The modern economist
discard the marginal productivity theory on the ground that it
completely ignores the supply side of a
factor of production. Moreover, it simply states as to how
many units of a factor of production will be employed at
different prices but it does not explain the real issue, i.e.,
the determination of the price of the factor of production.
They, therefore, use the tools of demand and supply in solving
the problem of determination of factor prices. Just as the price
of a commodity in the market, they say, is determined by
matching of demand and supply, similarly the price of an agent
of production is determined by their forces of demand and supply
in the factor market. The demand for and supply of a factor in a
resource market under conditions of perfect competition is new
explained in brief.
Demand For a Factor of Production:
The demand for
factors is a derived demand. They are not demanded for their own
sake but their services are required for the production of other
goods and services which the consumers need. For instance, labor
is hired because it helps in the production of the commodities.
Similarly, land is not desired for itself. It is demanded for
the things which It grows or for the construction of a factory
or shop, etc., on it.
The demand for a
factor of production, like the price of commodity, is a function
of price. How much a factor of production will be demanded in
the market depends upon two parameters:
(1) the magnitude of
demand and (2) the elasticity of demand for that factor.
(1)
The Magnitude of Demand:
(i) If a factor
of production is very important in the process of production of
a particular commodity or commodities, it will have a higher
demand in the factor market.
(ii) If the demand
for final product is expected to be high, then the demand for
all the factors which produce the product will go up.
(iii) If a factor of
production has close substitutes, then its demand will not rise
even if the demand for final product in which it is used
increase. The reason is that the employers of factors of
production would prefer to engage a substitute which is
available in the market at an attractive price.
(2)
Elasticity of Demand for Factors:
By elasticity of
demand for factors is meant the degree of responsiveness of
demand for the various factors to changes in their prices. The
main propositions on which the elasticity of demand for the
factors of production depends are as fellows:
(i) If the price of a
factor of production forms a very small proportion in the total
costs of a product, then its demand will be inelastic. If cost
forms a greater proportion of the total cost, then its demand
will be elastic.
(ii) The demand
for a factor of production also depends upon the elasticity of
demand for a commodity in which it is used. If the demand for a
commodity is fairly elastic, then the demand for factors which
go to make the product will also be elastic and vice versa.
(iii) If a factor of
production is easily substitutable in the market, then its
demand will be fairly elastic. In case, it is indispensable, the
demand will be inelastic.
Market Demand Curve for a Factor of Production:
We have stated
earlier that the demand curve for a factor is the marginal
revenue productivity curve of a firm. If we add up laterally
individual demand curves of all the firms, we get market demand
curve for a factor. This is illustrated with the help of the
curve.
Diagram/Curve:
.JPG)
In Fig. 18.3 (a) when
the wage is OW1 the firm s in equilibrium at point K
and the demand for the factor is OR. When wage is OW2,
the firm is in equilibrium at point M. The firm engages OS units
of a factor. If we sum up laterally the individual demand curves
of all the firms, we get DD/ market demand curve for
a factor.
.JPG)
It is clear from this
Fig. 18.3 (b) that with the fall in wages, the demand for a
factor increases and vice versa. For instance, at OW1,
market is OK units (in thousand) of factor are demanded. When
wage falls to OW, the demand for factor increases from OK to OR.
With further fail in wage to OW2, the market demand
for factor increase from OR to OS. The market demand curve for a
factory is a negatively sloped curve indicating inverse
relationship between price of a factor and its quantity
demanded.
Supply of a Factor of Production:
The
supply of a factor of production can be defined as:
"A schedule of the
various quantities of a factor of production that would be
offered for sale at all possible prices at any one instant of
time".
We have stated
earlier that the demand far various factors of production is a
derived demand. Just as the supply and stock of a
commodity can be different, similarly the supply and stock of a
factor of production can also vary. If the supply price of a
factor is high, other things remaining the same, larger will be
the units of factor offered for sale. If the
supply price is low, less quantity of factors of production will
be supplied in the factor market. The supply of a factor to
an industry depends upon the transfer earnings of the various
units of factor. Another characteristic of factors of
production is that they do not bear direct relation between the
prices of services offered by the factors of production
and their cost of production.
The supply of factors
of production is very complicated because each kind of factor
presents a peculiar problem of its own. Land, for instance, is
fixed in quantity and its total supply cannot be increased even
if its price rises. However, for a particular use, its supply
can be varied. Similar is the case with labor. The total supply
of labor in the country depends upon various factors, such as
size of population, labor efficiency, expenses of training and
education, geographical distribution, attitude towards work,
etc. The total supply of labor in the country is fixed but for a
particular occupation it can be increased by drawing workers
from other occupations and by increasing the working hours of
the labor already employed. The supply of capital is also
complicated as it depends upon the power and willingness of the
people to save. The marginal efficiency of capital and the rate
of interest also play a very important role in the supply of
capital in the country.
In nutshell, we can
say that the supply of a factor is also a function of price. The
higher the price of a factor of production, other things
remaining the same, the greater will be its supply and vice
versa. The supply curve of a factor of production is
positively inclined, i.e., its slopes upward from left to right
as is shown below:
Diagram:
In the diagram (18.4)
we measure units of a factor, say labor, along OX axis and wage
on OY axis. If the wage is OP, OL workers are supplied. At wage
OR, the supply of workers increases from OL to ON. The normal
supply curve of a factor is positively sloped. If rises from
left to-right upward indicating that at higher factor prices,
greater quantity of factor is offered in the factor market and
vice versa.
In a
perfect competitive market, there are large number of firms
to demand the services of a factor of production and also large
number of households, to supply the services of a factor. In
such a factor market, the price of a factor is determined by the
interaction of the forces and demand and supply as is shown in
the figure below:
Diagram:
In this diagram 18.5,
DD/ is the demand curve and SS/ is the
supply curve of a factor, The demand and supply curves intersect
at point E. The equilibrium factor price is OP. The price of a
factor cannot be stable at the level higher than or lower than
OP. For example, the price cannot be established at OP1.
Since at price OP1, the quantity offered to
supply is greater than the quantity demand (QM), therefore, the
competition between the owners of the factor will force down the
price to OP level. Similarly, the price of factor cannot be
determined at the level of OP2 because at this price,
the supply of a factor is less than demand by M1Q1.
The
competition among the
producers demanding the factor of production will push the price
to OP level. We thus find that the reward of a factor of
production is determined by the interaction of the forces of
demand and supply.
Criticism:
The theory of
factor pricing is criticized on the ground of its weak
assumptions.
(i) The theory is
based on the assumption of perfect competition in both the
product and factor markets. While in reality, it is the
imperfect competition which prevails in both the markets.
(ii) The theory
assumes that all the unit of a factor are homogenous. But in the
real life they are different from each other.
(iii) The theory
assumes that different factors of production are capable of
being substituted for one on other. In the real world, we find
that factors of production are not close substitutes of one
another.
(iv) The theory
ignores the increasing returns in factor pricing.
