Demand for Resources and Wage Determination

Significance of Resource Pricing

• Money-income determination: Households provide resources to producers, and increased resource prices lead to increased household income.

• Cost minimization: Increased resource prices decrease profits.

• Resource allocation: Resource prices allocate resources among industries and firms, similar to how product prices allocate finished goods and services to consumers.

• In a dynamic economy, technology and product demand change, necessitating the continuous shift of resources from one use to another.

• Resource pricing is a major factor in producing those shifts.

• Policy Issues: Includes use of taxes and subsidies and redistribution of wealth and resources

Resource Markets

• Derived demand: Demand for resources is based on the demand for products produced using the resource.

• The strength of the demand for any resource depends on:

  • The productivity of the resource in helping to create a good or service.

  • The market value or price of the good or service it helps produce.

Resource Markets: Formulas

• Marginal Revenue Product (MRP): Additional output resulting from using one more resource input unit (e.g., labor).

  • MRP = \frac{\Delta \text{Total Revenue}}{\Delta \text{Resource Input}}

• Marginal Resource Cost (MRC): Amount that each additional unit of a resource adds to the firm’s total (resource) cost.

  • MRC = \frac{\Delta \text{Total Resource Cost}}{\Delta \text{Resource Input}}

Resource Demand

• Resource Demand = MRP

• Under perfect competition, demand is perfectly elastic.

• Under imperfect competition, demand is downward sloping.

• Market resource demand is the sum of all individual firms' resource demand curves.

Resource Demand & MRP: Example 1

• This section presents a table showing the relationship between units of resource, total product, marginal product, product price, total revenue, and marginal revenue product.

Resource Demand & MRP: Example 1 Graph

• A graph illustrates resource demand as MRP, with quantity of resource demanded on the x-axis and resource price (wage rate) on the y-axis.

Resource Demand & MRP: Example 2

• This section presents a table showing the relationship between units of resource, total product, marginal product, product price, total revenue, and marginal revenue product under imperfect competition.

Resource Demand & MRP: Example 2 Graph

• A graph illustrates resource demand as MRP under both pure and imperfect competition, with quantity of resource demanded on the x-axis and resource price (wage rate) on the y-axis.

Determinants of Resource Demand

• Product Demand: Demand for a product determines product price, which in turn determines MRP (D = MRP).

• Productivity:

  • Quantity of related resources: The greater the amount of capital and land resources used with labor, the greater will be labor’s marginal productivity and, thus, labor demand.

  • Technological Advancement: Increases quality of related resources, increasing productivity of related resources. For example, improved capital improves the productivity of labor using the capital.

  • Quality of Variable Resource: Increased quality of variable resource increases MRP of variable resource, increasing demand for variable resource.

  • These three effects combined explain why average real wages are higher in developed nations than developing ones.

• Price of other resources

  • Substitute Resources:

    • Resource A and B are substitutes.

    • Substitution effect: When the price of resource A falls, firms reduce consumption of resource B and increase consumption of resource A (substitute resource A for resource B).

    • Output effect: When the price of resource A falls, firms earn larger profits at all output levels, which will increase their product supply curve, increasing the output level and therefore the demand for all resources including resource B.

    • Net Effect: Both effects occur; whichever dominates determines the impact on consumption of resource B.

  • Price of Complementary Resources:

    • Resource A and B are complements.

    • A decrease in the price of resource A causes:

      • Increase in the MRP of resource B.

      • Increase in demand for resource B.

    • Price of resource B increases

Determinants of Resource Demand: Examples

Resource Demand Example - Job Trends

• This section includes tables showing the 10 fastest-growing and most rapidly declining U.S. occupations in percentage terms from 2006-2016.

Elasticity of Resource Demand

• Formula:

  • E = |\frac{\% \Delta \text{Resource Quantity}}{\% \Delta \text{Resource Price }}|

• Classifications:

  • E > 1: Elastic

  • E < 1: Inelastic

  • E = 1: Unitary

• Determinants:

  • Ease of resource substitution: Increased resource substitutability = Increased elasticity

  • Elasticity of product demand: Increased product elasticity = Increased resource elasticity

  • Percent of total costs: Increased percentage of total cost = Increased elasticity

Least Cost Combination of Resources

• No specific details provided in this section of the transcript.

