MyECNclass.com Class Notes
by
Resources and Their Use
The Benefit (utility) to a Producer of Using a Resource
The additional benefit or revenue that a producer or firm receives when it makes a product with a resource is based on the marginal product of an additional unit of resource (the marginal product) and on the revenue that can be earned by selling the output produced (the firm’s marginal revenue). Thus, the benefit to a firm of using a unit of a resource can be calculated by multiplying the the firm’s marginal revenue (MR) by the resource’s marginal product (MP). The result is called the marginal revenue product (MRP).
MRP = MR × MP
Should the Firm Use More of a Resource?
The marginal revenue product tells us how valuable to the producer or firm an additional unit of resource is. The decision to hire an additional unit of a resource will thus be made by weighing this benefit against the cost. The cost of each unit of a resource is its price or its wage. The firm will only find it worthwhile to hire an additional unit of a resource as long as its marginal revenue product is greater than the price of the resource.
So, if the worker's price or wage is W, the worker is worth hiring only if
W ≤ MRP
For example, if the marginal revenue of the firm’s output is $1 per unit of output, and the marginal product of a worker is 12 units of output, should the firm hire another worker if the wage of the worker would be $6?
In this case, the marginal revenue product of the worker would be MR × MP = $1 × 12 = $12. Since the cost of hiring the worker (the wage) would be $6, the marginal revenue product is greater than the price of the worker, so the additional worker should be hired.
Deciding Which Resources to Use
A producer who has the choice of using many kinds of resources must select to use, or increase its use of, the resource that will give it the most benefit or revenue per dollar spent on the resource. If a firm is to find the resource with the most benefit per dollar spent, then it is trying to find the resource that has the greatest marginal revenue product per dollar spent on the resource. If the price of the resource is referred to as the wage, then the resource that should be used is the one with the greatest
| Productivity per dollar spent = |
Marginal Revenue Product |
or |
MRP |
| wage |
wage |
Remember that the MRP is the Marginal Revenue of the firm multiplied by the Marginal Product of the worker, or MR × MP.
As long as some resource has a larger MRP per dollar spent than other resources, the firm should increase its spending on that resource.
Once all resources have about the same MRP per dollar spent, or the same
then changing the mix of resources is no longer necessary. You may notice that this condition is the same as that we had for consumers choosing between goods to consume; the decision is very similar.
Also, you may have noticed that, since the marginal revenue is probably the same no matter which resource produces the product, we could use a comparison of
between resources instead, provided that each resource has a marginal revenue product that is greater than or equal to its price or its wage.
An Example
Suppose a producer could hire unskilled workers at $16 an hour or skilled workers at $26 an hour. Given the current output of the firm, unskilled workers have a marginal product of 20 units of output per hour, while skilled workers have a marginal product of 30 units of output per hour. Which should the firm be most willing to hire?
| Productivity per dollar spent on unskilled labor = |
MP |
or |
20 |
= 1.25 per dollar |
| wage |
$16 |
| Productivity per dollar spent on skilled labor = |
MP |
or |
30 |
= 1.154 per dollar |
| wage |
$26 |
Thus, the firm should hire more unskilled workers, until the ratio of marginal product per dollar spent is the same as that for skilled workers. This is assuming that the firm should hire more workers at all. Remember, the marginal revenue product of the worker hired still has to be greater than the wage or price of the worker.
General Conditions for Comparting Resources (workers)
In general, the conditions for hiring one kind of worker over another can be summarized as follows:
To hire workers of type "A" rather than not hiring any or hiring other types...
First, WA ≤ MRPA ,
where WA is the price of hiring A workers, and MRPA is the marginal revenue product of A workers.
| Second, |
MRPA |
> |
MRPB |
| WA |
WB |
where (additionally) WB is the price of hiring B workers, and MRPB is the marginal revenue product of B workers.
This second condition ensures that the productivity per dollar spent is higher for A workers than for other workers, which is necessary to make the optimal hiring decision.
If we know WA ≤ MRPA and WB ≤ MRPB, then we don't have to use MRPs; we can instead use Marginal Products in our formula (which is easier if we have the MP numbers but not MRP).
| A firm will hire A workers rather than B workers if |
MPA |
> |
MPB |
| WA |
WB |
where MPA is the marginal product of type A workers and MPB is the marginal product of type B workers.
Another Sort of Example
Suppose a producer could hire unskilled workers at $16 an hour . Given the current output of the firm, unskilled workers have a marginal product of 20 units of output per hour, while skilled workers have a marginal product of 30 units of output per hour. What wage (price) should the firm be willing to pay skilled workers? (notice we are not told how much their wages are)
Let's take the above formula and treat A workers as skilled workers (since the question assumes we are hiring them).
| A firm will hire skilled workers rather than unskilled workers if |
MPskilled |
> |
MPunsilled |
| Wskilled |
Wunskilled |
Substituting these numbers in the formula above means
| it makes sense to hire skilled workers rather than unskilled workers if |
30 |
> |
20 |
| Wskilled |
$16 |
Solving for Wskilled (by cross-multiplying) gives Wskilled < 30 ÷ 20 × $16 = $24,
which means that as long as the skilled workers ask for less than $24 per hour, they are more economical to hire than unskilled workers.
Notice that formula can be used to find any wage or MP that might be necessary to justify hiring one worker over another.
