3. The demand for resources a. You are an Economics teacher. Please explain to y

Question

3.   The demand for resources

a. You are an Economics teacher. Please explain to your class the significance of resource pricing on resource allocation among:

i.   Firms and industries,

ii. The determination of income,

iii. Include the impacts on the ability of a firm to achieve cost minimization.

1. Discuss how resource prices affect the ability of firms in an industry relative to their ability to acquire resources and the subsequent impact on output,

2. Discuss the impact of resource prices on the determination of income that results from the sale of those resources.

3. Discuss the impact of resources prices on the ability of firms to minimize costs.

b. Explain to the class the marginal productivity theory of resource demand and why businesses care about it.

i.   State the assumptions

ii. Explain MRP and MRC, and the firms’ rule for employing resources

iii. Be sure to explain the terms and what they mean to a business.

c. The determinants of resource demand.

i.   Discuss the 3 determinants of resource demand

1. Changes in product demand

2. Changes in productivity

a. Quantities of other resources b.   Technological advance

c. Quality of the variable resources

3. Changes in the prices of other resources including:

a. The case of substitute resources – the substitution effect and the output effect

b.   The case of compliments

Explanation / Answer

Definition:-

Analysis of how scarce resources ('factors of production') are distributed among producers, and how scarce goods and services are apportioned among consumers. This analysis takes into consideration the accounting cost, economic cost, opportunity cost, and other costs of resources and goods and services. Allocation of resources is a central theme in economics (which is essentially a study of how resources are allocated) and is associated with economic efficiency and maximization of utility.

Resource allocation is the process of assigning and managing assets in a manner that supports an organization's strategic goals.

Resource allocation includes managing tangible assets such as hardware to make the best use of softer assets such as human capital. Resource allocation involves balancing competing needs and priorities and determining the most effective course of action in order to maximize the effective use of limited resources and gain the best return on investment.

i) Firms & industries

In our paper, Resource Allocation within Firms and Financial Market Dislocation i.e Industries: Evidence from Diversified Conglomerates, which was recently made publicly available on SSRN, we study the resource allocation problem in a sample of diversified firms in the United States. Economists have used these firms as a laboratory for studying resource allocation decisions inside firms (Zingales [2000]). There are two prevailing views on how capital is allocated within these firms. Stein [1997], among others, has put forth the view that conglomerates may outperform external capital markets by virtue of exerting centralized control over the capital allocation process (“bright side” view). This view has been challenged by several studies, such as Rajan, Servaes, and Zingales [2000], and Scharfstein and Stein [2000], who argue that resource allocation inside firms is distorted toward weaker divisions by managerial socialistic concerns (“dark side” view). We propose and estimate a model that nests these views. Our model is based on a dynamic tradeoff between the bright and dark sides of internal capital markets. The cost of conglomerates arises from managerial preferences for corporate socialism. The benefit is that funds can be allocated between divisions without firms experiencing frictions of accessing external capital markets. The cost of accessing external capital markets varies over time introducing a time-varying wedge between the costs and benefits of internal capital markets.

Keynes’s Income-Expenditure Approach:

It is worth noting here that the Keynesian theory is relevant in the context of the short run only since the stock of capital, techniques of production, efficiency of labour, the size of population, forms of business organisation have been assumed to remain constant in this theory.

Further in his model of income determination Keynes assumed that price level in the economy remains unchanged. Therefore, in the Keynesian theory which deals with the short run, the level of income of the country will change as a result of changes in the level of labour employment.

Thus, in free market economy in the short run, when capital stock and technology remain unchanged, income is a function of labour employment. In fact, both income and employment go together. The higher the level of employment, the higher the level of income.

As level of employment is deter­mined by aggregate demand and aggregate supply, the level of income is also determined by aggre­gate demand and aggregate supply. In this article, we shall explainhow the equilibrium level of national income is determined through Keynes’s income-expenditure analysis.

This analysis ex­plains determination of national income by relating income (output) to aggregate expenditure on goods and services. The, aggregate expenditure shows aggregate demand for goods and services. Keynesian theory of income determination can be explained by assuming two sectors in the economy, namely, households and business firms. Keynes focused on this simple two sector model of deter­mination of national income and derived conclusions regarding policy formulation from this basic model.

Analysis of determination of national income can be extended to incorporate Government and foreign trade. We start with the analysis of determination of national income by taking a simple two-sector economy with a fixed price level

Cost minimisation is a financial strategy that aims to achieve the mostcost-effective way of delivering goods and services to the require level of quality.

RESOURCE PRICES, SUPPLY DETERMINANT:

The prices of the resource inputs that affect production cost and the ability to sell a particular good, which are assumed constant when a supply curve is constructed. An increase in resources prices causes a decrease in supply and a decrease in resource prices causes an increase in supply. Resources prices are one of five supply determinants that shift the supply curve when they change. The other four are production technology, other prices, sellers' expectations, and number of sellers.

The resource prices paid for the use of labor, capital, land, andentrepreneurship affect production cost and the ability to supply a good. If resource prices increase, then production cost is higher and the sellers are inclined to offer less of the good for sale. If resource prices decrease, then production cost is lower and the sellers are inclined to offer more of the good for sale.

The Cost of Production

The ability to supply a good depends on production cost, or theopportunity cost of employing the four factors of production--labor, capital, land, and entrepreneurship. The corresponding resource prices are wage, interest, rent, and profit.

Consider the production and supply of Wacky Willy Stuffed Amigos as an illustration.

Resource Demand as Derived Demand

Marginal Revenue Product

Rule for Employing Resources: MRP = MRC

MRP as Resource Demand Schedule

Resource Demand under Imperfect Product Market Competition

Market Demand for a Resource

Determinants of resource demand:-

Changes in product demand:
[Remember: resource demand is a 'derived demand' from its product]

Changes in productivity

Changes in the prices of other resources
[Depends on whether labor and capital are substitutes/complements in production]

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