Chapter 27

Chapter 27 – The Demand for Resources

Significance of Resource Pricing

Income determination – Resource prices determine the income of households

Resource Allocation – Resource prices allocate resources among industries/firms

Cost Minimalization – Must produce profit-maximizing output with the most efficient combination of resources

Policy Issues – To what extent should the gov’t regulate wages

Marginal Productivity Theory of Resource Demand – Firm is a resource price “pricetaker”

Resource Demand as a Derived Demand

Derived Demand – Demand for Resources is derived from the products they help produce

Marginal Revenue Product – Strength of Demand depends on…Productivity of the Resource, The Market Value of the product

Productivity – Marginal Product – additional output resulting from using each additional unit of labor

Product Price – Marginal Revenue Product – the change in total revenue resulting from the use of each additional unit of a resource

Rule for Employing Resources – MRP = MRC

MRP schedule is the demand schedule for labor

Marginal resource cost (MRC) – additional in resource cost for each additional resource unit

It is profitable to hire resources until MRP = MRC

MRP as Resource Demand Schedule – In a competitive labor market, each firm is a wagetaker, hire to the point where MRP exceeds MRC. Each point on the MRP schedule constitutes a firm’s demand for labor

Resource Demand under Imperfect Product market competition

When the firm is a price maker, product price must be lowered to sell the marginal product of additional workers

Marginal Product diminishes and Product price falls as output increases

Lower price applies to all units sold

D = MRP in imperfect competition, broken line curve is that of a purely competitive seller

Resource demand curve of an imperfectly competitive seller is less elastic than that of a purely competitive seller

Downward slope is greater for a imperfectly competitive seller because the purely competitor can sell additional output a a constant price

Market Demand for a resource – sum up all the firms demands (MRP curves)

Determinants of Resource Demand – Resource demand is shifted by….

Changes in Product demand – increase in the demand for a product will increase the demand for resources used in its production, decrease in product demand will decrease the resource demand. Decline in the product demand/price will shift the resource demand curve to the left

Changes in Productivity – Increase in productivity, increase in demand. Depends on Quantities of other resources, Technological advance – lead to better quality capital

Quality of variable resource – increase in labor quantity would make a new demand curve

Changes in the Price of Other Resources

Substitute Resources – Substitution effect says that if another resource is cheaper, it will be substituted

Output effect – With lower production costs comes the increase in demand and thus need more workers

Net Effect – If Substitution effect > output effect, decrease in demand for labor and vice versa

Complementary Resources

If two resources must be used in a fixed proportion, then there is no substitution effect, only output effect

When labor and capital are complementary, a decline in the price of one increases the need for the other

Demand for labor increases when the demand for products increases, the Productivity of labor increases, The price of a substitute input decreases (if output effect > substitution effect), price of a substitute input increases (if sub effect > Output effet)

Occupational employment Trends – Increase in labor demanded results in increases in employment in that field

Fastest growing fields – in the service industry

Fastest shrinking fields – manufacturing jobs that can be automated

Elasticity of Resource Demand

Elasticity of Resource Demand = % Change in resource quantity/% change in price

Ease of Resource Substitutability – the greater the number of substitute goods, the greater the elasticity of demand for that resource

Elasticity of Product Demand – the greater the product demand elasticity, the greater the elasticity for the resources

Ratio of Resource Cost to Total Cost – The greater the percentage of cost to produce for an item, the more elastic it is

Optimal Combination of Resources

Least Cost Rule – producing at the least cost when the last dollar spent on each resource yields the same marginal product

Profit maximizing rule – Only one unique level of production that maximizes profit

MRP(resource) = P(resource) at maximum profit

Profit maximizing combination of resources – each resource follows the MRP = P rule

Producing at Least Cost – find the combination of labor and capital that will create the lowest total costs

Marginal Productivity theory of Income Distribution – income gets distributed according to contribution societies output. Workers get paid for their marginal contributions to their firmsPeople criticize this system for…

Inequality – productive resources (intelligence, physical attributes, opportunity in life) are distributed unequally. In this system, retarded people, some of whom make no contribution to society would not get paid

Market Imperfections – assumes a perfectly competitive market, real world imperfections can distort wages

Chapter 26

Chapter 26 – Technology, R&D and Efficiency

Invention Innovation and Diffusion

In the long run, technology is constant but firms can change their plans and are free to enter and exit industries

