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

Micro‑economic Decision‑Makers – Firms and Production

Objective

Explain what determines a firm’s demand for the factors of production (land, labour, capital and entrepreneurship) and how these determinants are shown on the factor‑demand curve. Relate factor demand to profit‑maximisation, costs, revenue and the market structure in which the firm operates.

1. Derived (Derived) Demand for Factors

• Definition: Firms do not purchase factors for their own sake; they need them because they are required to produce a product that can be sold. This is called derived demand.
• The quantity of a factor a firm wishes to employ depends on the expected revenue from the extra output that the factor creates.

1.1 The Factor‑Demand Curve

The factor‑demand curve relates the price of a factor (wage, rent, interest) on the vertical axis to the quantity of that factor demanded on the horizontal axis, assuming the firm is profit‑maximising and product‑market conditions are given.

At every point the firm will hire the factor as long as its Marginal Revenue Product (MRP) is at least as large as the factor’s price.

\$\text{MRP}= \text{MP}\times \text{MR}\$

• MP = marginal product of the factor (extra output from one more unit of the factor).
• MR = marginal revenue from selling that extra output.

1.2 Link to Profit‑Maximisation

A profit‑maximising firm chooses output where MR = MC. Because MRP = MP × MR, the condition for hiring an additional unit of a factor can be written as:

\$\text{MRP} = \text{Factor price} \quad\Longleftrightarrow\quad \text{MP}\times\text{MR}= \text{Factor price}\$

Thus the factor‑demand curve is derived from the profit‑maximising rule: hire a factor up to the point where the extra revenue it generates equals its cost.

2. Influences on the Demand for Factors

2.1 Example – Change in Product Demand

A smartphone maker expects a 20 % rise in sales after launching a new model. The expected marginal revenue on each extra phone rises, so the MRP of both labour and capital rises. The labour‑demand and capital‑demand curves shift outward, leading the firm to hire more workers and purchase more machines.

2.2 Example – Rise in Factor Price

The national minimum wage is increased from £8 to £10 per hour. The wage (price of labour) is now higher than the labour MRP for the last few workers, so the firm reduces its workforce – a movement up the labour‑demand curve.

2.3 Example – Change in Factor Availability

Skilled software engineers are scarce in a region, pushing their wages up to £45 000 per year. The higher wage reduces the quantity of engineers a tech firm can afford, effectively moving the firm to a lower point on the labour‑demand curve.

2.4 Example – Improvement in Productivity

Automation doubles the output per worker on an assembly line. The marginal product of labour doubles, so the labour MRP doubles. The labour‑demand curve shifts right even though the wage is unchanged.

3. Labour‑Intensive vs. Capital‑Intensive Production Techniques

3.1 Reasons for Choosing Each Technique

• Labour‑intensive – preferred when:

  • Wages are relatively low compared with the cost of capital.
  • Skilled labour is abundant and easily replaceable.
  • The product requires flexibility, customisation or a “hand‑made” image (e.g., bespoke clothing).

• Capital‑intensive – preferred when:

  • Capital (machinery, equipment) is cheap, subsidised or technologically advanced.
  • Skilled labour is scarce or expensive.
  • Large‑scale, uniform production is needed (e.g., automobile assembly lines).

3.2 Advantages & Disadvantages

4. Production vs. Productivity

4.1 Definitions

• Production – total quantity of goods or services produced in a given period.
• Productivity – amount of output produced per unit of a factor (e.g., output per worker‑hour). It measures how efficiently inputs are turned into output.

4.2 Influences on Productivity

• Technology – new machines or processes raise the marginal product of both labour and capital.
• Human capital – training, education and experience improve workers’ efficiency.
• Physical capital – better or more modern equipment.
• Organisation – division of labour, management techniques, workflow design.
• Scale of production – economies of scale can raise average productivity.

4.3 Measuring Productivity (IGCSE focus)

\$\text{Productivity} = \frac{\text{Total Output}}{\text{Total Input of a Factor}}\$

• Labour productivity = total units produced ÷ total labour‑hours.
• Capital productivity = total units produced ÷ total capital‑stock (e.g., number of machines).

5. Costs and Revenue (IGCSE 3.6)

6. Types of Markets (IGCSE 3.7)

7. Summary of the Influences on Factor Demand

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 product demand, factor price, factor availability or factor productivity cause either a movement along the factor‑demand curve (price change) or a shift of the curve (other changes).
• Profit‑maximising firms hire each factor up to the point where MRP = factor price and choose output where MR = MC.
• Choosing between labour‑intensive and capital‑intensive techniques depends on relative factor costs, availability and the nature of the product.
• Higher productivity raises both output and the demand for the factor that becomes more efficient.
• Understanding costs, revenue and market structure is essential for analysing a firm’s production decisions.