Lecture%2013 - Lecture 13 Factor Pricing Review...

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Lecture 13: Factor Pricing Review Distinctions: Land: inelastically supplied Labour: demographically supplied. But also has to be performed by the supplier, which means that non-monetary factors matter. Capital: reproducible. Comes out of saving. Time enters the equation in a way that it doesn’t for other inputs. Demand for Inputs Principle: The demand for factors of production, or inputs is a derived demand. What this means is that factors are not demanded for themselves, but for the final goods they help to produce. The demand for inputs is derived from the demand for final goods and services. Thus, a rise in demand for final goods and services will increase the demand for inputs. We can do a little better than this, however. We can say something about the elasticity of derived demand. The basic principle is that the smaller the share of cost attributable to an input, the lower its elasticity of demand. Let’s see how this works. Suppose that labour is the only input, so that wages are 100 percent of cost. A fall in the price of labour by 1 percent lowers cost by 1 percent and in equilibrium lowers price by 1 percent. If the elasticity of demand is -1, a 1 percent fall in the wage will increase the demand for labour by 1 percent. Suppose instead that labour is 50 percent of cost. In that case, a one percent fall in wages reduces cost and presumably price by one-half percent. If the final demand elasticity is -1, the quantity of labour increases by one-half percent (labour input is
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proportional to output so the two increase by exactly the same perentage. In this case demand for labour is -0.5 = (dL/L)/ (dW/W) = 0.5%/(-1%).
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