--------------
The Prices of Labor and Other Resources
The resource market is where resources, most especially labor, are bought and sold. The sellers of resources include workers selling their time to employers. The employers are the buyers in such a market. The price is the wage rate (or salary). Otherwise, it is like the market for anything else. The markets for other resources will be a lot like that for labor, so labor is the one we will focus on.
Labor Supply
The supply of labor is based on the marginal opportunity cost of the time of workers, or what the workers are giving up to engage in a particular type of work.
Since the marginal opportunity cost to workers will tend to be higher the more labor the workers are supplying, the supply of labor will be an upward sloping curve.
Changes or Differences in Labor Supply
The supply of labor to a particular occupation or employer may vary if work conditions change. For example, if a job is more dangerous, workers give up safety to take that job, and so their opportunity costs are higher. This will reduce the supply of labor to that job. Similar things occur if a job is less prestigious, less pleasant, or less comfortable to work at.
Labor supply to a particular job or occupation will tend to increase if:
- the alternative things that workers can do, such as leisure activities, become less attractive
- alternative ways of earning money (other jobs) become fewer or less attractive
- the job or occupation itself becomes more attractive or pleasant
Labor supply to a particular job or occupation will tend to decrease if:
- the alternative things that workers can do, such as leisure activities, become more attractive
- alternative ways of earning money (other jobs) become more numerous or more attractive
- the job or occupation itself becomes less attractive or pleasant
Labor Demand
The demand for labor is based on the marginal utility or value to an employer of hiring an additional worker. This is based on the marginal product of an additional worker (marginal product) and on the revenue that can be earned by selling the output of that worker. Thus, the demand for labor is determined by the marginal product of labor (MP) and the marginal revenue of the firm (MR) when it sells the products made by the worker. This can be calculated by multiplying the marginal product by the marginal revenue. The result is called the marginal revenue product (MRP), and it is the demand for labor.
MRP = MR × MP
Since both the marginal product of labor and the marginal revenue from selling the product will tend to decrease as more workers are hired (and as more output is produced), the demand for labor will be a downward-sloping curve.
We can also see that the demand for labor is downward sloping by considering how an employer will react to different prices of labor. As labor prices rise, an employer will seek other resources to use instead. Using other resources in place of the more expensive labor is called substitution in production. Also, as labor becomes more expensive, employers may be forced to pass the higher costs on to their consumers, who will buy less of the product. This will require that fewer workers are hired to make the product. This reaction is called substitution in consumption. Substitution in production and substitution in consumption both will result in a smaller quantity of labor being hired as the price of labor rises.
Changes in Labor Demand
The demand for labor by may change if the marginal revenue changes (because of a change in the demand for the goods being sold by the employer). Since the demand for the goods being sold by the employer affects the demand for labor, the demand for labor is sometimes called a "derived demand."
The demand for labor is also dependent upon the marginal product of labor, which can change if the amount of capital available for workers to use is changed. Specifically, if the amount of capital for workers to use is increased, marginal product (and thus, labor demand) will increase, since workers become more productive if they have more tools and equipment to work with.
Capital can be physical, such as tools and equipment, but can also take the form of worker training, education or skills. These are called "human capital." Just like physical capital, human capital can be used without being used up, but human capital belongs to the worker, and usually is acquired by the worker when she or he invests in education or training.
Labor demand for a particular employer or occupation will tend to increase if:
- substitute resources become more expensive or harder to obtain
- complement resources become less expensive or easier to obtain
- demand for the products made by workers increases
- physical or human capital is increased
Labor demand for a particular employer or occupation will tend to decrease if:
- substitute resources become less expensive or easier to obtain
- complement resources become more expensive or harder to obtain
- demand for the products made by workers decreases
- physical or human capital is decreased
Why Wages Differ
In a competitive labor market, differences in the supply and demand for labor can explain much of the differences in the wages or salaries of workers. If two jobs require the same kinds of work and produce products of equal value, the wages of workers in those jobs may still be different, because of the demand and supply characteristics. If one job is more pleasant than another, or requires less sacrifice on the part of workers in some way, the wage in that job will tend to be lower, since the supply of labor to the pleasant job will be greater.
For example, if the same job can be performed under conditions of personal safety or hazard, the supply of labor in the unsafe setting will be less, since workers in that setting will be giving up safety. As a result, we would expect those workers to make more money, even though they are doing the same kind of work as those in a safe environment. We might also expect there to be fewer of those workers.
Similarly, if everything else was the same in two jobs, but one was less pleasant than the other, because it had inflexible work hours, a less comfortable work environment, gave less prestige, etc., we would expect the wage to be higher in the less pleasant job.
Differences in job characteristics, such as safety, comfort, pleasantness, flexible work hours, and such are called non-pecuniary job characteristics. The differences in wages that occur because of these are called compensating wage differentials.
Wages might also differ just because of differing numbers of available workers, which would also mean the supply of labor differed:
Demand differences, caused by differences in either the marginal product of workers or the high demand for the product of workers, can also explain wage differences. Some workers may earn more than others because they are in a high-demand profession.
Of course, differences in both supply and demand may account for wage differences as well. In general, if wages are higher in a profession in which there are fewer workers, the high wages are probably due to supply. If wages are higher in a profession in which more workers are hired, the difference in wages is likely due to demand.
___
Copyright 2020 by Ray Bromley. For economics information, and other information about Ray Bromley, visit www.raybromley.com. Permission to copy for educational use is granted, provided this notice is retained. All other rights reserved.
Send comments or suggestions to