chapt 16 micro

Determinants of Labor Demand: Factors That Shift the Labor Demand Curve

Table 16.4 Determinants of Labor Demand: Factors That Shift the Labor Demand Curve-This table provides a summary of the determinants that impact the demand for labor and how this demand shifts when the determinants change.

Last Word: Labor and Capital: Substitutes or Complements?

Banks will use the least cost combination of resources. Before ATMs, tellers would handle cash for customers (labor). ATMs arrived in 1980s and they can handle cash for customers (capital). At first, tellers were displaced but today there are more ATMs and more tellers. Labor and capital are now complements. In summary-What happens when a technological advance makes a capital good with a MP/P that is greater than for other inputs? The firm will change their resource mix. If the new good is a substitute for a particular type of labor, the firm will replace labor with the new capital. If the new good is a complement of a particular type of labor, then the firm will add additional amounts of that labor. At first, ATMs displaced bank tellers, but now data shows that the number of bank tellers have increased over time. Since ATMs have freed up tellers from cash handling, the tellers can do other banking tasks, such as selling financial products.

Occupational Employment Trends

Changes in labor demand affect wage rates and employment in specific occupations. Increases in labor demand for certain occupational groups result in increases in their employment; decreases in labor demand result in decreases in their employment. Of the 10 fastest-growing occupations in percentage terms, five-home health aides, personal care aides, physician assistants, nurse practitioners, and physical therapist assistants-are related to the health field. The rising demand for these laborers is derived from the growing demand for health services, which is caused by several factors. The aging of the U.S. population has brought with it more medical problems; the rising standard of income has led to greater expenditures on health care; and the continued presence of private and public insurance has allowed people to purchase more health care than most could afford individually. Rising employment in health services: Personal care aides. Home health aides. Physician assistants. Declining employment: Telephone operators. Parking enforcement workers. In summary-There is rising employment in health services due to rising demand for health care with the aging of the population. Use of insurance has allowed people to buy more health care than they could have without it. In other areas, labor-saving technology is replacing workers through the use of automated or computerized equipment.

Determinants of Resource Demand (2 of 2)

Changes in price of substitute resources-Changes in the prices of other resources may change the demand for a specific resource. For example, a change in the price of capital may change the demand for labor. The direction of the change in labor demand depends on whether labor and capital are substitutes or complements in production.: Substitution effect-The decline in the price of machinery prompts the firm to substitute machinery for labor. This substitution allows the firm to produce its output at lower cost. So, at the fixed wage rate, smaller quantities of labor are now employed. This substitution effect decreases the demand for labor. More generally, the substitution effect indicates that a firm will purchase more of an input whose relative price has declined. Conversely, it will use less of an input whose relative price has increased. Output effect-Because the price of machinery has fallen, the costs of producing various outputs must also decline. With lower costs, the firm finds it profitable to produce and sell a greater output. The greater output increases the demand for all resources, including labor. Thus, this output effect increases the demand for labor. More generally, the output effect means that the firm will purchase more of one particular input when the price of the other input falls. It will purchase less of that particular input when the price of the other input rises. Net effect-The substitution and output effects are both present when the price of an input changes, but they work in opposite directions. For a decline in the price of capital, the substitution effect decreases the demand for labor, while the output effect increases it. The net change in labor demand depends on the relative sizes of the two effects: If the substitution effect outweighs the output effect, a decrease in the price of capital decreases the demand for labor. If the output effect exceeds the substitution effect, a decrease in the price of capital increases the demand for labor. Changes in the price of complementary resources-Certain products, such as computers and software, are complementary goods; they "go together" and are jointly demanded. Resources may also be complementary; an increase in the quantity of one resource used in the production process requires an increase in the amount used of the other resource, and vice versa. Suppose a small design firm does computer-assisted design (CAD) with a relatively expensive personal computer as its basic piece of capital equipment. Each computer requires exactly one design engineer to operate it; the machine is not automated-it will not run itself-and a second engineer would have nothing to do. Assume that a technological advance in the production of these computers substantially reduces their price. There can be no substitution effect because labor and capital must be used in fixed proportions, one person for one machine. Capital can't be substituted for labor. But there is an output effect. Other things equal, the reduction in the price of capital goods means lower production costs. Producing a larger output will therefore be profitable. In producing more output, the firm will use both more capital and more labor. When labor and capital are complementary, a decline in the price of capital increases the demand for labor through the output effect. In summary-Changes in the prices of substitute resources may affect the demand for a specific resource. The substitution effect tells us that a firm will purchase more of an input whose relative price has declined and, conversely, use less of an input whose relative price has increased. The output effect indicates that the firm will purchase more of one particular input when the price of the other input falls and less of that particular input when the price of the other input rises. Netting the two together will determine the final total change. With complementary resources the changes in demand for each resource will be directly related, meaning they will rise and fall together.

