March 18, 2018 

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LAW OF DIMINISHING MARGINAL RETURNS: A principle stating that as more and more of a variable input is combined with a fixed input in short-run production, the marginal product of the variable input eventually declines. This is THE economic principle underlying the analysis of short-run production for a firm. Among a host of other things, it offers an explanation for the upward-sloping market supply curve. How does the law of diminishing marginal returns help us understand supply? The law of supply and the upward-sloping supply curve indicate that a firm needs to receive higher prices to produce and sell larger quantities. Why do they need higher prices?

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The willingness and ability of scarce resources or factors of production to offer their services for use in productive activities. Factor supply relates price and quantity, specifically, factor supply is the range of factor quantities that are supplied at a range of factor prices. This is one half of the factor market. The other half is factor demand. The factors of production subject to factor supply include any and all of the four scarce resources--labor, capital, land, and entrepreneurship. However, because labor involves human beings directly, it is the factor that tends to receive the most scrutiny and analysis.
Factor supply is the supply side of the factor market, capturing the relation between the price and the quantity supplied of a factor. In general, a higher factor price induces an increase in the quantity supplied, while a lower price has the opposite effect.

Factor supply works much like the market supply of any good or service. Sellers, or factor owners, are enticed to offer a larger quantity for sale at a higher price. However, because the factors supplied are diverse (labor, capital, land, and entrepreneurship), so too are the principles underlying supply. In fact, some factors are produced goods with supplies governed by the same production and cost principles governing market supply, especially the law of diminishing marginal returns. Other factor supplies involve human resources and are governed by other principles, especially consumer demand theory.

A Word or Two About Four Factors

Factor supply includes all four factors of production. These four factors are exceedingly diverse. And while these four share a number of common factor supply traits, several differences also exist.

Consider a few features of the four factors.

  • Labor: The most important feature of labor is that the person cannot be separated from the resource. The satisfaction of the person (for good or bad) depends on the productive activity undertaken by the resource. This affects the wage a worker is willing to receive. It can also affect the decision to supply a larger or smaller quantity at a higher wage.

  • Capital: The primary feature of capital is that the supply and demand of capital services are often controlled by the same decision maker. The firms that own the capital goods are also the ones that use the productive services. This has implications for the factor supply of capital services, the market for capital goods, and the financing of capital investment.

  • Land: The key feature of land is that it provides two distinct types of productive services--space and materials. As space, land provides a place to locate productive assets, like factories, and the accessibility of that place to other locations. As materials, land provides firms with the raw materials used to produce output. As a result, the factor supply of space can be quite different than the factor supply of materials.

  • Entrepreneurship: Entrepreneurs, of course, are also people, meaning satisfaction is also associated with entrepreneurial activities. The central feature of entrepreneurship is the risk involved in organizing production. The factor supply of entrepreneurship is closely intertwined with risk, both in terms of what is being risked and how the entrepreneurs feel about the risk.

Factor Supply Curve

Factor Supply Curve
Factor Supply Curve
Factor supply is commonly represented by a factor supply curve, which graphically indicates the quantity of a factor that is supplied at alternative factor prices. While all factors of production, or scarce resources, including labor, capital, land, and entrepreneurship, have factor supply curves, labor is the factor most often analyzed. Like other supply curves, the factor supply curve tends to be positively sloped. Higher factor prices are associated with larger quantities supplied and lower factor prices go with smaller quantities supplied.

The exhibit to the right displays a typical factor supply curve. This particular curve is the supply of gourmet chefs in the greater Shady Valley metropolitan area. The number of chefs (labor) is measured on the horizontal axis and the wage paid per chef is measured on the vertical axis. This factor supply curve indicates that a $10 wage entices 2,000 chefs to supply their services, a $30 wage entices 4,000 chefs to supply their services, and a $50 wage entices 6,000 chefs to supply their services. The number of chefs willing and able to supply their productive services increases with the wage.

Marginal Factor Cost and Two Market Structures

The cost incurred by factors of production when offering their productive services is key to factor supply. This factor cost is also intertwined with the structure of the factor market.

Consider first factor cost. The key concept is marginal factor cost. This is the change in total factor cost resulting from a change in the quantity of input used. It is formally specified as:

marginal factor cost (MFC)=change in total factor cost
change in factor quantity
Marginal factor cost is different for different market structures, especially the structure on the buying side of the market. The two extremes are perfect competition and monopsony.
  • Perfect Competition: The benchmark is perfect competition, an extreme, idealized market structure in which participants have absolutely NO market control. Firms operating in this market structure epitomize price takers.

