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 captaI-intensive
production 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 standardised model of car is
likely to be very capital-intensive, whereas a
beauty salon is likely to be labour-intensive.
 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
The most obvious example is the size of the factory
or office. It will take time for a firm desiring
expansion, to extend its buildings or build new ones.
Similarly, one wanting to reduce output is unlikely to
be able to stop renting or sell off its buildings quickly.
 Altering factors of production
• In contrast, it is likely to be easier to change the
quantity of labour. Even in the very short run, it may
be possible to after the quantity of labour by changing
the amount of overtime available. It may also be
possible to change orders for raw materials and capital
equipment. but it will depend on the length of
contracts and, in the case of increasing demand, the
availability of spare capacity in firms producing them
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.
Table 21.1: Combining labour with machines
Answer
 Factors influencing demand for capital
goods
•
Among the key factors influencing demand for
capital goods are the price of capital goods.
price of other factors of production. profit
levels, corporation tax income, interest rates,
confidence levels and advances in technology.
A rise in the price of 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. This will occur if the factors are substitutes and the
rise in price of another factor makes the production of a
unit of output more expensive man that involving a rise in
capital. If another factor is a complement, an increase in
its price would cause a decrease in demand for capital.
 If profit levels are high
• • If profit levels are high, firms will have both
the ability and the incentive to buy capital
goods.
 A cut in corporation tax
• • 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
• • Rising real disposable income will lead to an
increase in consumption. This, in turn, is likely
to encourage firms to invest as they will
expect to sell a higher output in the future.

• Income after deduction of direct tax call

disposable income.
 A cut in interest rates
• • A cut in interest rates would also tend to raise
consumption and thereby encourage firms to expand
their capacity. In addition, lower interest rates would
increase investment because they would reduce the
opportunity cost of investing and lower the cost of
borrowing. Firms can use profits to buy more capital
goods instead of depositing them in bank accounts.
With low interest rates, firms would be sacrificing less
interest by buying capital goods. Borrowing to buy
capital goods would also be less costly.
 firms’ expectations about the future
• • Another key influence on investment is
firms’ expectations about the future. If they
are confident that sales will rise, they will
invest now. In contrast, a rise in pessimism will
result in a decline in investment.
 Advances in technology
• • Advances in technology will increase the
productivity of capital goods If new and more
efficient machinery is developed, firms are
likely to invest more
 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
• 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 double again by 2050
 Answer
A Rising living standards tend to increase
demand for water significantly. More water is
demanded for a variety of purposes including
washing, watering gardens, cleaning cars,
filling swimming pools, processing food and
other industrial uses.
 Answer
B As living standards in most countries should
rise in the future, demand for water is likely to
increase, which will cause its price to rise as
shown in the diagram below. Supply will
extend as water companies will have a
financial incentive to collect more rain in
reservoirs, dam more rivers and desalinate sea
water.
Answer
 Factors of production and sectors of
production
The demand for factors of production can alter as
an economy changes its industrial structure. As
mentioned in Chapter 20, the distribution of
resources among different sectors changes with
economic development. In most cases, agricultural
reform permits resources to move to low-cost
manufacturing. Then, resources move to higher
value added manufacturing and then finally the
service sector becomes the most important one Not
all economies, however, conform to this pattern.
 Factors of production and sectors of
production
India’s service sector has expanded before it
has built up a sizeable manufacturing sector.
Now, in most countries, the service sector
makes the largest contribution to output.
Indeed. in 2016 the service sector accounted
for 63% of global output.
 Answer
A A piecework model is a method of paying workers
on the basis of amount of output produced by
them.
B i It may increase output as workers will spend less
time travelling to and from work. Thus, they may
start working earlier and finish later. However,
there is some risk that, without supervision, they
may reduce their effort and output but a
piecework model may overcome this limitation.
 Answer
Ii Costs should be reduced as the firm will not
need much space to accommodate workers.
Some rooms may be required for meetings
and key staff but considerably less factory or
office space and less car parking space would
be required. This saving should be greater
than any rise in communication costs, which,
given advances in technology, should be low.
21.2 Labour-intensive or capital-intensive
production
There are a number of reasons why some
producers use labour-intensive methods of
production One is that there is a large supply
of labour in the country, making labour
relatively cheap
 Answer
• Capital intensive: a, d, e.
• labour intensive: b, c.
 21.3 Production and productivity
•
There are clear links between production and
productivity, but they are not the same thing. If output
per worker per hour increases and the number of
working hours stays the same, production will increase.
It is possible, however, that productivity could rise and
production could fall. This could occur if unemployment
increases. Indeed, a rise in unemployment may increase
productivity as it is the most skilled workers who are
likely to keep their jobs
 21.3 Production and productivity
• 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 I
 Multiple choice questions

