13.1 The Demand for Factors LO 1
A firm’s decisions on how much to produce and how to produce it
imply demands for factors of production. We say that demand for
factors is derived from the demand for goods they are used to
produce.
A profit-maximizing firm will hire units of a factor until the last unit
adds as much to revenue as it does to cost. Thus, the marginal
revenue product of the factor will be equated with that factor’s
marginal cost.
When the firm is a price taker in factor markets, the marginal cost of
the factor is its price per unit. When the firm sells its output in a
competitive market, the marginal revenue product is the factor’s
marginal product multiplied by the market price of the output.
A price-taking firm’s demand curve for a factor is negatively sloped
because the law of diminishing returns implies that the marginal
product of a factor declines as more of that factor is employed (with
other inputs held constant).
The demand for a factor will increase if the factor becomes more
productive, if the price of the product increases, or if more of other
factors of production are available.