DEMAND FOR FACTORS OF PRODUCTION

By the end of this unit, students will be able to explain:

• Why different combinations of the factors of production might be used and the
terms labour intensive and capital intensive.
• What is meant by factors of production being substitutes or complimentary.
• What is meant by the short run and long run for factors of production.
• What might change the demand for factors of production.
WHAT FACTORS OF PRODUCTION ARE EMPLOYED
What are the different factors of production?
Different firms and industries will employ a different combination of capital, labour,
and capital.
The best combination of factor inputs will depend on the product being produced
and the relative cost and efficiency of the factors of production.
For example, a technologically modern car factory is likely to employ a large amount
of capital and a relatively smaller amount of labour – car production is very capital
intensive.
In contrast, a business such as a hairdressing salon is likely to be more labour
intensive.
 WHAT FACTORS OF PRODUCTION ARE EMPLOYED
• The combination of factors of production will also depends on the relative productivity and cost of
the factors of production.
• As the productivity of machinery/capital increases, firms might try to replace labour with machinery
– becoming more capital intensive.
• However, in countries where labour is very cheap, firms might prefer to use less machinery and more
labour – production in countries with cheap labour tends to be labour intensive.
• Here we can see that capital and labour are often substitutes for each other.
WHAT FACTORS OF PRODUCTION ARE EMPLOYED
• However, they are only substitutes when both labour and capital can produce the
same product/service. It is not possible or efficient to replace the capital required to
produce certain outputs. For example, no amount of additional labour can replace an
airplane as a piece of capital, just as capital is unlikely to replace a barman or a
hairdresser.
• Often capital and labour are complimentary to each other. This means that an
increase in the productivity or decrease in the cost of one – labour or capital – could
lead to an increase in the use of both factors.
SUMMARY
• The combination of factor inputs depends on the product being produced and the
relative productivity and cost of the factors of production.
• Cheaper labour is likely to lead to more labour intensive production where
possible.
• A fall in the cost or increase in the efficiency of capital will lead to more capital
intensive production.
• Labour and capital inputs can be either substitutes or complimentary to each other,
depending on the product/service being produced.
• When substitutes an improvement in productivity or decrease in cost will cause a reduction in the other
factor.
• When complimentary improvements in productivity or decreases in cost can cause an increase in the
use of all factors of production.
 ALTERING FACTORS OF PRODUCTION
What do we mean by the short run and the long run?
In the long run all factors of production are variable.
In the short run at least one factor of production is fixed.
Which factors do you think are usually fixed in the short run?
 Land and capital.
This is because it can take some time to move to a different factory or place of business, sell or buy more
capital, or change how much land is being used.
Labour, however, is much easier to change in quite short periods of time – workers can work overtime or new
employees can be found relatively quickly and easily (depending on the level of skill required).
The length of time for changing capital as the factor of production will depend on the product being produced.
For example, increasing the capacity of a car factory by moving to a new location and increasing machinery will
probably be a much longer short run than increasing the capacity of a coffee shop.
COMBINING THE FACTORS OF PRODUCTION
Firms will try to choose the combination of factors of production
that result in the factors being utilised efficiently.
 Lots of capital machinery but not enough workers to use the machines will
mean the capital is not utilised efficiently.
 Similarly, too many workers and the output per worker (average product
per worker) will fall – think about a restaurant, car wash, clothes factory, or
any other business that continues to increase labour without also increasing
the other factors of production.
The combination with the highest productivity is the combination
where the output per worker is the highest – although this might not
be the profit maximising output.
DEMAND FOR CAPITAL GOODS
There are many factors that influence the demand for capital goods. These include:
• The price/cost of capital.
• The price of other factors of production – the effect depends on whether the other factor is a
substitute or a compliment to capital.
• Profitability of the firm.
• Corporation tax.
• Changes in income levels.
• Interest rates – consumption and investment.
• Confidence levels.
• Advances in technology.
DEMAND FOR LAND
Demand for land depends on its potential for creating revenue for the firm.
Fertile land will be more productive in growing crops and will therefore generate
more revenue for a farm.
 It will therefore be in high demand and so will cost a higher rent.

Locations with many potential customers, such as city centers, are also likely to be in
higher demand because they have more potential for generating revenue.
 This is especially true the more wealthy the people living in he city are.
FACTORS OF PRODUCTION AND SECTORS OF
PRODUCTION
In an economy, the number of workers employed in the three main sectors of production
– primary, secondary, tertiary – changes as the economy becomes more developed.
Usually, but not always, this involves a movement from agriculture and farming based
economies to manufacturing, and then on to the service (tertiary) sector as the
dominant sector in the economy.
The dominant sector in the economy, and the stage of development for an economy, will
determine which factors of production are demanded.
An undeveloped, primarily agriculture based economy will most likely be more labour
and land intensive, whereas a developing economy with a focus on manufacturing is
more likely to be capital and labour intensive – whether more capital or labour
intensive depends on the relative cost and productivity of labour and capital in that
economy.