Firms and production

Demand for factors of production

Demand for factors of production is derived demand

Factors affecting demand for factors of production (all)

Demand for the product, demand for a factor of production is derived demand, ie it depends on the
demand for the product that the factor of production produces for example an increase in demand
for tomatoes leads to an increase in demand for land to plant tomatoes (Land), an increase in
demand for seed and fertilisers (capital) used in tomato farming and an increase in demand for
workers required to plant and harvest tomatoes (labour)

The cost of factors of production - The higher the cost of land, labour and capital, the lower their
demand tends to be. Similarly, if labour costs are relatively high compared with the cost of capital
then workers might be replaced by machinery and technology.

Factors that influence the demand for Capital and Labour

 The Productivity of Labour and Capital – when there is a high productivity of capital or a low
productivity of labour, there is a higher demand for capital and lower demand for labour, and
vice versa.
 Market Prices for Labour and Capital – Labour and Capital are substitutes so when the price of
labour increases, the demand for capital increases and vice versa.
 Profit Levels – if profit levels are high, they are able to buy expensive capital which is more
efficient than labour, therefore demand for labour will decrease and demand for capital will
increase
 Business Confidence – If a firm has high business confidence, meaning confidence in business
for the future, demand for both labour and capital will increase and vice versa.
 Demand for Goods and Services – when there is a high demand for goods and services, there is
a high demand for labour and capital as the firm will want to produce as much of the good as
possible so they can earn a higher total revenue through the sale of more output and therefore
gain more profit
 Interest Rates – when interest rates are high, loans are more expensive to pay off and therefore
firms are less willing to get loans for expensive capital. This causes demand for capital to
decrease and demand for labour to increase.

Factors that influence the demand for land

 Productivity – the greater the output from land the higher will be the demand for it
 Location – city centre sites can attract a large number of customers so there is a higher demand
for land there and therefore rent increases
 Country Wealth – as countries become richer, the demand for natural resources like water
increases. Water is needed for domestic, agricultural, industrial, and energy production
purposes their availability and their productivity.

Labour-intensive and capital-intensive production

A labour intensive organisation will employ more labour than capital equipment and machinery.
Advantages Disadvantages

Quality of products can vary due to expertise of the

Customised products are easier to make
worker

Less expensive machinery costs Skilled workers take time to train

Humans can use their own initiative and problem Skilled workers will be paid more than unskilled
solve workers

A capital intensive organisation will employ more capital equipment and machinery and relatively
few workers.

Advantages Disadvantages

Less employee wages and costs More difficult to customise orders

Quality can be standardised, the same every time Breakdowns in production can be costly

Machines can work continuously, 24/7 Initial set up costs of machinery are high

Whether firms choose more capital- or labour-intensive production methods depends on several
related factors:

• The cost of labour compared with the cost of capital - Firms will tend to choose more capital-
intensive methods of production if labour costs are relatively high and vice versa.

• The size of the market - Capital-intensive production tends to take place for mass-market products
such as soft drinks, passenger vehicles and consumer electronics. Labour-intensive methods are
often used for personalised services, such as a private tutor, counsellor, adviser, instructor or coach.

• The firm's objectives - profit-maximisers operating in mass markets tend to opt for capital-
intensive production methods in order to minimise their unit costs of production. Other firms might
choose to use labour-intensive methods as they operate on a smaller scale or to safeguard jobs.
Black & Decker, operating in Shenzhen, China, uses labour-intensive production methods to create
jobs in the special economic zone, benefiting from tax incentives from the government.

Production and productivity

Production – the act of processing raw materials. Production is measured in units of output

Productivity –Productivity is a measure of how well resources are used in the production process
that is, the economic efficiency of land, labour, capital and enterprise. It is the amount of output that
can be produced from a given amount of input/resources.

Formula
Output
𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑣𝑖𝑡𝑦 =
𝐼𝑛𝑝𝑢𝑡
Labour Productivity – the amount of output that can be produced from a given amount of labour
 Output
Formula: 𝐿𝑎𝑏𝑜𝑢𝑟 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑣𝑖𝑡𝑦 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠

Labour productivity can be improved using the following methods;

Increase use of machinery (to aid tasks) – Machinery allows the increase of production as well as
the quality of the finished product to be better.
Division of labour and specialisation – Allows production to be more efficient resulting in a higher
output. Total output of goods and services is raised and quality can be improved. A higher output at
lower costs means more wants and needs might be satisfied with a given amount of scarce
resources.
Skill training – Skills training increase productivity. In addition to learning how to complete new
tasks and take on more responsibility, employees can learn advanced techniques to help those
complete everyday tasks more efficiently.
Motivate workers with financial incentives (pay raises, profit sharing), increase job satisfaction
(better working environment)
Capital Productivity – the amount of output that can be produced from a given amount of capital/
machines

Formula
Output
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑣𝑖𝑡𝑦 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 (𝑚𝑎𝑐ℎ𝑖𝑛𝑒𝑠)
Higher productivity is important for an economy for several reasons:

• Economies of scale - Higher levels of output, whether through capital-intensive or labour-intensive

methods of production, help to reduce unit costs of production. These cost-saving benefits can be
passed on to consumers in the form of lower prices. In addition, cost savings from higher
productivity levels can help firms to earn more profit on each item sold.

• Higher profits - Productivity gains are a source of higher profits for firms. These efficiency gains can
be reinvested in the business to fund research and development or used to expand the operations of
the business. Either way, higher profits help to fund the long-term survival of the firm.

• Higher wages - Highly productive firms that enjoy cost savings and higher profitability can afford to
pay higher wages to their workers, especially if they become more efficient. Such firms also tend to
attract the best workers, as people prefer to work for firms with better prospects and profitability.

• Improved competitiveness - Productive firms can gain advantages beyond economies of scale. For
example, they are more efficient, so they can compete more effectively on a global scale. Samsung's
efficiency gains during the late 2000s ensured that the South Korean company took market share
from Nokia and Apple to become the market leader in the smartphones industry.

• Economic growth - Productivity is a source of economic growth because it increases the productive
capacity of an economy, thus shifting its production possibility curve outwards. This helps to raise
employment and standards of living in the economy. Higher wages, from improved efficiency of
firms and higher labour productivity, also mean that the government collects more tax revenues to
fund its expenditure on the economy

Determinants of productivity

The five main determinants of productivity growth are as follows:

• Investment - This is the expenditure on physical capital such as machinery, vehicles and buildings.
For example, investment in the latest technologies generally helps workers to do their jobs better -
that is, to produce more output and of better quality.

• Innovation - This refers to the commercialisation of new ideas and products. The invention of
tablet computers and smartphones has transformed the way many people work, as they are able to
conduct their business while mobile rather than at the office. Such innovations have increased the
speed of work, improved communications and enhanced organisation at work. Thus, innovation
helps to boost productivity.

• Skills and experience - The productivity of labour is determined by its quantity and quality. The
quality of labour can be increased by improving the skills and experience of the labour force.
Education and training, for example, enhance the human capital (skills and experience of the
workforce) in the economy, thus boosting productivity.

• Entrepreneurial spirit - Entrepreneurs take risks in the production process in the pursuit of profit.
They plan and organise the various factors of production in the production process. Productivity is
dependent on the drive (motivation) of entrepreneurs, such as their willingness and ability to exploit
new business opportunities.

• Competition - This creates an incentive tor firms to be more productive. Without competition,
firms might lack the incentive to be efficient or innovative. By contrast, competition forces firms to
be more efficient, thus helping to boost the economy's overall productivity.