Question

Resources must be used in the production process to produce goods and services. Resources are also called factors of production. Resources are traded in the market where the equilibrium quantity and price of the resources are determined. Most markets are competitive, that is, there are many buyers and sellers. Resource demand or factor demand is a derived demand. Where is this demand derived from? Give an example to illustrate this relationship.

Answer 1

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.

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.

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 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.

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