The Capital stands for machinery, equipment, buildings and other tools which are used in the production of goods and services. In economics, as a factor of production, the capital refers to the physical capital, not to the financial capital. Although money is not a factor of production, firms often use credits to buy or hire the capital they use for production, and pay interest in return. Even if they use their own funds, the opportunity cost of using them is the interest foregone. So, the compensation for the use of capital is interest.

the demand for a factor of production is called “derived demand”, in the sense that it is derived from the demand and supply interaction in the market for the good or service it is used for.

The relationship between the factors of production that a firm uses and the output it produces is called a firm’s production function. A typical production function can be expressed as: Q = TP = f (K, L, N)

Here, Q stands for Quantity Output and TP stands for Total Product. When talking about production, these two terms can be used interchangeably. K means physical capital, L means labor and N means land (or natural resources).

A labor demand curve shows the number of workers firms are willing and able to hire at different wages.    If the labor market is competitive, the firm is a price-taker and can hire as many workers as it likes at the current wage.

Market Price: As you recall, marginal revenue product of labor is shown with the equation of: P*MPL = MRPL. In the equation, P stands for the market price of the good or service the firm produces. if the market price for the good that it produces drops, labor demand of the firm decreases as well. This means less employment at a given wage.

Prices of other Factors of Production: In the short run, we assume the other factors of production cannot be changed. However, if capital or land becomes cheaper relative to labor, in the long run firms may decide to employ more of them and less of labor, and vice versa. It is also possible to compare the methods of production in a developed country where the physical capital is relatively cheaper and a those in a developing country where the labor is relatively cheaper.

The workers have a different decision to make. If a worker chooses to work, s/he earns wages. However, work is (usually) not much fun and s/he gets tired, feels stress and pressure at work.

The law of demand applies in labor markets this way: A higher salary or wage that is, a higher price in the labor market. At a given wage level, each firm has a certain level of demand for labor. Adding up the labor demand by all individual firms, we find the market demand for labor for each wage level.

Population in a country or an area can change for many reasons. During peacetime, almost all countries see increases in their population. As the newborn babies grow and reach working age, they enter the market, increasing labor supply.

Immigration is another reason for population change. When people immigrate into a country, some of them enter the labor force and increase the number of workers willing to supply their labor at a given wage rage. Similarly, migrations from a country or an area (due to war, famine, crime etc.) causes a drop in the number of available workers and shifts the labor supply curve left.

if wages are as low, workers do not want to work that much but firms demand more workers. So, there will be excess demand and the wage will increase. Wage  is the equilibrium or market-clearing wage where labor demand is equal to labor supply.

Capital market builts a  bridege  in mobilizing resources and diverting them in productive channels. It facilitates and encourages the procedure of economic growth in the country. Functions of capital market include linking between savers and investors.   it has been shown that those hiring decisions also determine how much labor to use during the production process and how much a worker is paid. While businesses are deciding on the optimum quantity of labor in the production of their goods and services, they should also decide on the quantities of other inputs to production simultaneously.

When analyzing your business or a potential investment, it is important for you to know and understand the three categories of financial capital: equity capital, debt capital, and specialty capital. These catagories  of financial capital consist of the funds that firms use to buy and operate capital. A financial market is where businesses get the funds that they use to buy capital. In a financial market, while firms are the demanders of the funds, people are the savers and ready to lend their sacrificed consumption, in other words, their savings. Financial markets are the channels through which firms borrow financial resources to buy capital.

What are the reasons that might cause changes in the demand for capital? To answer this question, we should look for reasons other than interest rate changes, because changes in interest rate is not going to cause changes in the demand for capital. In fact, we stay on the same demand curve. Thus, talking about demand changers means that the demand curve should shift to the right or left. Since the demand for capital reflects the marginal revenue product of capital, anything that influences the marginal revenue product of capital will affect the demand for capital.

The interest rate, in macroeconomics, is often determined in the framework of total money supply and total money demand for an economy. However, since we focus on microeconomics, we should rather consider a micro-based theory of interest rate. Specifically, the loanable funds theory of interest explains the interest rate not in terms of the total supply of and demand for money but, rather, in terms of the supply of and demand for funds available for lending and borrowing.

The interest rate is determined by the forces of demand and supply in a market called the loanable funds market in which borrowers (demanders of funds) and lenders (suppliers of funds) encounter. To understand the role that the interest rate plays in the demand for capital, it is proper to assume that there is no difference in prevailing interest rates that specific consumers and firms face in the economy.

Funds are supplied to the loanable funds market by lenders (savers) those who are households or businesses that in order to have more available funds in the future, they are willing to give up some current use of them. Generally, lending option is preferred as the interest rates increase. However, compared to the firms, the decision of consumers about saving should be analyzed more deeply.

Economists think that when households make their consumption choice at any point of their life, they consider the stream of income over their lifetimes not the current income they have. This means that households’ consumption possibilities are defined by the expected income. Thus, consumers make the decision of whether to spend less of their expected income now in the hope that they will have more available income to spend in the future or to consume more now by borrowing against their future income.

Since the purchase of new capital is usually financed in the loanable funds market, a change in the demand for loanable funds follows a change in the demand for capital, and that influences the interest rate. A change in the interest rate, in turn, impacts the quantity of capital demanded on any demand curve. Therefore, the relationship between the demand for capital and the loanable funds market goes both ways. Changes in the demand for capital impacts the loanable funds market, and changes in the loanable funds market can alter the quantity of capital demanded.

The effect of an increase in interest rates on saving is ambiguous. An increase in interest rates causes saving to increase due to substitution effect but to decrease due to income effect. Since both effects work in opposite directions, the total effect is ambiguous.

Individuals may go to credit market to borrow whenever they realize a temporary decline in their current income, assuming that they expect their income to go back to normal later on. Both consumer and business demand more loans as the interest rate decreases and demand less as the interest rate goes up. When we add together the demand of the households and businesses for loanable funds.

Tax policies applied by the government can affect the price of the capital indirectly. For instance, assume the government decreases the tax rate on firms’ profit if they increase their expenses on capital. Such a policy would effectively lower the price of capital, causing firms to substitute capital for other factors of production and increasing the demand for capital.

Like all other factors of production, the price of land which is land rent is determined in the land market. Thus, we can use supply and demand analysis to determine the equilibrium price of a specific land. The following assumptions related to the land market are made for the purpose of analysis. First of all, there is no quality differences between any acres of land, meaning that each acre of land is productive as every other acre. Secondly, all land is used just for one purpose, for example, producing carrots. Finally, the land is rented or leased in a competitive market.