Page 565 - Economics

CONFIRMING PAGES

CHAPTER 25
497
The Demand for Resources
The sensitivity of producers to changes in resource quantity of labor to produce the additional output. This
prices is measured by the elasticity of resource demand . implies an elastic demand for labor. But if the demand for
In coefficient form, the product is inelastic, the increase in the amount of the
product demanded will be small, as will be the increases in
percentage change in resource quantity

__________________________________ the quantity of labor demanded. This suggests an inelastic
E rd
percentage change in resource price demand for labor.
When E rd is greater than 1, resource Remember that the resource demand curve in
demand is elastic; when E is less than 1, Figure 25.1 is more elastic than the resource demand
rd
resource demand is inelastic; and when curve shown in Figure 25.2 . The difference arises be-
E equals 1, resource demand is unit- cause in Figure 25.1 we assume a perfectly elastic product
rd
O 25.1 elastic. What determines the elasticity of demand curve, whereas Figure 25.2 is based on a
Elasticity of resource demand? Several factors are at downsloping or less than perfectly elastic product demand
resource demand work. curve.
Ease of Resource Substitutability The de- Ratio of Resource Cost to Total Cost The
gree to which resources are substitutable is a fundamental larger the proportion of total production costs accounted
determinant of elasticity. The greater the substitutability for by a resource, the greater the elasticity of demand for
of other resources, the more elastic is the demand for a that resource. In the extreme, if labor cost is the only pro-
particular resource. Because automated voice-mail systems duction cost, then a 20 percent increase in wage rates will
are highly substitutable for telephone receptionists, the shift all the firm’s cost curves upward by 20 percent. If
demand for receptionists is quite elastic. In contrast, good product demand is elastic, this substantial increase in costs
substitutes for physicians are rare, so demand for them is will cause a relatively large decline in sales and a sharp
less elastic or even inelastic. If a furniture manufacturer decline in the amount of labor demanded. So labor de-
finds that several types of wood are equally satisfactory in mand is highly elastic. But if labor cost is only 50 percent
making coffee tables, a rise in the price of any one type of of production cost, then a 20 percent increase in wage
wood may cause a sharp drop in the amount demanded as rates will increase costs by only 10 percent. With the same
the producer substitutes one of the other woods. At the elasticity of product demand, this will cause a relatively
other extreme, there may be no reasonable substitutes; small decline in sales and therefore in the amount of labor
bauxite is absolutely essential in the production of alumi- demanded. In this case the demand for labor is much less
num ingots. Thus, the demand for bauxite by aluminum elastic. (Key Question 5)
producers is inelastic.
Time can play a role in the ease of input substitution.
For example, a firm’s truck drivers may obtain a substan- QUICK REVIEW 25.2
tial wage increase with little or no immediate decline in
employment. But over time, as the firm’s trucks wear out • A resource demand curve will shift because of changes in
product demand, changes in the productivity of the resource,
and are replaced, that wage increase may motivate the and changes in the prices of other inputs.
company to purchase larger trucks and in that way deliver • If resources A and B are substitutable, a decline in the price
the same total output with fewer drivers. of A will decrease the demand for B provided the substitution
effect exceeds the output effect. But if the output effect
exceeds the substitution effect, the demand for B will
Elasticity of Product Demand Because the increase.
demand for labor is a derived demand, the elasticity of the • If resources C and D are complements, a decline in the price
demand for the output that the labor is producing will in- of C will increase the demand for D.
fluence the elasticity of the demand for labor. Other things • Elasticity of resource demand measures the extent to which
equal, the greater the price elasticity of product demand, producers change the quantity of a resource they hire when
the greater the elasticity of resource demand. For example, its price changes.
suppose that the wage rate falls. This means a decline in • The elasticity of resource demand will be less the greater
the cost of producing the product and a drop in the prod- the difficulty of substituting other resources for the
uct’s price. If the elasticity of product demand is great, the resource, the smaller the elasticity of product demand, and
the smaller the proportion of total cost accounted for by
resulting increase in the quantity of the product demanded the resource.
will be large and thus necessitate a large increase in the

mcc26632_ch25_487-504.indd 497 9/8/06 1:09:48 PM
9/8/06 1:09:48 PM
mcc26632_ch25_487-504.indd 497