Factor Demand and Factor Supply

As a consumer, you're most likely only concerned with the things you want to buy. When you receive some money, you just can't wait to go to town and get all your favorite products. What you may not have realized is that the producers of all your favorite products also can't wait to buy all the things they need to make your favorite products. So, it's a cycle, and the things producers need to make products are called factors of production. Read on to learn about how factor demand and factor supply work!

Factor Demand and Factor Supply Factor Demand and Factor Supply

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Table of contents

    Factor Demand and Factor Supply Definition

    We're here to talk about the definitions of factor demand and factor supply, but let's lay some foundation first. Producers need certain things so they can combine them to make their products. These things are called the factors of production, and they are the resources used by producers in their productive processes.

    Factors of production are the resources producers use in their productive processes.

    The factors of production are labor, capital, land, and entrepreneurship.

    These factors of production are provided by households in the factor market, which is the market where the buying and selling of factors of production take place.

    The factor market is the market where the factors of production are bought and sold.

    The factor market is characterized by demand (producers) and supply (households). It is this demand and supply that are referred to as factor demand and factor supply by economists. So, what are they? Factor demand is the willingness and ability of producers to purchase factors of production at any given time. Factor supply is the availability of factors of production for purchase by producers at any given time.

    Factor demand is the willingness and ability of producers to purchase factors of production at any given time.

    Factor supply is the availability of factors of production for purchase by producers at any given time.

    Figure 1. shows you the relationship between producers and households in the factor market.

    Demand and Factor Supply Circular flow diagram for factor demand and factor supply StudySmarterFig 1. Circular flow diagram for factor demand and factor supply

    Factor Demand and Factor Supply Curve

    Economists like to make things easy on the eyes. They do this using graphs, and the factor market is often represented by the factor market graph, on which there are the factor demand curve and the factor supply curve. The factor market graph is simply the graphical representation of the factor market.

    The factor market graph is the graphical representation of the factor market.

    On the factor market graph, there is the factor price and the quantity of the factor. The factor price refers to the price paid by producers to purchase factors of production. The quantity of a factor is the quantity of a factor demanded or supplied.

    The factor price refers to the price paid by producers to purchase factors of production.

    The quantity of a factor is the quantity of a factor demanded or supplied.

    The factor market graph shows both the factor demand curve and factor supply curve as these two form the factor market. The factor demand curve is the graphical illustration of the relationship between factor price and the quantity demanded of a factor. The factor supply curve is the graphical illustration of the relationship between factor price and the quantity supplied of a factor.

    The factor demand curve is the graphical illustration of the relationship between factor price and the quantity demanded of a factor. The factor demand curve has a downward slope from the left to the right.

    The factor supply curve is the graphical illustration of the relationship between factor price and the quantity supplied of a factor. The factor supply curve has an upward slope from the left to the right.

    The factor market graph is plotted with the factor price on the vertical axis and the quantity of the factor on the horizontal axis. The factor market graph, the factor demand curve, and the factor supply curve are all shown in Figure 2 below.

    factor demand and supply graph showing curves studysmarterFig 2. - Factor market graph showing the factor demand and factor supply curves

    The point where the factor demand and factor supply curves meet is called the factor market equilibrium.

    Factor Demand and Factor Supply and Marginal Analysis

    Businesses make decisions using marginal analysis where they consider the benefits and costs of adding an extra unit of a factor of production.

    The marginal factor cost of a factor is the cost of adding an extra unit of that factor.

    The marginal revenue is the extra revenue derived from producing an extra unit of a product.

    In production, the marginal benefit of a factor is the extra output produced as a result of adding an extra unit of a factor. This is known as the marginal product.

    The marginal revenue product is the extra revenue derived from adding an extra unit of a factor.

    From the above definition, we can say that the marginal revenue product of labor is the extra revenue derived from employing an extra unit of labor. According to the marginal-productivity theory of factor demand, the demand for a factor of production is dependent on the marginal product of that factor. Producers will add factors of production as long as the cost of adding any factor of production does not exceed the revenue it brings. Therefore, producers will stop adding factors of production at the point where the marginal revenue product equals the marginal factor cost. Mathematically, this is written as:

    Marginal Revenue Product (MRP)=Marginal Factor Cost (MFC)

    Change in Factor Demand and Factor Supply

    There are things that can cause changes in factor demand and factor supply. These things are called the determinants of factor demand and factor supply.

    The determinants of factor demand and factor supply are things that cause a decrease or increase in factor demand and factor supply.

    While changes in factor price can cause movements along the factor demand curve and factor supply curve, changes in the determinants of factor demand and factor supply cause a complete shift in the factor demand curve and factor supply curve.

    Changes in Factor Demand

    Let's look at changes in factor demand. The determinants of factor demand are changes in the prices of products, the supply of other factors, and technology.

