Firms demand more of a factor when demand for their product rises, when the factor is cheaper, available and more productive.
Firms do not want factors of production for their own sake. They want them to produce goods that customers buy. So when demand for the product rises, firms demand more workers, machines and space.
Price of the factor: if a factor becomes more expensive, firms use less of it and switch to others. If wages rise, a firm may buy more machines instead of hiring.
Availability: firms can only use factors they can get. A shortage of skilled workers may push firms to use more machines.
Productivity: the more output a factor produces, the more firms want it. Well-trained workers and efficient machines are in higher demand.
- Derived demand
- Factors are wanted because the product is wanted.
- Influences
- Product demand, factor prices, availability, productivity.
Worked example: A restaurant expanding
A busy restaurant decides how to serve more customers.
- Demand for the product: more diners means it needs more cooks and tables.
- Price of factors: cooks' wages have risen, so it buys a high-speed oven too.
- Availability: it cannot find experienced chefs, so it trains junior staff.
- Productivity: the new oven lets each cook prepare more meals per hour.
Watch out for this
Firms hire more workers when wages rise.
Higher wages make labour more expensive, so firms usually want fewer workers and may use more machines instead.
Check your understanding
Wages rise sharply while the price of robots falls. What are firms likely to do?
- Use more machines and fewer workers
- Hire more workers
- Stop producing altogether