Very long run – tech can change and firms can develop and offer new products

Invention - the discovery of a product or process through the use of imagination, Patent – the exclusive right to produce and sell any new and usefull process, machine or product for a length of time

Innovation - The first use of an invention, a process, a new business venture etc. Either product or process innovation

Allows firms to leapfrog over other firms, existing firms have a strong incentive for R&D

Diffusion – the spread of an innovation through imitation or copying

R&D expenditures

US firms channeled 72% of R-D funds towards development, 22% on applied research and 6% to basic research

Modern View of Tech Advance

Modern economists see capitalism as the driving force of technological advance, even advances in pure science are often motivatied by commercial ventures

Role of Entrepreneurs and Other Innovators

Entrepreneur – risk bearer

Other innovators – other people in R-D that don’t bear risk

Forming Start-ups

Focus on starting a new idea from scratch

Innovating with existing firms

Often pay innovators bonuses for innovation, have spinoff firms for R-D

Anticipating the Future – try to gauge how tech will develop

Exploiting University and Government Scientific Research

The 6% allocated to basic scientific research is small because that research can not be capitalized on

A Firm’s optimal amount of R-D

Expand an activity until Marginal Benefit = Marginal Cost

Interest Rate Cost of Funds

Bank Loans – The cost of using the funds is the interest paid to the lender, The marginal cost is the interest rate for each additional dollar

Bonds – May be able to raise funds by selling bonds. Cost is the interest paid to the lenders-the bondholders

Retained Earnings – Well established firms may be able to draw on company savings

Venture Capital – Part of household savings that finance a startup in exchange for shares in the profit

Personal Savings – entrepreneurs savings, the marginal cost is the foregone interest rate

Interest rate cost of funds curve - A graph of interest rate vs amount borrowed

Expected rate of return

Marginal benefit is the expected profit form the last dollar

Expected-rate-of-return curve – Marginal benefit of each dollar of expenditure on R-D

Slopes downward b/c diminishing rate of returns

Allocates money to have the highest rate of return

Optimal R-D Expenditure

Interest-rate-of-return curve and expected-rate-of-return curve intersect at the Optimal amount of R-D (where rate of return and interest rate are equal)

Optimal vs Affordable – R-D may be affordable beyond the optimal amount

Expected, not guaranteed returns – they are an informed gamble

Adjustments – Adjust the R-D expenditure when return on various projects Change

Increased profit via Innovation

Increased Revenue via Product Innovation

Consumers purchase the highest marginal utility per dollar

Consumers will buy a new product only if it increases the total utility they obtain from their limited incomes

Important factors – Importance of price, Unsuccessful new products – R-D is wasted, Product improvements

Reduced Cost via Process Innovation – better processes lower ATC and increase TP (total product)

Imitation and R-D incentives

Imitation problem – if a rival company copies a product then the first companies R-D profits are diminished

Fast-second strategy – a dominant firm may let little companies do the R-D and then copy them quickly

Benefits of being first

Patents, Copyrights and trademarks, Brand name recognition, Trade Secrets and Learning by doing – ie Coke recipe, Time lags – have some time to make a big profit, Profitable buyouts – small company may be purchased for a lot of money

Role of Market structure

Market structure and Technological Advance –

Pure competition – provides an incentive to develop, expected return from R-D may be much less, in highly competitive firms such as agriculture, development comes from outside (gov’t),

Monopolistic Competition – Strong profit incentive to innovate, unique products = monopoly, most monopolies are small so its tough for them to get capital for R-D

Oligopoly – Can finance, can maintain economic profit, broad scope offsets the misses, however Oligopoly breeds complacency, competing with itself

Pure Monopoly – little incentive for R-D, only to reduce the risk of being blindside by a new development

Inverted U Theory

Graph of R&D expenditures vs Concentration ratio is an inverted U

Low concentration firms are competitive, with easy entry

High concentration – monopoly profit is already pretty high and R-D won’t add much to the profit

Market Structure and Technological Advance: the Evidence

Best mix is Oligopoly with smaller firms

Technological Advance and Efficiency

Productive Efficiency – Enables society to produce the same amount of a particular good or service while using fewer scarce resources, freeing the unused resources to produce something else

Allocative Efficiency – New product gives more utility/dollar, Profit-maimizing monopolist restricts output to keep its product price above marginal cost

Creative Destruction – Innovation can destroy monopolies, in CD, new products will put monopolistic industries for old products out of business