowest money cost. Just like consumers don't just want low prices,
they consider quality, and want the highest value, not just the lowest
possible money cost.
CENTRAL PROPOSITION OF THE MP OF THEORY
1. Firms want to max profits and minimize per unit costs of production.
2. Firms will hire additional units of inputs as long as those additional units of input generate more revenues than the cost of the input.
3. To max profit, firms will never pay more for a unit of input than the input is worth in terms of increasing revenue.
4. The value of an input (resource) to the firm is determined by how much additional revenue can be generated by hiring the input.
Examples: Hiring decisions when a firm is expanding. Firms continue to hire additional workers as long as the MRP of the worker hired is greater than the wage. Decisions on buying new equipment/vehicles/computers, etc.
In real world, it is difficult to measure MP and MRP,
so business decisions might be based on this type of thinking: "To increase
profits this year, should we hire more workers or invest in additional
computer equipment, or both?" Firm's behavior would be consistent
with equalizing MP/Price across all inputs, even if they don't consciously
do so. In the long run, firms that are successful and survive, will
act efficiently and competitively and will achieve cost minimization as
described in the econ theory in this chapter.
SUPPLY OF RESOURCES
Trade has to be Win-Win for both parties to engage in a voluntary transaction. Resource owners (workers) will only supply their services if they value the benefits of doing so more than the costs (the other things they could do with their time or resources - leisure, education, raising children, retirement, etc). Resource owners will supply their services to those who offer them the most attractive employment alternative, all factors considered. Money is not usually the only variable. What else matters???
Examples: You are a business major accepted into the joint BA/MBA program, and you get a job offer while doing an internship. However, the job would mean that you couldn't be in the MBA program.
Ceterius paribus, as the price of the resource (wage) rises, the incentive of potential suppliers to provide the resource increases. See page 329.
Example: Retired people value leisure, but could
be enticed back into the labor market if the wage was high enough.
SHORT RUN SUPPLY
In the LR, major adjustments in resource supplies can
be made in response to changes in resource prices. For example, if
there is a suddenly a shortage of physicians or economics professors, leading
to higher wages for those workers, more people will be attracted into those
professions. But the response will take
time, due to the long period of training (9 - 11 years beyond HS).
In the SR, the supply of resources is determined by Resource Mobility: the degree to which resources can be transferred from one use to another in the SR in response to changing price incentives. Resources that can easily be transferred to alternative uses are highly mobile and the supply of those resources will be highly elastic - highly sensitive to price changes. Resources that cannot be easily transferred to alternative uses are said to be highly immobile, and the supply is inelastic - relatively insensitive to price changes.
Examples: a) farm land is highly mobile for certain crops - it can be equally well suited to effectively raising corn or soybeans or wheat. The farmer's skills and farmer's capital equipment are also highly mobile, making it easy to shift from one crop to another from year to year in response to grain prices.
b) Large trucks are truck drivers are resources that are also highly mobile, well suited for transporting a variety of products.
c) Labor skills would be highly mobile within a certain geographic area. Plumbers, accountants, carpenters, school teachers would be highly mobile within Genesee County labor market. However, labor skills would much less mobile between Genesee County and Florida, Maine, Alaska or Hawaii. If wages for carpenters are high in Oakland County, it would be relatively easy for carpenters in Flint to commute. If wages are really high in Alaska for carpenters, labor supply would much less mobile and more inelastic.
d) In general, the more (less) highly specialized a skilled
worker or machine is, the less (more) mobile the labor supply is.
A janitor is highly mobile, easy to transfer skills from one industry to
another. A trained rodeo rider would be highly immobile. A
desktop computer is highly mobile, a specialized computerized accounting
system for a company is highly immobile.
LONG RUN SUPPLY
In the LR, resource mobility is much higher than in the SR, meaning that Supply is more elastic in the LR than in the SR, given time to adjust to higher prices (wages) see page 331. Investment in human or physical capital will increase LR supply of resources in response to higher prices. If price goes from P1 to P2 for engineering services, the quantity goes from Q1 to Q2 in the SR. Current engineers will work more hours and maybe retired engineers will work part time. Workers with skill in mathematics or physics may shift to engineering, with no or limited additional training, etc.
Given more time to adjust to higher wages, more people get degrees in engineering and and labor increases from Q2 to Q3, maybe after many years. The training time is the "gestation period" - the time it takes from the increase investment in resources and the actual availability of the resource. The more specialized the skill, the longer the gestation period.
Example: computer field, especially for Y2K.
Because of the increased demand for computer programmers, wages increased,
attracting more people into the field. However, a labor shortage
developed because of limited resource mobility (not everyone has the necessary
skills) and a long gestation period for training, resulted in a shortage.
Solution: attract computer programmers from other countries. LR supply
is more elastic, as foreigners are attracted here and as more people invest
in the training necessary.
SUPPLY, DEMAND AND RESOURCE PRICES
See graphs on pages 332 and 333. Resource supply is more elastic/responsive in the LR compared to the SR.
1. Changes in demand in the Product Market determine changes in demand in the resource market, page 333. Resource demand is derived demand.
2. Resource prices coordinate actions of firms demanding inputs and households supplying them.
3. Resource prices transmit information about relative scarcity of resources.
4. Profit max provides incentives to economize on scarce resources.
5. Resource prices provide incentives for resource suppliers to provide resources - e.g. invest in human capital, especially those most in demand.
Efficient resource markets, directed by market forces,
lead to economic efficiency and a higher standard of living, wealth creation,