Income Distribution

In effect, workers receive income payments (wages) equal to the marginal contributions they make to their employers' outputs and revenues. In other words, workers are paid according to the value of the labor services that they contribute to production. Similarly, owners of the other resources receive income based on the value of the resources they supply in the production process. Marginal productivity theory of income distribution. Paid according to value of service: Workers. Resource owners. Inequality: Productive resources unequally distributed. Critics argue that the distribution of income resulting from payment according to marginal productivity may be highly unequal because productive resources are very unequally distributed in the first place. Aside from their differences in mental and physical attributes, individuals encounter substantially different opportunities to enhance their productivity through education and training and the use of more and better equipment. Some people may not be able to participate in production at all because of mental or physical disabilities, and they would obtain no income under a system of distribution based solely on marginal productivity. Ownership of property resources is also highly unequal. Many owners of land and capital resources obtain their property by inheritance rather than through their own productive effort. Hence, income from inherited property conflicts with the "To each according to the value of what he or she creates" idea. Critics say that these inequalities call for progressive taxation and government spending programs aimed at creating a more equitable income distribution. Market imperfections-The marginal productivity theory of income distribution rests on the assumptions of competitive markets. However, not all labor markets are highly competitive. In some labor markets, employers exert their wage-setting power to pay less-than-competitive wages. And some workers, through labor unions, professional associations, and occupational licensing laws, wield wage-setting power in selling their services. Even the process of collective bargaining over wages suggests a power struggle over the division of income. In wage setting through negotiations, market forces-and income shares based on marginal productivity-may get partially pushed into the background. In addition, discrimination in the labor market can distort earnings patterns. In short, because of real-world market imperfections, wage rates and other resource prices are not always based solely on contributions to output. In summary-Income is distributed according to how the resource contributed to creating society's output. Income payments based on marginal revenue product provide a fair and equitable distribution of society's income. It is not a perfect system, however, as it can result in a highly unequal distribution. This may be because production resources were unequally distributed in the first place. Market imperfections can also result in unequal distributions. In some labor markets, employers are able to exert their wage-setting power to pay less-than-competitive wages.

Marginal Productivity Theory of Resource Demand

MRP = MRC rule. To maximize profit, hire additional resources as long as the additional product produced adds more to revenues than to costs. MRP schedule equals the firm's demand for labor. MRC exactly equal to wage rate. Can restate our rule for hiring resources as follows: It will be profitable for a firm to hire additional units of a resource up to the point at which that resource's MRP is equal to its MRC. For example, as the rule applies to labor, if the number of workers a firm is currently hiring is such that the last worker's MRP exceeds his or her MRC, the firm can profit by hiring more workers. But if the number being hired is such that the last worker's MRC exceeds his or her MRP, the firm is hiring workers who are not "paying their way," and it can increase its profit by discharging some workers. The point of reference is now inputs of a resource, not outputs of a product. In summary-A firm will maximize profits at the point at which marginal revenue product equals marginal resource cost.

Marginal Resource Cost

Marginal resource cost (MRC). Change in total resource cost resulting from unit change in resource input (labor): Marginal resource cost=change in total cost/change in resource quantity In summary-Marginal resource cost is equal to the amount that each additional unit of a resource adds to a firm's total cost.