Profit Maximization Rule

• MRP = MRC

• Under Pure Competition:

  • MRP = P

  • Max @ P = MRC

  • Also least cost production

  • \frac{MRP}{P} = \frac{MP}{MC} = 1

• Under imperfect competition:

  • MRP = MRC

Marginal Productivity Theory of Income Distribution

• In theory, the wage paid for labor is directly related to the productive input (MRP) of the laborer.

• Income should therefore be a function of an individual’s productive capability.

• Criticisms:

  • Inequality: Productive resources, which increase labor productivity, are not equally distributed.

  • Market Imperfections: Not all labor markets are competitive.

  • Monopoly employers reduce wages below the competitive wage rate.

  • Labor Unions, Professional Associations, Occupational Licenses, etc. increase wages above the competitive wage rate.

Labor, Wages, and Earnings

• Labor:

  • Blue and white collar workers of all varieties

  • Professionals – lawyers, physicians, dentists, and teachers

  • Owners of small businesses – contractors, retailers, etc. who provide their own labor to produce goods and services

• Wages:

  • Price paid for labor

  • Money payments - hourly pay, salaries, bonuses, commissions, royalties, etc.

  • Fringe benefits – paid vacation, insurance, pension matching, etc.

  • Nominal wage – dollar value of wage

  • Real wage – inflation adjusted value of wage

  • Real hourly compensation = real wages and salaries + real employer contributions to social insurance and private benefits

General Level of Wages

• Wages vary greatly by job.

• Economists tend to examine average (general) wages in order to adjust for this.

• The general wage level is higher for developed nations than it is for developing nations.

General Level of Wages: Data

• Includes charts and tables showing hourly pay in U.S. dollars for various countries in 2006, and average wages in total U.S. dollars for various countries in 2021 or latest available year.

General Level of Wages: Determinants

• Role of productivity:

  • Plentiful capital: US has on average $90,000 of capital per worker

  • Access to abundant natural resources: Localized resources are cheaper – lower shipping costs and no import duties

  • Labor quality: Health, vigor, education, and training

• Other factors:

  • Efficacy, efficiency, and flexibility of management

  • Business, social, and political environment

  • Size of domestic market – does it allow for economies of scale to be exploited

  • Specialization of production enabled by free-trade agreements with other nations

General Level of Wages: Trends

• Graphs illustrating the relationship between real wages and productivity over time.

Purely Competitive Labor Market

• Numerous firms compete with one another in hiring a specific type of labor.

• Each of many qualified workers with identical skills supplies that type of labor.

• Individual firms and individual workers are “wage takers” since neither can exert any control over the market wage rate.

• Market Demand for Labor: Sum of the labor demand curves for all firms.

• Market Supply of Labor:

  • No unions – workers compete individually for jobs.

  • Sum of labor supply curve for individual workers

• Labor market equilibrium Wage where quantity of labor supplied and demanded are equal.

• Illustrative graphs showing market and individual firm perspectives.

Monopsony Model

• Monopoly – “one seller”

• Monopsony – “one buyer”

• A monopolist producer of a product is a monopsonist purchaser of labor needed for that product

• Characteristics:

  • Single buyer

  • Labor is relatively immobile, either geo-graphically or because workers would have to acquire new skills

  • Firm is a “wage maker,” sets wage for the market by controlling demand for labor

• Labor supply curve is upward sloping.

• MRC of Labor > Wage Rate

• Wages are uniform - when the wage is increased for a new worker, it must be increased for all workers

• MRC = wage of new employee + wage increase to all employees

• Equilibrium wage rate and employment is lower with a monopsonist employer.

• Illustrative graph provided.

Three Union Models

• Demand-Enhancement Model

• Exclusive (Craft Union) Model

• Inclusive (Industrial Union) Model

Demand-Enhancement Model

• Unions seek to increase demand for union labor.

