Firms & Production
Microeconomic Decision Makers
Demand for Factors of Production
To produce, a firm must hire the four factors of production: land, labour, capital and enterprise. A firm's demand for any factor is a derived demand: the firm does not want the factor for its own sake, but for the output it helps to produce. Several influences decide how much of a factor a firm demands.
Because demand is derived, a rise in demand for a final product feeds straight through to the inputs used to make it. When demand for tyres rises (from D₁ to D₂), the price and quantity of tyres both rise; and because tyres are made from rubber, demand for rubber shifts out in the same way, raising its price and quantity too.
| Influence | How it affects demand for the factor |
|---|---|
| Demand for the product | A rise in demand for the product (higher total demand / economic activity) raises demand for the factors used to make it. |
| Price of the factor | A lower price of a factor tends to raise the quantity of it demanded; a higher price reduces it and may push the firm towards a cheaper substitute factor. |
| Price of other factors | If capital becomes cheaper than labour, firms switch towards capital, lowering demand for labour, and the reverse. |
| Availability of the factor | If a factor is scarce or hard to obtain, firms may have to demand alternatives. |
| Productivity of the factor | A more productive factor (better-trained workers, more advanced machines) is worth more to the firm, so demand for it rises. |
Exam tip
Give each influence on factor demand its direction
Each influence on demand for factors of production earns one mark for naming it and one for the direction of its effect. Strong pairs: demand for the product (more demand for the good raises demand for the factors that make it, because factor demand is derived), the factor's own price (cheaper means more is demanded) and its productivity (more productive means more is demanded). For another factor, name its price: dearer capital can raise demand for labour as a substitute, and cheaper capital used alongside workers can raise it as a complement. The bare word "substitute" is not enough.