Question

a. Pleasethoroughlyexplainthedeterminantsoftheelasticityofresource demand.
i. Discuss the following:
1. Ease of resource substitutability 2. Elasticity of product demand
3. Ratio of resource cost to total cost
b. Please explain how a firm would determine the optimal combination of resources required to produce a given level of output.
i. Discuss / explain.

Answer 1

The determinants of the elasticity of resource demand are:

1. Elasticity of product demand

The resource elasticity from product can be derived as higher the product elasticity, higher resource elasticity is there and low product elasticity leads to low resource elasticity.

2. Ease of resource substitutability

Higher the number of substitutes more Elastic the resource demand is and Lower the number of substitutes or no substitutes, Inelastic resource demand. If more time is available for substitution, more elastic the demand is

3. Ratio of resource cost to total cost

If resource cost is a large proportion of total cost the elasticity will be high and if smaller the proportion, lower the elasticity.

The optimal combination of resources is achieved through cost-minimisation and profit-maximisation.

The Least-Cost Rule

A firm is producing a specific output with the least-cost combination of resources when the last dollar spent on each resource yields the same marginal product.

Marginal product Marginal product
of labor (MPL) = of capital (MPC)
Price of Labor (PL ) Price of Capital (Pc )

The Profit-Maximizing Rule

In competitive markets, a firm will achieve its profit-maximizing combination of resources when each resource is employed to the point at which its marginal revenue product equals its resource price.
MRPL/PL = MRPC/PC = 1 (*ratios must equal 1)

* The profit maximizing equation hold the premise that the firm is also using the least cost combination. However, a firm operating at least cost combination may not be operating at the output that maximizes its profits.