Question

a) How do supply and demand work to determine the amount of a factor of production a firm in a competitive market employs?

b) What does marginal revenue productivity have to do with competitive demand for a resource?

Answer 1

(a)

Factors of production economically termed as inputs which is used for manufacturing of goods and services where the ultimate objective is to make profit. It includes :

• Land
• Labor
• Capital
• Entrepreneurship

In the view of modern economists, product prices are fixed after taking into account the interaction of two forces in the market- demand and supply. Likewise in a competitive market, the factors of production prices are also fixed by taking into account the interaction of demand and supply in the factor market.

• Demand for a Factor of Production

Demand for inputs are always derived from the demand for outputs. If the demand for outputs are high, then simultaneously the demand for inputs are also high. Likewise if the demand for outputs are low, then simultaneously the demand for inputs are also low. Following are the two criteria for demand for factor of production.

1. Importance of demand for a factor: It means that if factor of production is more important in the production process, then factor of production occupies high demand in the market. It also means that if factor of production has close substitutes, then it has a low demand in the market.
2. Ability to change and adapt : It means that demand for factor will be inelastic, if the price is very low and demand will be elastic if the price of factor is very high. Availability of substitutes also determines whether the demand for factor is elastic or inelastic.

• Supply for a Factor of Production

In order to fix the price of a factor it is important to understand the supply to the market. The slope of supply curve of a factor of production is always upward to right, this is because when the price of a factor is higher, then the supply is also higher where all other factors remain constant.

For example, if we consider the aggregate supply of labor in the whole country, then it can be analysed by taking into account factors such as size, population, efficiency, wages, geographical distribution etc.

Where demand of a factor is equal to the supply of factor, it is said to be equilibrium point.

(b)

Resource demand depends on the resource productivity in generating products and generating market value for such productions. The generation of outputs shall be based on the availability of inputs. Likewise we can also say that the production based on volume of inputs used in order to generate outputs.

Production function = Output quantity / Input quantity

Marginal Product is the additions in output or the additional output which comes out from each and every additional units of resource. Therefore;

Marginal Product = Output Change/ Additional Input

Marginal Revenue Product is the variation in aggregate revenue which comes out from each and every additional unit of resources. Therefore ;

Marginal Revenue Product = Revenue Change/ Additional Input

Due to decreasing in marginal product, marginal revenue product decrease with increase in output.