Least-Cost Rule

Minimize cost of producing a given output. Consider firms that are competitive buyers in resource markets. Because each firm is too small to affect resource prices, each firm's marginal resource costs will equal market resource prices, and each firm will be able to hire as many units as it would like of any and all resources. Thus, if there are just two resources, labor and capital, a competitive firm will minimize its total cost of producing a specific quantity of output when their respective ratios of MP to price are equal: Last dollar spent on each resource yields the same marginal product: Marginal Product of Labor (MPL)/Price of labor (PL)=Marginal Product of Capital (MPC)/Price of capital (PC). Whenever the same total-resource cost can result in a greater total output, the cost per unit-and therefore the total cost of any specific level of output-can be reduced. Being able to produce a larger output for a specific total cost is the same as being able to produce a specific output for a smaller total cost. In achieving the utility-maximizing combination of goods, the consumer considers both his or her preferences as reflected in diminishing-marginal-utility data and the prices of the various products. Similarly, in achieving the cost-minimizing combination of resources, the producer considers both the marginal-product data and the prices (costs) of the various resources. In summary-The least-cost rule states that a firm will seek to minimize the cost of producing a given output in order to maximize profits. A producer's least-cost rule is analogous to the consumer's utility-maximizing rule described in Chapter 7. In achieving the cost-minimizing combination of resources, the producer considers both the marginal product data and the prices (costs) of the various resources.

Significance of Resource Pricing

Money-income determination-Resource prices are a major factor in determining households' incomes. Firms' expenditures to acquire economic resources flow as wage, rent, interest, & profit incomes to the households that supply those resources. Cost minimization-To the firm, resource prices are costs. And to obtain the greatest profit, the firm must produce the profit-maximizing output with the most efficient (least costly) combination of resources. Resource prices play the main role in determining the quantities of land, labor, capital, & entrepreneurial ability that firms will combine in producing each g or s. Resource allocation-Just as product prices allocate finished g's & s's to consumers, resource prices allocate resources among industries & firms. In a dynamic economy, where technology & product demand often change, the efficient allocation of resources over time calls for the continuing shift of resources from one use to another. Resource pricing is a major factor in those shifts. Policy issues-Many policy issues surround the resource market. Examples: To what extent should govt redistribute income through taxes & transfers? Should govt increase the legal minimum wage? Should govt encourage or restrict labor unions? The facts & debates relating to these policy questions are grounded in resource pricing. In summary-Studying resource pricing aids in the understanding of economic activity in several ways. Resource prices are a major factor in determining the income of households. To firms, resource prices represent costs. To make the most money, firms must produce at the profit-maximizing output with the least costly combo of resources. Resource prices help in the allocation of resources among the various industries & firms that need them. And finally, many policy issues like CEO pay, labor unions, & minimum wage increases are based on resource pricing. While the focus in this chapter is on the labor resource, the principles apply just as well to the other economic resources: land, capital, & entrepreneurial ability.

Profit-Maximizing Rule

Only one unique level of output maximizes profit. This unique profit-maximizing output level occurs when the firm produces the quantity of output at which marginal revenue equals marginal cost (MR = MC). Near the beginning of this current chapter we determined that this profit-maximizing condition requires that firms purchase and use the quantity of each resource at which MRP = MRC for that resource. In a purely competitive resource market, the marginal resource cost (MRC) is equal to the resource price P. Thus, for any competitive resource market, we have as our profit-maximizing equation. MRP (Resource)=P (Resource). Each resource is employed to the point where its MRP is equal to its price. PL=MRPL & PC=MRPC MRPL/PL = MRPC/PC=1 In summary-Just minimizing costs is not enough for maximizing profit. There is only one unique level of output that will maximize profit. Profit maximization occurs where marginal revenue equals marginal cost. A firm will achieve its profit-maximizing combination of resources when each resource is employed to the point at which its marginal revenue product equals its resource price.

Top Ten Oil Importing Nations, 2017

Remember-The total, or market, demand curve for a specific resource shows the various total amounts of the resource that firms will purchase or hire at various resource prices, other things equal. Recall that the total, or market, demand curve for a product is found by summing horizontally the demand curves of all individual buyers in the market. The market demand curve for a particular resource is derived in essentially the same way-by summing horizontally the individual demand or MRP curves for all firms hiring that resource. Global Perspective 16.1 Top Ten Oil Importing Nations, 2018-shows the average volume of oil imported into selected countries. These countries' demands for imported oil form part of the horizontally summed worldwide demand for oil that helps to determine the market price of oil. The demand for imports of crude oil varies substantially among the Top Ten oil importing countries. And because the Top Ten collectively account for 70% of all international oil imports, their collective demand has a strong influence on the worldwide market equilibrium price of oil. In-summary-In this Global Perspective, we see the percentage share of world exports for the top 10 oil importing nations as of 2018. Because they account for 70% of all international oil imports, their collective demand has a strong influence on the worldwide market equilibrium price.