• 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
 Multiple choice questions

• 3 Which of the following would cause an

increase in demand for capital goods?
A A decrease in corporation tax
B A fall in disposable income
C A rise in interest rates
D Arise in pessimism
 Multiple choice questions I

• 4 Twenty-five workers produce a total output

of 300 What is the average product per
worker?
A12
B25
C 300
D7500
 Answer
• 1A
• Agriculture and mining are in the primary sector and their
employment fell from 14 m to 13 m. Manufacturing is in the
secondary sector and employment stayed constant at 20 m.
Retailing and education are in the tertiary sector and
employment in these two industries rose from 15 m to 17m.
• 2A
• Doctors and operating theatres are used together. They are
not substitutes – an operating theatre cannot be used
without a doctor. A doctor is an example of labour and an
operating theatre is an example of capital.
 Answer
• 3A
• A decrease in corporation tax would provide an incentive for firms
to buy more capital goods. They would know that they would be
able to keep more of any profits made. B, C and D would also be
likely to reduce demand for capital goods. Less disposable income
would be likely to reduce demand for the capital goods. Higher
interest rates would have the same effect besides increasing the
cost of investment. A rise in pessimism would be likely to make the
entrepreneurs expect a lower return from investment.
• 4A
• Average product per worker is total product divided by the number
of workers. In this case,
• it is 300/25
 Four-part question
A Define investment. (2)
B Explain wfly 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 unemployment. (8)
 Answer
• a Investment is spending on capital goods.
 Answer
B The production of cars may increase if there is a
rise in demand for cars. In the short term, car firms
may make more cars by asking existing workers to
work overtime. Working longer hours may reduce
output per worker hour as the workers may
become tired and so may not be able to put so
much effort in their work. In the longer term, the
car firms may employ more workers. If these
workers are less skilled than the original workers
employed, labour productivity will fall.
 Answer
C Car production has become more capital-intensive
because advances in technology have significantly
increased the range of tasks that can be completed by
machinery with the minimum of human supervision.
Capital equipment has increased the number of cars
that can be produced in a given time period and has
reduced the cost of production. Relying more on capital
equipment has also improved the reliability of the cars
produced by reducing human error. Lower costs of
production and higher revenue have encouraged car
firms to spend more on capital goods.
 Answer
D Industries becoming more capital-intensive may
increase unemployment in a country. The capital
goods may be a substitute for labour and so capital
goods may replace some workers. A number of
these workers may lack geographical or
occupational mobility. For example, making more
use of tractors and combine harvesters may reduce
the number of farm workers. If these workers
cannot find jobs in other industries, they will stay
unemployed.
 Answer
There are a number of reasons, however, why
more capital-intensive production may not
increase unemployment. One is that there will
be an increase in demand for capital goods
and for the service of maintaining the capital
goods. This will encourage the capital goods
industries to employ both more capital goods
and labour.
 Answer
Becoming more capital-intensive may make a range of industries
more efficient. Lower costs of production can enable the industries
to lower their prices and so become more internationally
competitive. If industries can gain larger markets, their output will
increase. This may mean that while the proportion of capital
increases relative to labour, more of both may be employed. For
example, an industry may have initially employed 50 000 workers
and workers may have accounted for 60% of the factors of
production employed. Using more capital goods and producing more
may mean that workers now account for only 35% of the factors of
production employed but the number of workers employed may
now be 60 000. Over time, in most countries, industries have
become more capital-intensive but employment has actually
increased.