The demand for a factor of production is said to be derived demand because 1. It is a function of the profitability of an enterprise 2. It depends on the supply of complementary factors 3. It stems from the demand for the final product 4. It arises out of means being scarce in relation to wants Which of the above reasons is/are correct ?
- (a)1 only
- (b)3 only
- (c)2 and 4 only
- (d)1, 2, 3 and 4
Answer
Why
Correct — B, (b) 3 only.
Read what the stem actually asks. It does not ask what determines the demand for a factor of production; it asks why that demand is CALLED a derived demand. The word 'because' ties every numbered reason to the NAME, and only one of the four reasons explains the name.
REASON 3 — 'It stems from the demand for the final product.' THIS IS THE DEFINITION. A factor of production is not wanted for itself. Nobody desires an hour of a weaver's labour, a bale of raw cotton or the use of a loom for the satisfaction it gives; each is wanted only because cloth is wanted. The demand for the factor is therefore DERIVED FROM the demand for the good it helps to produce, and that is the whole content of the term. If the demand for cloth disappears, the demand for weavers disappears with it, however productive or however cheap they may be.
REASON 1 — 'It is a function of the profitability of an enterprise.' Not the reason for the name. Profitability influences how much a firm can and will hire, but the term 'derived demand' is not about the firm's financial position at all. It is about the SOURCE of the want. Even a firm making large profits will stop hiring weavers if nobody wants cloth, and a firm making thin profits will keep hiring them if cloth sells.
REASON 2 — 'It depends on the supply of complementary factors.' TRUE as a statement about factor demand, and this is the trap. Factors are used together, so the availability of complements genuinely affects how much of any one factor a firm wants — a shortage of looms limits the demand for weavers. But that is a DETERMINANT of the quantity demanded, not the reason the demand is called derived. Being true and being the answer are different things, and this statement is the reason the option 'is/are correct' is phrased in the singular as well as the plural.
REASON 4 — 'It arises out of means being scarce in relation to wants.' This is the definition of the ECONOMIC PROBLEM itself — scarcity of means relative to unlimited wants — and it is true of every demand in economics, for final goods as much as for factors. A statement true of all demand cannot explain why one particular kind of demand carries a special name. It is a real definition placed where it does not answer the question.
Only reason 3 explains the term, so the answer is option (b). The stem's opening clause ends on 'because' with no punctuation, the four reasons follow, and the question sentence — 'Which of the above reasons is/are correct ?' — comes AFTER them, with no line inviting the candidate to select from codes given below. That layout is used on about a dozen items of this booklet and is not a defect.
Why the others are wrong
- (a)1 only — This selects profitability as the explanation of the term. It confuses the CAPACITY to hire with the SOURCE of the want. Profit does enter factor demand, but through a different door: a firm hires a factor up to the point where the value of its marginal product equals its price, and that calculation is about the revenue the factor generates, not about the firm's overall profitability. A firm's existing profits are the result of past decisions; the demand for a factor looks forward to what can be sold. The name 'derived demand' points at the product market, and this reason does not.
- (c)2 and 4 only — This picks the two statements that are true in themselves and false as answers, and drops the one that is the definition. Complementarity between factors is a genuine determinant of factor demand, and scarcity of means relative to wants is a genuine definition — of economics itself, not of derived demand. Choosing both is the characteristic error on 'because' questions: the candidate has checked each statement for TRUTH and never checked it against the ASK. Reason 4 in particular applies to the demand for bread just as much as to the demand for bakers, so it cannot be what distinguishes factor demand from any other.
- (d)1, 2, 3 and 4 — The all-inclusive option, and it fails because two of the four reasons are simply not reasons for the name and one is not correct as stated. It is the landing place for a candidate who reads a list of economically respectable sentences and cannot see a basis for rejecting any of them. The basis is the stem's own word: 'because'. Each numbered item is offered as an explanation of why the demand for a factor is called DERIVED, and an item that is true of all demand, or that describes a determinant rather than an origin, does not explain anything about the name.
Concept
DERIVED DEMAND is one of the small number of terms that organise the whole of factor-market economics.
