Page 562 - Economics

CONFIRMING PAGES

PART SEVEN
494
Microeconomics of Resource Markets
increase its marginal productivity and therefore its including labor. So this output effect increases the
demand. In effect, there will be a new demand curve demand for labor. More generally, the output effect
for a different, more skilled, kind of labor. means that the firm will purchase more of one
All these considerations help explain why the average level particular input when the price of the other input
of (real) wages is higher in industrially advanced nations falls and less of that particular input when the price
(for example, the United States, Germany, Japan, and of the other input rises.
France) than in developing nations (for example, India, • Net effect The substitution and output effects are
Ethiopia, Angola, and Cambodia). Workers in industrially both present when the price of an input changes, but
advanced nations are generally healthier, better educated, they work in opposite directions. For a decline in the
and better trained than are workers in developing coun- price of capital, the substitution effect decreases the
tries. Also, in most industries they work with a larger and demand for labor and the output effect increases it.
more efficient stock of capital goods and more abundant The net change in labor demand depends on the rel-
natural resources. This creates a strong demand for labor. ative sizes of the two effects: If the substitution effect
On the supply side of the market, labor is relatively scarce outweighs the output effect, a decrease in the price of
compared with that in most developing nations. A strong capital decreases the demand for labor. If the output
demand and a relatively scarce supply of labor result in effect exceeds the substitution effect, a decrease in
high wage rates in the industrially advanced nations. the price of capital increases the demand for labor.

Complementary Resources Recall from Chap-
Changes in the Prices of Other ter 3 that certain products, such as computers and soft-
Resources ware, are complementary goods; they “go together” and
Changes in the prices of other resources may change the are jointly demanded. Resources may also be complemen-
demand for a specific resource. For example, a change in tary; an increase in the quantity of one of them used in the
the price of capital may change the demand for labor. The production process requires an increase in the amount
direction of the change in labor demand will depend on used of the other as well, and vice versa. Suppose a small
whether labor and capital are substitutes or complements design firm does computer-assisted design (CAD) with
in production. relatively expensive personal computers as its basic piece of
capital equipment. Each computer requires a single design
Substitute Resources Suppose the technology in engineer to operate it; the machine is not automated—it
a certain production process is such that labor and capital will not run itself—and a second engineer would have
are substitutable. A firm can produce some specific amount nothing to do.
of output using a relatively small amount of labor and a Now assume that a technological advance in the pro-
relatively large amount of capital, or vice versa. Now assume duction of these computers substantially reduces their
that the price of machinery (capital) falls. The effect on price. There can be no substitution effect, because labor
the demand for labor will be the net result of two opposed and capital must be used in fixed proportions, one person
effects: the substitution effect and the output effect. for one machine. Capital cannot be substituted for labor.
• Substitution effect The decline in the price of But there is an output effect. Other things equal, the re-
machinery prompts the firm to substitute machinery duction in the price of capital goods means lower produc-
for labor. This allows the firm to produce its output tion costs. Producing a larger output will therefore be
at lower cost. So at the fixed wage rate, smaller quan- profitable. In doing so, the firm will use both more capital
tities of labor are now employed. This substitution and more labor. When labor and capital are complemen-
effect decreases the demand for labor. More gener- tary, a decline in the price of capital increases the demand
ally, the substitution effect indicates that a firm will for labor through the output effect.
purchase more of an input whose relative price has We have cast our analysis of substitute resources and
declined and, conversely, use less of an input whose complementary resources mainly in terms of a decline in
relative price has increased. the price of capital. Table 25.3 summarizes the effects of
• Output effect Because the price of machinery has an increase in the price of capital on the demand for labor.
fallen, the costs of producing various outputs must Please study it carefully.
also decline. With lower costs, the firm finds it Now that we have discussed the full list of the deter-
profitable to produce and sell a greater output. The minants of labor demand, let’s again review their effects.
greater output increases the demand for all resources, Stated in terms of the labor resource, the demand for

9/8/06 1:09:47 PM
mcc26632_ch25_487-504.indd 494 9/8/06 1:09:47 PM
mcc26632_ch25_487-504.indd 494