Chapter 21: Firms and production

21.1-demand for factors of production

What factors of production are employed are influenced by:

The type of product produced Substitutes Complements

Productivity of the factors Rise Rise
Cost Fall Fall
May result in a change of the May increase the employment
combination of resources being of all factors in a firm
employed

Altering factors of production

If a firm wants to change the quantity if resources being employed, it will be easier to do this with
some factors than others.
There has to be one fixed factor of production which cannot be altered quickly. Example: the size of a
factory. It will take time to expand, and one wanting to reduce output is unlikely to be able to stop
renting its building off quickly.
Combining the factors of production
It is important to achieve the right combination of factors of production. While deciding the
combination of resources, firms seek to achieve the highest possible productivity. If not some
resources would be under-utilised (more) or there would be an insufficient amount of resources (less).

Production is output
Productivity is out per worker or output per factor of production.
The key factors influencing demand for capital goods:
1- Price of capital goods-

Rise Contraction in demand

Rise in price of another Increase demand
fop

In the case of the other factor being a:

Substitute- rise in price of another factor makes the production of a unit of output more expensive
than that involving a rise in capital. Demand will increase.
Complement- Increase in its price- cause a decrease in demand for capital
2- If profit levels are high
3- Corporation tax- a tax on profit of a company- a cut in this
Firms will have both the ABILITY and the INCENTIVE to buy capital goods

4- Rising disposable income will lead to an increase in consumption.

5- Lower interest rates- lower cost of borrowing- firms would sacrifice less interest by
borrowing capital goods
 Increase in consumption- Firms will expect to sell a higher output- encourage firms to invest
more

6- Firm’s expectation about the future. Confidence in rise of sales will lead them to invest now
but a rise in pessimism will result in a decline in investment
7- Advances of technology- increase productivity of capital goods- new and more efficient
machinery- firms will invest more.

Demand for land

Productivity is a key factor influencing demand for land. The more productive something is increases
demand and eventually price.
Factor of production and sectors of production
The demand for fop can alter as an economy changes its industrial structure.
The distribution of resources among different sectors changes with economic development.

Labour-intensive or capital-intensive production

Labour intensive
1- In countries with a large supply of labour, it is relatively cheap
2- Some producers are too small to take advantage of capital equipment (won’t make more than
they can sell)
3- Handmade or custom-made products-
 will earn a higher price
 as consumers may think that it is made of higher quality-more likely to meet their individual
needs provide a greater status
 some consumers like the personised attention.

Advantage of labour over capital:

 Workers can be more flexible in terms of what they do
 The size of labour force can be adjusted by small amounts
 Labour can also provide feedback on how to improve production methods and the quality of
products
 If the price of capital increases and labour can carry out some functions with the same level of
productivity as the machines they replace. Firms may switch.
 Capital goods need to be maintained/ can break down

Advantages of capital over labour:

 Advances in technology tend to make capital goods more affordable and more productive
 Have the capacity to produce more products at a lower average cost (technical economies)
 Capital goods produce products at a uniform standard unaffected by human error
 They do not engage in industrial action
 They also do not have time off ill
 Not affected by tiredness
As economies develop, both production and productivity tend to increase due to advance in
technology and improvements in technology. These developments can result in productivity rising so
much that total output can increase while the number of working hours declines.