The Demand for Labor: Imperfect Competition in the Sale of the Product

Resource demand (here, labor demand) is more complex when the firm is selling its product in an imperfectly competitive market, one in which the firm is a price maker. That is because imperfect competitors (pure monopolists, oligopolists, and monopolistic competitors) face downsloping product demand curves. As a result, whenever an imperfect competitor's product demand curve is fixed in place, the only way to increase sales is by setting a lower price (and thereby moving down along the fixed demand curve). More info Figure 16.2-we graph the MRP data from Table 16.2 and label it "D = MRP (imperfect competition)." The broken-line resource demand curve, in contrast, is that of the purely competitive seller represented in Table 16.1.A comparison of the two curves demonstrates that, other things equal, the resource demand curve of an imperfectly competitive seller is less elastic than that of a purely competitive seller. Consider the effects of an identical percentage decline in the wage rate (resource price) from $11 to $6 in Figure 16.2. Comparison of the two curves reveals that the imperfectly competitive seller (solid curve) does not expand the quantity of labor it employs by as large a percentage as does the purely competitive seller (broken curve). Table 16.2 The Demand for Labor: Imperfect Competition in the Sale of the Product-The productivity data in Table 16.1 are retained in columns 1 to 3 in here. But here ​​we show in column 4 that product price must be lowered to sell the marginal product of each successive worker. The MRP of the purely competitive seller of Table 16.1 falls for only one reason: Marginal product diminishes. But the MRP of the imperfectly competitive seller of Table 16.2 falls for two reasons: Marginal product diminishes and product price falls as output increases. We emphasize that the lower price accompanying each increase in output (total product) applies not only to the marginal product of each successive worker but also to all prior output units that otherwise could have been sold at a higher price. Figure 16.2 The imperfectly competitive seller's demand curve for a resource- An imperfectly competitive seller's resource demand curve D (solid) slopes downward because both marginal product and product price fall as resource employment and output rise. This downward slope is greater than that for a purely competitive seller (dashed resource demand curve) because the pure competitor can sell the added output at a constant price. Other info-It isn't surprising that the imperfectly competitive producer is less responsive to resource price cuts than the purely competitive producer. When resource prices fall, MC per unit declines for both imperfectly competitive firms as well as purely competitive firms. Because both types of firms maximize profits by producing where MR = MC, the decline in MC will cause both types of firms to produce more. But the effect will be muted for imperfectly competitive firms because their downsloping demand curves cause them to also face downsloping MR curves--so that for each additional unit sold, MR declines. By contrast, MR is constant (and equal to the market equilibrium price P) for competitive firms, so that they don't have to worry about MR per unit falling as they produce more units. As a result, competitive firms increase production by a larger amount than imperfectly competitive firms whenever resource prices fall. In-summary-Under imperfect product market competition, the resource demand curve (the solid line in the graph) slopes downward because both marginal product and product price fall as output rises. The downward slope is greater than that for a purely competitive seller (the dashed line) because the pure competitor can sell the added output at a constant price.

Derived Demand for Resources

Resource demand is a schedule or a curve showing the amounts of a resource that buyers are willing and able to purchase at various prices over some period of time. Resource demand is derived demand. This is true because resources usually don't directly satisfy customer wants. Rather, they do so indirectly through their use in producing g's & s's. Assume perfect competition: Product markets-In a competitive product market, the firm is a "price taker" and can sell as little or as much output as it chooses at the market price. Because the firm is selling such a negligible fraction of total output, its output decisions exert no influence on product price. Resource markets-Similarly, the firm is a "price taker" (or "wage taker") in the competitive resource market. It purchases such a negligible fraction of the total supply of the resource that its buying (or hiring) decisions don't influence the resource price. Resource demand is the starting point for any discussion of resource prices. Derived demand for resources depends on: Marginal product of the resource (MP)-The resource's productivity in helping to create a g or s. Price of the product it produces (P)-The market value or price of the g or s it helps to produce. Remember-Other things equal, a resource that is highly productive in turning out a highly valued commodity will be in great demand. A relatively unproductive resource that is capable of producing only a minimally valued commodity will be in little demand. And no demand whatsoever will exist for a resource that is phenomenally efficient in producing something that no one wants to buy. In summary-To keep the example simple, assume that resources are bought and sold in perfectly competitive markets and that the products produced by the resources are also bought & sold in perfectly competitive markets. Note that there is a derived demand for resources since we don't consume resources directly but indirectly through the consumption of the g's & s's produced with the resources. The strength of the demand depends on the productivity of that resource in helping to create a g or s & the market value or price of the g or s it helps produce.

