Hot dogs provide us with satisfaction, or what economists refer to as ‘utility’. We use this concept when we attempt to explain how many hot dogs will be purchased. We know that price has a negative effect on the consumption of hot dogs. We also know that tastes and preferences, income, the price of substitute and complementary goods, and population also effect demand. We use this model extensively to determine demand for all consumer goods.
We have to use a slightly different model when we try to determine the demand for factors of production; those goods and services that do not directly satisfy wants. For example, a Reuters article out of the UK suggests that Tiger Woods will play the Abu Dhabi Championship instead of his usual appearance at Torrey Pines. The purse for the Abu Dhabi tournament is $2.7 million and other reports and blogs have suggested that Tiger will earn around $3 million before he plays his first shot. Love him or hate him, Tiger’s presence at a tournament increases ticket sales and television audiences. This increases the revenue of the producer or promoter. The demand for an input depends on how much revenue that input can produce. In Tiger’s case, the promoters of the tournament must expect an increase in revenues in excess of $3 million (assuming that number is correct) just because Tiger is playing in the tournament. Tiger is an input in this case.
Another story from Bloomberg is a little more complicated. Rising world incomes and the push for ethanol based fuels has increase the demand and price of food, particularly corn and soybeans. The increase in price is a signal for farmers to grow more of these crops. With revenues per acre rising, the value of farm land is increasing. The value of land is determined much the same way that Tiger is valued. The more revenue it can produce, the more it gets paid. Farmers that want to grow more corn and soybeans can use more land, more equipment (capital) or more of both. Labour plays a small role in modern agriculture. Purchasing and cultivating more land is not usually a short term option due to the relatively fixed supply of arable land. In the short run, using land more extensively is not an option. Using land more intensively – getting more output per acre – is a valid short term supply response to rising prices. To get land to be more productive, a farmer must apply more capital. The demand for farm equipment depends upon the price of the products that the equipment will be used to produce. An increase in food prices leads to an increase in the demand for farm equipment, which leads to an increase in revenues for farm equipment producers. Deere & Co., the maker of the infamous green and yellow John Deere tractors, recently reported profits that vastly exceeded analysts’ estimates.
The theory of demand for consumer goods and services is based on utility maximization. The theory of demand for inputs, or factors of production, is based on profit maximization and the two theories are slightly different. An understanding of the demand for factor inputs makes it possible to explain why Tiger gets $3 million to plays a tournament and why Deere & Co. can make large profits when food prices are rising.
Michael S. Leonard
Kwantlen Polytechnic University