Chapter 21
Firms and
production
Learning objectives
By the end of this chapter you will be able to:
■ analyse the influences on the demand for factors of production
■ analyse the reasons for adopting labour-intensive production or capital-intensive productio
■ distinguish between productivity and production
21.1 Demand for factors of production
What factors of production are employed
• The type of factors of production employed is influenced by the type of product produced, the
productivity of the factors and their cost.
• A firm producing a standardized model of car is likely to be very capital-intensive, whereas a
beauty salon is likely to be labor-intensive.
• When factors of production are substitutes, a rise in the productivity may result in a change in
the combination of resources being employed.
• A fall in the price of capital goods might lead to the replacement of some workers with
machines.
• In other cases, where factors of production are complements, a fall in the price of one may
increase the employment of all factors in a firm.
Altering factors of production
• If a firm wants to change the quantity of resources employed by it, it will find it
easier to do this with some factors than others.
• In the short run, there is likely to be at least one fixed factor of production.
• This means the quantity cannot be altered quickly.
Combining the factors of production
It is important to achieve the right combination of factors of production.
For example, it would not make sense for a
hairdressing salon to have ten hairdryers and two
hairdressers, or a farmer to have a large amount of
land and only a few cattle.
In the first case, labour would be under-utilised and in the second case, there would be an
insufficient number of livestock to make full use of land. While deciding the combination of
resources, firms seek to achieve the highest possible productivity.
Factors influencing demand for capital goods
Among the key factors influencing demand for capital goods are :
• The price of capital goods • Income
• Price of other factors of production • Interest rates
• Profit levels • Confidence levels
• Corporation tax • Advances in technology.
Factors influencing demand for capital goods
• A rise in the price of capital goods will cause a contraction in demand for capital
goods, whereas an increase in the price of another factor of production, particularly
labour, may increase the demand for capital goods.
• If profit levels are high, firms will have both the ability and the incentive to buy
capital goods.
• A cut in corporation tax would also mean that firms would have more profit
available to plough back into the business and greater incentive to do the same.
• Rising real disposable income will lead to an increase in consumption.
Factors influencing demand for capital goods
• A cut in interest rates would also tend to raise consumption and thereby encourage
firms to expand their capacity.
• Another key influence on investment is firms’ expectations about the future. If they
are confident that sales will rise, they will invest now.
• Advances in technology will increase the productivity of capital goods.
Demand for land Productivity is a key factor influencing demand for
land. In terms of agricultural land, the most fertile land will be in highest
demand and receive the highest rent. City centre sites are also very
productive as firms have the potential to attract a high number of
customers. If a shop in the centre of New York becomes vacant, it is
likely that a number of retail firms would compete for it in the
expectation that they could earn a high revenue there. The competition
pushes up the rent that can be charged for a favourable site. One
natural resource, which is experiencing an increasing world demand, is
water. Water is used for domestic, agricultural, industrial and energy
production purposes. As countries become richer, they make heavier
demands on scarce water supplies. The global use of water has
increased six times in the last one hundred years and is predicted to
Factors of production and sectors of production
• The demand for factors of production can alter as an economy changes its industrial
structure.
• The distribution of resources among different sectors changes with economic
development.
• In most cases, agricultural reform permits resources to move to low-cost manufacturing.
• Resources move to higher value added manufacturing and then finally the service sector
becomes the most important one.
• Not all economies conform to this pattern.
21.2 Labour-intensive or capital-intensive production
There are a number of reasons why some producers use labour-intensive methods
of production.
1. There is a large supply of labour in the country, making labour relatively cheap.
2. Some producers may be too small to take advantage of capital equipment.
21.2 Labour-intensive or capital-intensive production
• Firms may switch from capital-intensive production to labour-intensive production if
the price of capital increases and labour can carry out the same functions with the
same level of productivity as the machines they replace.
• In practice, firms tend to switch from labour-intensive production to capital-intensive
production.
• This is because advances in technology tend to make capital goods more affordable
and more productive.
• Education is becoming more capital-intensive with developments such as online
university degrees.
21.3 Production and productivity
• There are clear links between production and productivity, but they are not the
same thing.
• If output per worker hour increases and the number of working hours stays the
same, production will increase.
• It is possible that productivity could rise and production could fall.
• This could occur if unemployment increases.
21.3 Production and productivity
• Indeed, a rise in unemployment may increase productivity as it is the most
skilled workers who are likely to keep their jobs.
• As economies develop, both production and productivity tend to increase due to
advances in technology and improvements in education.
• These developments can result in productivity rising so much that total output
can increase while the number of working hours declines.
Multiple choice questions
1 The table shows the distribution of the labour force of a country between two years.
2 A doctor and an operating theatre are:
A. Complementary factors of production
B. Substitute factors of production
C. An example of labour and land
D. An example of enterprise and capital
3 Which of the following would cause an increase in demand for capital
goods?
E. A decrease in corporation tax
F. A fall in disposable income
G. A rise in interest rates
H. A rise in pessimism
4 Twenty-five workers produce a total output of 300. What is the average product per worker?
A. 12
B. 25
C. 300
D. 7500
Four-part question
a Define investment. (2)
b Explain why the production of cars may increase whilst the productivity of car workers may
fall. (4)
c Analyse the reasons why car production has become more capital-intensive. (6)
d Discuss whether or not industries becoming more capital-intensive will increase