5.2 Changes in Factor Demand

What shifts the demand for a factor?

Factor demand (like labor demand) is derived demand — it comes from demand for the output it helps produce. It shifts when: (1) demand for the output/product changes, (2) the price of other inputs (substitute or complementary resources) changes, (3) productivity/technology changes, or (4) the number of firms in the market changes.

Output demand and marginal revenue product

A resource's demand curve is its marginal revenue product (MRP) curve. If demand for the product rises, price and marginal revenue rise, increasing MRP at every quantity of the input — shifting factor demand right. A drop in output demand shifts it left.

Productivity, technology, and other inputs

An increase in a resource's marginal productivity (better technology, more/better complementary capital) raises MRP and shifts factor demand right. If a substitute input's price falls, firms use less of the original resource (demand falls); if a complementary input's price falls, firms use more of both (demand rises).

Key terms

Derived demand

Demand for a factor of production that comes from the demand for the final good/service it helps produce.

Marginal Revenue Product (MRP)

The additional revenue a firm earns from employing one more unit of a resource; it forms the resource demand curve.

Effect of rising output demand on factor demand

Increases factor demand (shifts curve right) because MRP rises at every input level.

Effect of a cheaper substitute input

Decreases demand for the original resource as firms switch to the now-cheaper substitute.

Effect of a cheaper complementary input

Increases demand for the related resource, since using both together becomes more profitable.

Try an AP-style question

An increase in the price of the product workers make will…

1. decrease labor supply
2. increase labor demand
3. decrease labor demand
4. have no effect