Influences on the demand for factors of production: demand for the product, the price of different factors of production, their availability and their productivity

Published by Patrick Mutisya · 14 days ago

IGCSE Economics 0455 – Microeconomic Decision‑Makers: Firms and Production

Microeconomic Decision‑Makers – Firms and Production

Objective

Understand the influences on the demand for factors of production, namely:

  • Demand for the product

  • Price of the factor of production

  • Availability of the factor

  • Productivity of the factor

1. Derived (or Derived) Demand for Factors

Firms do not demand factors of production for their own sake; they demand them because they are needed to produce a product that can be sold. This is called derived demand. The quantity of a factor that a firm wishes to hire depends on the expected revenue from the product it helps to create.

2. Influence of the Demand for the Product

The stronger the market demand for a product, the greater the quantity of the factor required.

  • If consumer demand rises, firms increase output, raising the quantity of labour, capital, land, etc., they need.

  • If consumer demand falls, firms cut back production and the demand for factors falls.

Mathematically, the marginal revenue product (MRP) of a factor is:

\$\$

MRP = MP \times MR

\$\$

where MP is the marginal product of the factor and MR is the marginal revenue from selling an additional unit of output.

3. Influence of the Price of the Factor

The price (or wage, rent, interest) of a factor affects the quantity demanded in two ways:

  1. Cost consideration: Higher factor prices raise production costs, reducing the profitability of additional output. Firms will demand less of that factor.

  2. Substitution effect: If the price of one factor rises, firms may substitute it with a cheaper factor (e.g., using more labour instead of capital).

4. Influence of the Availability (Supply) of the Factor

When a factor is scarce, its price tends to rise, which in turn reduces the quantity demanded (as explained above). Conversely, abundant factors are cheaper and more likely to be employed.

Availability also affects the firm’s ability to hire:

  • Limited skilled labour may constrain output even if product demand is high.

  • Abundant land or capital can encourage expansion.

5. Influence of the Productivity of the Factor

Productivity measures how much output a unit of factor can produce. Higher productivity makes a factor more valuable, increasing its demand.

  • Technological improvements raise the marginal product (MP) of labour, shifting the factor demand curve to the right.

  • Training and education increase human capital, enhancing labour productivity.

Summary of Influences

InfluenceEffect on Factor DemandUnderlying Reason
Demand for the product↑ Demand when product demand ↑; ↓ when product demand ↓Derived demand – more output requires more factors
Price of the factor↓ Demand when price ↑; ↑ Demand when price ↓Higher cost reduces profitability; substitution possible
Availability of the factorScarcity → higher price → ↓ Demand; abundance → lower price → ↑ DemandSupply constraints affect hiring ability and cost
Productivity of the factor↑ Productivity → ↑ Demand; ↓ Productivity → ↓ DemandMore output per unit makes the factor more valuable (higher MRP)

Suggested diagram: Factor demand curve shifting rightward with an increase in product demand or factor productivity, and leftward with a rise in factor price or reduced availability.

Key Points to Remember

  • Factor demand is always derived from product demand.

  • The marginal revenue product (MRP) determines the maximum price a firm is willing to pay for an additional unit of a factor.

  • Changes in factor price, availability, or productivity cause movements along or shifts of the factor demand curve.

  • Understanding these influences helps explain real‑world phenomena such as wage changes, capital investment cycles, and labour shortages.