Optimal Combination of Resources

So far, we have focused on one variable input, labor. But in the long run firms can vary the amounts of all the resources they use. That's why we need to consider what combination of resources a firm will choose when all its inputs are variable. While our analysis is based on two resources, labor and capital, it can be extended to any number of inputs. We will consider two related questions: What combination of resources will minimize costs at a specific level of output? What combination of resources will maximize profit? What combination of resources will minimize costs at a specific output level? Least-cost combination of resources. Least-cost rule. What combination of resources will maximize profit? Profit-maximizing combination of resources. Profit maximizing rule. In summary-In the long run, all resource inputs are variable, and so one must consider what combinations of resources a firm should choose when all its inputs are variable. A firm will produce a specific output with the least-cost combination of resources in order to maximize profit.

Numerical Illustration

TABLE 16.7 Data for Finding the Least Cost and Profit-Maximizing Combination of Labor and Capital, Siam's Soups*-we show the total products and marginal products for various amounts of labor and capital that are assumed to be the only inputs Siam needs in producing its soup. Both inputs are subject to diminishing returns. Assume that labor and capital are supplied in competitive resource markets at $8 and $12, respectively, and that Siam's soup sells competitively at $2 per unit. For both labor and capital we can determine the total revenue associated with each input level by multiplying total product by the $2 product price. These data are shown in columns 4 and 4'. They enable us to calculate the marginal revenue product of each successive input of labor and capital, as shown in columns 5 and 5', respectively. In summary-In columns 2, 3, 2′, and 3′ in this table, the total product and marginal product for various amounts of labor and capital are displayed. MRP is found in columns 5 and 5′. Labor and capital are assumed to be the only inputs needed in producing the product and both inputs are subject to diminishing returns. The profit maximizing combination of 5 units of labor and 3 units of capital is also a least cost combination for this particular level of output.

The Demand for Labor: Pure Competition in the Sale of the Product

Table 16.1 The Demand for Labor: Pure Competition in the Sale of the Product-shows the roles of resource productivity and product price in determining resource demand. Here we assume that a firm adds a single variable resource, labor, to its fixed plant. Columns 1 through 3 remind us that the law of diminishing returns applies here, causing the marginal product of labor to fall beyond some point. For simplicity, we assume that these diminishing marginal returns-these declines in marginal product-begin with the first worker hired. The MRP schedule, shown as columns 1 & 6 in here, is the firm's demand schedule for labor. To know why, you need to know the rule that guides a profit-seeking firm in hiring any resource: To maximize profit, a firm should hire additional units of a specific resource as long as each successive unit adds more to the firm's total revenue than it adds to the firm's total cost. IN REGARDS TO FIGURE 16.1-In a purely competitive labor market, market supply & market demand establish the wage rate. Because each firm hires such a small fraction of market supply, it can't influence the market wage rate; it is a wage taker, not a wage maker. Thus, for each additional unit of labor hired, each firm's total resource cost increases by exactly the amount of the constant market wage rate. More specifically, the MRC of labor exactly equals the market wage rate. Thus, resource "price" (the market wage rate equals resource "cost" (marginal resource cost) for a firm that hires a resource in a competitive labor market. As a result, the MRP = MRC rule tells us that, in pure competition, the firm will hire workers up to the point at which the market wage rate (its MRC) equals its MRP. Here is the key generalization: The MRP schedule constitutes the firm's demand for labor because each point on this schedule (or curve) indicates the number of workers the firm would hire at each possible wage rate. We show the D = MRP curve based on the data in Table 16.1. The competitive firm's resource demand curve identifies an inverse relationship between the wage rate and the quantity of labor demanded, other things equal. The curve slopes downward because of diminishing marginal returns. Figure 16.1 The purely competitive seller's demand for a resource-The MP curve is the resource demand curve; each of its points relates a particular resource price (= MRP when profit is maximized) with a corresponding quantity of the resource demanded. Under pure competition, product price is constant; therefore, the downward slope of the D = MRP curve is due solely to the decline in the resource's marginal product (law of diminishing marginal returns). In summary-This schedule demonstrates the demand for labor under a purely competitive environment. The MRP curve is the resource demand curve; each of its points relates a particular resource price with a corresponding quantity of the resource demanded. Under pure competition, product price is constant; therefore, the downward slope of the D = MRP curve is due solely to the decline in the resource's marginal product.