    1. Product price change - If the production of a product depends on a given factor, a change in the price of that product, which is usually driven by a change in demand for that product, will result in a change in the marginal revenue of that product. This means that there will be a resulting change in the marginal revenue product of that factor, causing the factor demand curve to shift either left or right.Example: If the price of shoes increases, due to an increase in demand for shoes, a shoe company will want to make more shoes. This will lead to an increase in demand for shoemakers (labor).
    2. Supply of other factors - The supply of other related factors, often driven by the price of those factors, can cause an increase or decrease in the demand of a factor. For example, if the price of leather declines, more shoes will be demanded due to a lower cost of production. This will lead to an increase in demand for shoemakers (labor).
    3. Technology - An advancement in technology can either cause the factor demand curve to shift right or left. Two simple scenarios will show this.Scenario 1: The introduction of cars causes the demand for horses to go down since horses are no longer the primary form of transportation. This would be represented by a leftward shift of the demand curve for horses.Scenario 2: The introduction of cars means that a goods producer can produce more goods to be transported, so the producer hires more employees. This would be represented by a rightward shift in the demand curve for labor.Here, it becomes clear that an advancement in technology either increases or decreases the demand for a factor.

    Look at Figure 3 for what a change in factor demand looks like.

    factor demand and supply change in demand studysmarterFig 3. - Change in factor demand

    D0 represents a decrease in factor demand whereas D1 represents an increase in factor demand.

    Changes in Factor Supply

    Now, let's look at changes in factor supply. The determinants of factor supply are changes in preferences and social norms, population size, opportunities, and wealth.

    1. Preferences and social norms - A change in preferences and social norms result in the increased supply of a factor as more households develop a norm to provide that specific factor. For instance, as the norm changes for women to work outside the home, the general labor supply increases.
    2. Population size - As the population increases in size, there will be more workers available at a given factor price, this will cause the labor supply curve to shift to the right.
    3. Opportunities - As a new employment opportunity emerges in a given field, the supply of labor also increases as more households want to benefit from this new opportunity.
    4. Wealth - When people gain more wealth, they may prefer more leisure to work. For instance, if teachers became wealthier due to an investment they all made, they would prefer leisure, hence, the supply of teachers would decline.

    Figure 4 shows you what the changes in factor supply look like.

    factor demand and supply changes studysmarterFig 4. - Changes in factor supply

    S0 represents a decrease in factor supply whereas S1 represents an increase in factor supply.

    Examples of Factor Demand and Factor Supply

    Examples of factor demand include the demand for labor, the demand for farmland (land), the demand for farm equipment (capital), and the demand for entrepreneurship (business startups).

    Examples of factor supply include the supply of labor, the supply of farmland (land), the supply of farm equipment (capital), and the supply of entrepreneurship (business startups).

    Note the examples involve the four factors of production.

    You just made it to the end of this article! You should read our articles on Factor Markets, Labor Market, Land Market, and Market for Capital where we explain factor demand and factor supply in more detail!

    Factor Demand and Factor Supply - Key Takeaways

    • Factors of production are the resources producers use in their productive processes. The factor market is the market where the factors of production are bought and sold.
    • Factor demand is the willingness and ability of producers to purchase factors of production at any given time. Factor supply is the availability of factors of production for purchase by producers at any given time.
    • The factor demand curve is the graphical illustration of the relationship between factor price and the quantity demanded of a factor. The factor demand curve has a downward slope from the left to the right.
    • The factor supply curve is the graphical illustration of the relationship between factor price and the quantity supplied of a factor. The factor supply curve has an upward slope from the left to the right.
    • The determinants of factor demand and factor supply are things that cause a decrease or increase in factor demand and factor supply.
    Frequently Asked Questions about Factor Demand and Factor Supply

    What causes changes in factor demand and factor supply?

    The determinants of factor demand and factor supply are things that cause a decrease or increase in factor demand and factor supply.

    What is factor demand and factor supply?

    Factor demand is the willingness and ability of producers to purchase factors of production at any given time.

    Factor supply is the availability of factors of production for purchase by producers at any given time.

    What are conditional and unconditional factor demand and factor supply?

    Conditional factor demand is the cost-minimizing levels of factors of production needed to produce a given level of output, for given costs per unit of inputs.

    The unconditional demand of a factor is computed by first maximizing the profit function=MRP-wL-rK.
    Necessary conditions are MRPL=w and MRPK=r.
    Then solve for the profit-maximizing levels of labor and capital.

    What is marginal productivity theory of factor demand?

    According to the marginal-productivity theory of factor demand, the demand for a factor of production is dependent on the marginal product of that factor.

    What are factor demand and factor supply function examples?

    The conditional factor demand functions for labor and capital are as follows:
    minimize Cost=wL+rK (w=wage, r=rent)
    subject to the production function f(L,K)=q
    The general form of the conditional factor demand functions are:

    L∗=L(w,r,q0)

    K∗=K(w,r,q0)

    Test your knowledge with multiple choice flashcards

    Wage rate is on the horizontal axis.

    The labor supply curve represents labor supply.

    A change in the wage rate only causes a movement along the labor supply curve.

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