  • Monopsony: In direct contrast to perfect competition is monopsony. Monopsony is a market with a single buyer that has total market control over the demand-side of the market.
For perfect competition, marginal factor cost is constant and equal to the factor price paid for the input, both of which are constant. For monopsony, marginal factor cost is greater than the factor price, both of which increase with larger quantities of output. The constant or increasing nature of marginal revenue is a prime indication of the market control of a firm.

Factor Supply Determinants

Factor supply determinants are as diverse as the inputs included under the heading of factor supply. In particular, factor inputs include both produced goods as well as humans. The determinants underlying the factor supply of produced goods are like those of market supply. The determinants underlying the factor supply of human inputs are related to those of market demand.

With this in mind, the factor supply determinants fall into three general categories: (1) market supply determinants, (2) market demand determinants, and (3) mobility. Comparable to any determinant, those falling into these three categories cause the factor supply curve to shift to a new location. An increase in factor supply is a rightward shift of the factor supply curve and a decrease in factor supply is a leftward shift.

Gourmet Chef Employment
Gourmet Chef Employment

Consider how an increase in factor supply and a decrease in factor supply are illustrated in this diagram for gourmet chef employment. Click the [Increase] button to display an increase in factor supply. Obviously the factor supply curve shifts rightward. At each wage, at every wage, more gourmet chefs are willing and able to supply their services. Now click the [Decrease] button to display a decrease in factor supply. Here the factor supply curve shifts leftward. At each wage, at every wage, fewer gourmet chefs are willing and able to supply their services.

Factor supply determinants are ceteris paribus factors held constant when a factor supply curve is constructed. They fall into three categories: market supply, market demand, and mobility.

  • Market Supply Determinants: The five standard supply determinants--resource prices, technology, other prices, expectations, and number of sellers--are also important factor supply determinants, especially for produced factor inputs such as capital goods. These work on factor supply exactly as they work on market supply.

  • Market Demand Determinants: Because labor and entrepreneurship have human involvement, three of the five standard demand determinants--income, preferences, and other prices--are also worth noting as factor supply determinants. Most notable of the three, labor is usually considered an inferior "consumption" good, meaning an increase in income decreases factor supply and a decrease in income increases factor supply.

  • Mobility: Mobility is the ease with which resources or factors of production can move from one productive activity to another. Two types of mobility are geographic--the movement from one location to another--and occupational--the movement from one productive activity to another. An improvement in either mobility causes an increase in factor supply and a decline in either mobility causes a decrease in factor supply.

Supply Times Three

The study of factor supply involves three related, but often confused, phrases--supply by a firm, supply to a firm, and market supply.
  • Market Supply: The best place to begin is with market supply. Market supply is the total supply of every seller in a market willing and able to sell a good. It is the range of quantities that all sellers are willing and able to sell at a range of prices. As a generic concept, market supply can apply to any type of commodity, good, service, or resource. There is a market supply for a product like club sandwiches and for a resource like gourmet chefs.

  • Supply by a Firm: A second type of supply is that offered BY a firm. This is the notion of supply typically analyzed in the context of product markets. The analysis of perfect competition, monopoly, monopolistic competition, and oligopoly is concerned with supply by a firm, the supply of production. The key is that business firms are on the selling side of the market. Market control plays a key role in supply by a firm. With fewer sellers in a particular market, each has greater control over the supply by their firm. In the extreme case of a monopoly market with a single seller, the supply by a firm is also the market supply.

  • Supply to a Firm: A third type of supply is that offered TO a firm. This is the notion of supply that is most important to the discussion of factor markets. The commodities supplied to firms that are most important are factors of production. In this case, business firms are on the buying side of the market. Market control also plays a role in supply to a firm. However, in this case, firms are the buyers not the sellers. With fewer firms buying in a particular market, each has greater market control over the supply to their firm. In the extreme case of a monopsony market with a single buyer, the supply to a firm is also the market supply.

Other Supplies

Factor supply is one of several types of "supply" in the study of economics. When economists speak of "supply" with no modifiers, they are usually referring to "market supply." In addition to market supply and factor supply, two other types of supply include aggregate supply, which is the total production of final goods and services in the macroeconomy (that is, gross domestic product), and money supply, which is the quantity of money circulating around the economy.


Recommended Citation:

FACTOR SUPPLY, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2018. [Accessed: March 18, 2018].

Check Out These Related Terms...

     | factor supply curve | factor supply determinants | supply to a firm | supply by a firm | mobility | geographic mobility | occupational mobility |

Or For A Little Background...

     | factor market analysis | marginal factor cost | marginal physical product | marginal revenue | marginal factor cost curve | factors of production | law of diminishing marginal returns | law of diminishing marginal utility | market control |

And For Further Study...

     | marginal revenue product | factor demand | monopsony | bilateral monopoly | oligopsony | monopsonistic competition | market structures | aggregate supply | money supply | market supply |

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