Economics – The basic economic problem - Factors of production | e-Consult

(a) The reward to a factor of production is determined by the interaction of supply and demand in the factor market.

• Rent: The reward to land is determined by the demand for land by businesses to produce goods and services. Higher demand leads to higher rents. Factors influencing demand include consumer income, tastes, and the availability of alternative resources.
• Wages: The reward to labour is determined by the supply and demand for labour. Higher demand for skilled labour and a limited supply will lead to higher wages. Factors influencing demand include the level of economic activity and the productivity of workers.
• Interest: The reward to capital is determined by the supply and demand for loanable funds. Higher demand for investment by businesses will lead to higher interest rates. Factors influencing demand include the profitability of investment opportunities and the level of economic confidence.
• Profit: The reward to entrepreneurship is determined by the demand for the goods and services produced by businesses. Higher demand and lower costs will lead to higher profits. Factors influencing demand include consumer income, tastes, and the price of competing goods.

The price of each factor is essentially the cost to the user of that factor. If demand for a factor is high and supply is low, the price (reward) will be high. If demand is low and supply is high, the price will be low.