Other Factors of Production: Land and Capital - Online Tutor, Practice Problems & Exam Prep

In production economics, land, labor, and capital are key factors. Land earns rent and has a perfectly inelastic supply due to its fixed nature, while its demand is represented by the marginal revenue product (MRP) curve. Capital, on the other hand, is physical assets like factories and equipment, with an upward-sloping supply curve influenced by rental prices. Both factors follow the same logic of MRP determining demand, leading to equilibrium rental rates. Understanding these concepts is crucial for analyzing market dynamics and economic profits.

Other Factors of Production: Land

Alright, so we've spent most of our time talking about labor as a factor of production. Now let's extend our discussion to land and capital as well. First, let's think about how each of these makes money. Labor earns wages, right? When we had labor, we were earning wages. Well, land earns rent, and guess what? Capital also earns rent.

Let's start here with land. Remember that land is not just the physical land on the Earth but also includes natural resources such as forests, oil deposits, and similar assets, which are considered part of the land category. Let's start with the demand for land: it's going to depend on the value that the firm can earn from the land. This is similar to labor. Just like we had our Marginal Revenue Product (MRP) for labor, there's going to be an MRP for land. If we acquire one more unit of land, how much more revenue are we going to make? That's the marginal revenue product of land.

Now we're talking marginal revenue product of land. So, if we bought a little more land, how much more revenue will we make? What we're going to see is that the demand curve for land is the MRP curve for land. The MRP curve for land is the demand curve for land.

Now let's think about the supply of land. The supply of land is mostly fixed. We've got this famous saying by Will Rogers, also echoed by Mark Twain: "You should buy land. They ain't making any more of the stuff." Since there's a fixed amount of land, when we have a fixed quantity of something, there's only going to be one quantity regardless of the price. What situation was that? Was that elastic, inelastic, perfectly inelastic, perfectly elastic? On the graph, we'd see that the supply curve is perfectly inelastic. Remember, when we're inelastic, the curve stands straight up, while perfectly elastic means the curve is lying flat. Generally, we're going to see a straight up-and-down curve when we talk about the supply of land. There's only so much land, and it can be sold at any price.

This is how we'll see it on the graph: the downward demand represents the MRP for land, which is equal to the demand curve. We could do a production schedule just like we did with labor. If we have 1 acre of land, how much will we produce? With 2 acres? With 3 acres?

We're going to get these MRPs for land, and this will make the demand curve. So we've got a supply and a demand. We're going to have an equilibrium right here, and this is going to be the rental rate of the land at this point, and this would be the quantity of land which is fixed. Cool?

Alright, so that one's pretty simple. We've got that supply which is fixed, fixed downward demand, and we find our equilibrium. Let's pause here. In the next video, let's talk about capital.

Other Factors of Production: Capital

Alright, let's continue here with capital. Remember, this is physical capital, not human capital. Physical capital includes factories and equipment used to make our products. Alright. So let's start here with the demand curve. This follows the same logic that we saw with labor and we saw with land. The demand curve is the MRP. Let me go red. The MRP, whoops. MRR. MRP for capital. Right? MRP of capital. And how about the supply? Well, the supply curve for capital, it's going to be upward sloping. This isn't going to be like land where there's a fixed amount, right? The supply of capital is going to depend on what the going rent of the capital is. So we're going to see that we have an upward sloping supply curve in this case. Okay. It's upward sloping. So as the rental price increases, the supply is also going to increase, right? That supply is going to increase as well. Alright. So we've got that standard looking graph, right? We've got that x that we're used to and we've got going down the MRP of capital, I'll put MRP of cap and that is our demand curve. Alright? So just like we did with labor or just like we could do with land, right, if we had one more unit of capital, how much extra revenue are we going to get, right? We could have a marginal product of capital and then use that marginal product to calculate MRP, so it follows all the same logic that we've done with labor where we have our production function and we get our MRP. So MRP of capital and then we've got our upward sloping, we've got our supply of capital right here. Right? This is going to be the supply and we find some equilibrium. This would be the equilibrium rent, right here would be the rental rate, and this would be the quantity of capital right there. Cool? So pretty straightforward stuff. So that's about it here. Let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What is the difference between the supply curves of land and capital?

The supply curve of land is perfectly inelastic because the quantity of land is fixed; no matter the price, the amount of land available does not change. This is represented by a vertical supply curve. In contrast, the supply curve of capital is upward sloping, meaning that as the rental price of capital increases, the quantity of capital supplied also increases. This is because capital, such as factories and equipment, can be produced or acquired in response to higher rental prices, unlike land which is finite.

How is the demand for land determined in production economics?

The demand for land in production economics is determined by its marginal revenue product (MRP). The MRP of land is the additional revenue a firm earns from using one more unit of land. This concept is similar to the MRP of labor. The demand curve for land is essentially the MRP curve, indicating how much more revenue a firm can generate with additional land. Firms will demand land up to the point where the MRP equals the rental rate of the land.

What factors influence the rental rate of capital?

The rental rate of capital is influenced by the demand and supply of capital. The demand for capital is determined by its marginal revenue product (MRP), which is the additional revenue generated from using one more unit of capital. The supply of capital is upward sloping, meaning that as the rental price increases, more capital becomes available. The equilibrium rental rate is found where the MRP of capital (demand) intersects with the supply curve of capital.

Why is the supply of land considered perfectly inelastic?

The supply of land is considered perfectly inelastic because the total quantity of land is fixed and cannot be increased or decreased in response to changes in price. This is represented by a vertical supply curve. Famous sayings like 'buy land, they aren't making any more of it' highlight this fixed nature. Regardless of the rental rate, the amount of land available remains constant, making its supply perfectly inelastic.

How do firms determine the optimal amount of capital to use?

Firms determine the optimal amount of capital to use by analyzing the marginal revenue product (MRP) of capital. The MRP of capital is the additional revenue generated from using one more unit of capital. Firms will continue to invest in capital until the MRP equals the rental rate of capital. This ensures that the cost of renting additional capital is justified by the revenue it generates, leading to profit maximization.