DEMAND OF A FACTOR

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Factor demand is a derived demand. It is derived from demand for products that factors are used to produce.

Marginal Revenue Product (MRP)

The marginal revenue product, MRP, is the the additional revenue generated by employing an additional unit of a factor.

MRP = change in total revenue / change in the quantity of the factor

Since   change in total revenue/ change in quantity of output = Marginal revenue (MR); and

             change in the quantity of output/change in quantity of a factor= Marginal product (MP). Then:

MRP = MR X MP

Value of Marginal Product (VMP)

VMP equals to price (P) of a unit of output  multiplied by the marginal product (MP) of the factor of product.

VMP = P X MP

In perfect competition: P = MR, therefore, MRP = VMP

As stated in the law of diminishing returns, MP will eventually decrease as the quantity of factor increases in the short run. On the other hand, MR in non-perfect competitive market is also downward sloping. Therefore, MRP and VMP are downward sloping. The marginal revenue generated by each factor and the factor's per unit cost (factor price) determine the quantity of factor demanded by a firm. The factor demand curve is downward sloping. As the price of a factor increases, less factor will be demanded.

To maximize profit, a firm hires up to the point at which the MRP (VMP in Perfect competition) equals the factor price.

Hiring rule: 

MRP > P of the factor: firm should continue to hire more factors.

MRP = P of the factor: firm should stop hiring at the unit of factor.

MRP < P of the factor: firm should reduce the quantity of factors.

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