Question

Explain 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

Answer 1

(i)

1. Changes in Product demand:

With all else equal, an increase in the demand for a product that uses a particular resource will also increase the demand for that resource; likewise, if demand for a product decreases, then the demand for the resource will also decrease. Hence, resource demand is a derived demand. Example: When the demand for gasoline increases, then there will be greater demand for oil and vice versa, since oil is a major component of gasoline and one of its major uses.

*Demand determinants other than price that reduce demand shift the demand curve leftward, while demand determinants that increase demand shift the curve rightward. As shown in the graph below:

2. Changes in Productivity:

Changes in productivity using a resource can change the demand for a resource. For instance, if a natural resource can be mined more efficiently, thereby lowering its price, the demand for the resource will be increased, since it will allow any products based on the resource to be made more cheaply. The cost of other inputs can also affect resource demand since they are complementary. For instance, tobacco farming requires land, labor, and fertilizer. If any of them are in short supply, it will reduce for demand for any of the other resources needed to produce a product.

a. Quantities of other resource:

Resource quality also affects the demand for it, especially for skilled labor. For instance, a specialist can generally charge a higher price for services because she can perform them better and faster. So, for instance, a real estate lawyer can charge more for his real estate services than a general practitioner. Technology helps to increase the wages of skilled workers, because it makes each of them more productive. Ironically, unions often try to halt the progress of technology in their companies to protect jobs, but they also want to increase wages for their members. Hence, it is counterproductive to try to maintain the old way of doing things when technology would allow the workers to be paid more.

b. Technology:

Technology is the primary factor that can increase the productivity of a particular resource. For instance, the development of irrigation systems has allowed farmers to farm land that would otherwise be too arid. Automation also increases the productivity of labor, which increases the demand for skilled labor experienced in working with computers or robotics.

3. Changes in prices of other goods:

Changes in the prices of other resources can have either a substitution or complementary effect. Because several resources are used in the production of most items, the demand for a particular resource will depend on the prices of the other resources. There are several factors resulting from differences in the prices of different resources.

a. The case of substitute goods:

• The Substitution effect: The substitution effect reduces demand for a particular resource when the cost of another resource that can substitute as an input declines. This increases the demand for the substitute while decreasing demand for the prior resource. Automation is a common example of the substitution effect, where the continually declining cost of technology reduces the need for labor. Polyester can reduce the use of cotton in clothing if the price of cotton increases.
• The Output effect: The output effect occurs when the decreased cost of one input allows the firm to produce other products based on that input, thereby increasing the demand for the resources. Obviously, the net effect of substitution and output depends on the relative importance. If the substitution effect is more important, then demand for a particular resource will decline, and vice versa. If the output effect is more prominent, the demand for the resource will increase.

b. The case of compliments:

Many resources are complementary — they are used together to produce a product. If the resources must be used in a fixed ratio, then a reduction in the price of one resource will increase demand for the other resources as well. For instance, computer programmers need computers to do their programming, so when the price of computers drop, the demand for programmers increases. For a resource to be complementary, it cannot be substitutable. Hence, if technology can replace labor or reduce the need for labor, then it is not complementary but substitutable.