The Effect of an Increase in the Price of Capital on the Demand for Labor, DL

Table 16.3 The Effect of an Increase in the Price of Capital on the Demand for Labor, DL-Now that we have discussed the determinants of labor demand, let's again review their effects. Stated in terms of the labor resource, the demand for labor will increase (the labor demand curve will shift rightward) when: The demand for (and therefore the price of) the product produced by that labor increases. The productivity (MP) 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. Be sure that you can "reverse" these effects to explain a decrease in labor demand. In summary-This table provides a summary of how an increase in the price of capital will affect the demand for labor depending on whether they are substitutes or complements in production.

The 10 Fastest-Growing U.S. Occupations in Percentage Terms, 2016-2026

Table 16.5 The 10 Fastest-Growing U.S. Occupations in Percentage Terms, 2016-2026-lists the 10 fastest-growing U.S. occupations for 2016 to 2026, as measured by percentage changes and projected by the Bureau of Labor Statistics. Service occupations dominate the list. In general, the demand for service workers in the United States is rapidly outpacing the demand for manufacturing, construction, and mining workers. In summary-This table lists the ten fastest growing U.S. occupations for the years 2016 through 2026 as projected by the Bureau of Labor Statistics. You may notice that service occupations dominate the list, and five of them are related to the healthcare field.

The 10 Most Rapidly Declining U.S. Occupations in Percentage Terms, 2016-2026

Table 16.6 The 10 Most Rapidly Declining U.S. Occupations in Percentage Terms, 2016-2026-lists the 10 U.S. occupations with the greatest projected job loss (in percentage terms) between 2016 and 2026. Several of these occupations owe their declines mainly to labor-saving technological change. For example, automated or computerized equipment has greatly reduced the need for parking enforcement workers and telephone operators. In summary-This table lists the ten most rapidly declining U.S. occupations for the years 2016 through 2026 as projected by the Bureau of Labor Statistics. The list is composed of occupations being affected by labor saving technology with automated or computerized equipment and with the U.S. demand for these goods increasingly being filled by imports.

Marginal Revenue Product

The derived demand for a resource depends also on the price of the product it produces. Product price is constant (Table 16.1). Multiplying column 2 by column 4 provides the total-revenue data of column 5 (Table 16.1). From these total-revenue data we can compute marginal revenue product (MRP). Marginal revenue product (MRP). Change in total revenue resulting from unit change in resource input (labor): Marginal Revenue product = Change in total revenue/change in resource quantity In summary-The marginal revenue product represents the change in total revenue resulting from the use of each additional unit of a resource.