• Increase demand for union labor produced product

• Political lobbying is the main tool used

  • Construction lobbying – union only clauses

  • Teacher’s unions seek to increase public education funding

  • Lobby for tariffs on imported products – steel and timber unions

  • Lobby for increased military spending – aerospace unions

  • Lobby for increased minimum wage – increases price of substitute product

  • Lobby for decreased price of compliments – increase use of migrant labor for support industries to reduce cost

• Illustrative graph showing the effect of increased demand on wages and quantity of labor.

Exclusive (Craft Union) Model

• Unions enable workers to act as a monopolist.

• Reduce supply of labor in order to increase the price of labor (wage rate).

• Exclusive – control the level of workers in the union

• Use of occupational licensing to limit the number of workers in an industry

• Works best for high-skill industries

• Unions have supported policies aimed at:

  • Restricting permanent immigration

  • Reducing child labor

  • Encouraging compulsory retirement

  • Enforce shorter work weeks

• Unions have also:

  • Used violence and intimidation to force employers to employ only union labor

  • Used violence and intimidation to force employers to give in to increased wage/regulatory demands

  • Used violence and intimidation to drive away those who would seek employment without being a member of the union that they are not allowed to join

• Illustrative graph showing the effect of decreased supply on wages and quantity of labor.

Inclusive (Industrial Union) Model

• Unions enable workers to act as a monopolist.

• Reduce supply of labor in order to increase the price of labor (wage rate).

• Inclusive – unions seek to organize all available workers

• Works better for low and no skill workers

• Use control of entire industry and legal right to strike to force their will on employers

• Illustrative graph showing the effect on wages and quantity of labor.

Bilateral Monopoly Model

• Monosponist employer

• Effective monopolist labor market via unionization

• Outcome on employment and wages is undetermined.

• Depends on which effect dominates.

• Effects may cancel each other out.

• Illustrative graph showing the model.

The Minimum Wage

• Case against:

  • If minimum wage is above market rate the unemployment rate increases.

  • Poor target to improve household income

  • Only impacts the market for unskilled labor of citizens

  • Earned by teenagers, not breadwinners

  • Does not impact wages of illegal immigrants

• Case for:

  • Does not cause increased unemployment is employer is a monopsonist

  • In a competitive market the wage may force employers to focus on improving productivity

• Evidence:

  • Mainly unclear

  • Increasing the minimum wage does increase teenage unemployment

Wage Differentials

• Average annual wages in selected occupations (Table provided).

• Graphs correlating educational attainment with annual earnings.

Wage Differentials - Determinants

• Marginal Revenue Productivity

• Noncompetition

• Ability

• Human Capital – Education, Training, and Skills

• Compensating differences

  • Risk of injury

  • Physical wear and tear

• Market imperfections

  • Lack of job information – workers don’t know the opportunities and wages of all employers

  • Geographic immobility – workers may be unable to relocate for employment

• Unions and government restraints

• Discrimination

Pay for Performance

• Agency problem:

  • When the goals of the agent conflict with the goals of the principal that employs that agent

  • When managements incentives do not align their goals with the goals of shareholders

  • Reduced by structuring agent pay to match goals of the principal

Pay for Performance: Incentive-based Compensation

• Pay is tied to goals

• Piece rate:

  • Worker is paid by the unit for output

  • May incentivize employees to reduce the quality of output

• Commissions/Royalties:

  • Commission: Pay tied to dollar value of sales

  • May cause some to engage in questionable or even fraudulent sales practices

  • Making exaggerated claims about products or recommending unneeded repairs

  • May lead to private lawsuits or government legal action

  • Royalties: artists paid based on dollar value of sales

• Bonuses, Stock options, and Profit sharing:

  • Bonuses based on personal performance may disrupt the close cooperation needed for maximum team production

  • Profit sharing is usually tied to the performance of the entire firm

  • Less energetic workers can “free ride” by obtaining their profit share on the basis of the hard work by others

  • Stock options encourage some to manipulate information to distort stock price

  • Stock options encourage some to put short-term profits ahead of long-term viability

• Efficiency wages:

  • Wages/bonuses tied to efficiency of output

  • Reduces turnover

  • Fewer opportunities to higher new and talented workers

  • Major loss if highly efficient staff are lost