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

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

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

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

• 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.

Factor Supply Determinants

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

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

• 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