Elasticity of Resource Demand

The employment changes just discussed have resulted from shifts in resource demand curves. Such changes in demand must be distinguished from changes in the quantity of a resource demanded, which are caused by a change in the price of the specific resource. Such changes are caused not by a shift of the demand curve but, rather, by a movement from one point to another on a fixed resource demand curve. Figure 16.1 (This is a change in the quantity of labor demanded as distinct from a change in the demand for labor.) When Erd is greater than 1, resource demand is elastic; when Erd is less than 1, resource demand is inelastic; and when Erd equals 1, resource demand is unit-elastic. What determines the elasticity of resource demand? Several factors are at work. Elasticity of resource demand: ERD=percentage change in resource quantity/percentage change in resource price. Ease of resource substitutability-The degree to which resources are substitutable is a fundamental determinant of elasticity. The greater the substitutability of other resources, the more elastic is the demand for a particular resource. At the other extreme, there may be no reasonable substitutes. Time can play a role in the ease of input substitution. Elasticity of product demand-Because the demand for labor is a derived demand, the elasticity of the demand for labor's output will influence the elasticity of the demand for labor. Other things equal, the greater the price elasticity of product demand, the greater the elasticity of resource demand. For example, suppose that the wage rate falls. The result is a decline in the cost of producing the product and a drop in the product's price. If the elasticity of product demand is great, the resulting increase in the quantity of the product demanded will be large and thus necessitate a large increase in the quantity of labor demanded, which implies an elastic demand for labor. But if the demand for the product is inelastic, the increase in the amount of the product demanded will be small, and so will the increase in the quantity of labor demanded. Here, the demand for labor is inelastic. Ratio of resource cost to total cost-The larger the proportion of total production costs accounted for by a resource, the greater the elasticity of demand for that resource. In the extreme, if labor cost is the only production cost, then a 20% increase in wage rates will shift all the firm's cost curves upward by 20%. If product demand is elastic, this substantial increase in costs will cause a relatively large decline in sales and a sharp decline in the amount of labor demanded. Thus labor demand is highly elastic. But if labor accounts for only 50% of production cost, then a 20% increase in wage rates will increase costs by only 10%. With the same elasticity of product demand, the result will be a relatively small decline in sales and therefore in the amount of labor demanded. In this case, the demand for labor is much less elastic. In summary-A change in the demand of a resource must be distinguished from a change in the quantity demanded of a resource. The sensitivity of resource quantity to changes in resource prices along a fixed resource demand curve is measured in the elasticity of resource demand which is measured as the percentage change in the resource quantity divided by the percentage change in the resource price. Several factors determine the elasticity of resource demand. The ease of the resource substitutability is one. The greater the substitutability of other resources, the more elastic the demand will be for a particular resource. Since the demand for labor is a derived demand, the elasticity of the demand for the output product will also influence the elasticity of the demand of labor. And finally, the ratio of the resource cost to total cost is also a factor. The larger the proportion of total production costs accounted for by a resource, the greater the elasticity of demand will be for that resource.

Determinants of Resource Demand (1 of 2)

What'll alter the demand for a resource? That is, what will shift the resource demand curve? The fact that resource demand is derived from product demand and depends on resource productivity suggests two resource demand shifters. Also, our analysis of how changes in the prices of other products can shift a product's demand curve suggests a third factor: changes in the prices of other resources. Changes in product demand-Other things equal, an increase in the demand for a product will increase the demand for a resource used in its production, whereas a decrease in product demand will decrease the demand for that resource. Let's see how this works. Recall that a change in the demand for a product will change its price. Similarly, a decline in the product demand (and price) will shift the resource demand curve to the left. This effect-resource demand changing along with product demand-demonstrates that resource demand is derived from product demand. Example: Assuming no offsetting change in supply, a decrease in the demand for new houses will drive down house prices. Those lower prices will decrease the MRP of construction workers, and therefore the demand for construction workers will fall. Changes in productivity:Other things equal, an increase in the productivity of a resource will increase the demand for the resource, and a decrease in productivity will reduce the demand for the resource. The productivity of any resource may be altered over the long run in several ways: Quantities of other resources-The marginal productivity of any resource will vary with the quantities of the other resources used with it. The greater the amount of capital and land resources used with, say, labor, the greater will be labor's marginal productivity and, thus, labor demand. Technological advance-Technological improvements that increase the quality of other resources, such as capital, have the same effect on other resources. For example, the better the quality of capital, the greater the productivity of labor used with it. Dockworkers employed with a specific amount of real capital in the form of unloading cranes are more productive than dockworkers with the same amount of real capital embodied in older conveyor-belt systems. Quality of the variable resource-Improvements in the quality of the variable resource, such as labor, will increase its marginal productivity and therefore its demand. In effect, there will be a new demand curve for a different, more skilled, kind of labor. In summary-Other things equal, an increase in the demand for a product will increase the demand for a resource used in its production. Changes in productivity can be brought about by changes in quantities of other resources, technological advances, or the quality of the variable resources. Importance-All these considerations help explain why the average level of (real) wages is higher in industrially advanced nations (for example, the U. S, Germany, and Japan) than in developing nations (for example, Nicaragua, Ethiopia, and Cambodia). Workers in industrially advanced nations are generally healthier, better educated, and better trained than are workers in developing countries. Also, in most industries they work with a larger and more efficient stock of capital goods and more abundant natural resources. The resulting increased productivity creates a strong demand for labor. On the supply side of the market, labor is scarcer relative to capital in industrially advanced nations than in most developing nations. A strong demand and a relatively scarce supply of labor result in high wage rates in the industrially advanced nations.