THE DEFINITION. The demand for a factor of production is derived from the demand for the goods and services the factor helps to produce. Factors are wanted instrumentally; final goods are wanted directly. This is why the demand curve for labour is called the MARGINAL REVENUE PRODUCT curve — the value the factor adds is the revenue from the extra output it produces, so the product's price is built into the factor's demand curve.
THE CONSEQUENCES, which are what questions ask about. Factor demand moves WITH product demand. A collapse in the demand for a good becomes unemployment among those who make it, and no adjustment in the wage can prevent that entirely. Factor demand is a demand for a FLOW OF SERVICES, not usually for the factor itself. A firm hires labour hours and rents premises. The ELASTICITY of derived demand depends on the elasticity of demand for the final product, on the ease of substituting other factors, on the share of the factor in total cost, and on the elasticity of supply of the other factors. Where a factor accounts for a small share of the cost of the final good, the derived demand for it tends to be inelastic — the point sometimes called the importance of being unimportant.
DERIVED DEMAND IS NOT ONLY ABOUT FACTORS. The demand for any intermediate good is derived: the demand for cement comes from the demand for buildings, the demand for steel from the demand for vehicles and structures. The concept is the same wherever a thing is wanted for what it makes possible rather than for itself.
For an organisation administering social security this is more than a definition. Contributions are levied on wages, wages are paid out of employment, and employment is a derived demand. So contribution receipts follow the product market with a lag, and a downturn in output arrives at the fund as a fall in the wage bill.
Terminology items are the backbone of this paper's economy strand, and this one is unusually well built because three of its four reasons are respectable economics. It cannot be answered by rejecting nonsense; it has to be answered by holding the definition of the term in mind and testing each reason against it.
The key structural feature is the word 'because' at the end of the opening clause. It converts every numbered item from a statement into a proposed EXPLANATION, and that raises the bar: an item now has to be both true and explanatory. Reason 2 passes the first test and fails the second, and it is placed there precisely to catch a candidate who is only applying the first.
The layout is one of the paper's variants. The question sentence follows the numbered list — 'Which of the above reasons is/are correct ?' — and there is no 'Select the correct answer using the codes given below' line. About a dozen items on this booklet are set this way, and some of them offer 'Both 1 and 2' or 'Neither 1 nor 2' instead of numeric codes. Nothing is missing from the page. The singular-and-plural phrasing 'is/are', printed with a solidus and no spaces, is a further signal: the answer may be a single reason, and here it is.
The item pairs naturally with the preceding question on the theory of distribution. That one asks what distribution theory is about; this one asks about the demand side of the same theory.
Key facts
- Derived demand means the demand for a factor of production arises from the demand for the good or service it helps to produce; factors are wanted instrumentally, final goods directly.
- The demand curve for a factor is its marginal revenue product curve, so the price of the final product is built into the factor's demand.
- A firm hires a factor up to the point where the value of its marginal product equals its price.
- Complementarity between factors is a genuine determinant of the QUANTITY of a factor demanded, but it is not why the demand is called derived.
- Scarcity of means relative to unlimited wants is the definition of the economic problem and is true of every demand, not only of factor demand.
- The elasticity of derived demand depends on the elasticity of demand for the final product, the ease of factor substitution, the factor's share in total cost, and the elasticity of supply of other factors.
- The demand for any intermediate good is also derived — cement from buildings, steel from vehicles and structures.
Study next
Common traps
- Judging each numbered item only for truth. The stem's 'because' requires each item to explain the NAME, not merely to be a correct statement about factor demand.
- Accepting complementarity of factors. It affects how much of a factor is demanded but says nothing about where the demand comes from.
- Accepting the scarcity statement. It is the definition of economics and is true of the demand for final goods as well, so it cannot distinguish derived demand.
- Confusing profitability with the source of demand. A profitable firm stops hiring when its product stops selling, which is the whole point of the term.
Concept items in the economy strand are frequently set as 'X is called Y because' followed by three or four candidate reasons, and the discrimination is between the DEFINITION and the DETERMINANTS. The examiner supplies at least one statement that is true and irrelevant, and often one that is a correct definition of some other concept. When you meet the construction, write the term's definition in your own words before reading any numbered item, then test each item against the definition rather than against your general sense of economics. Expect derived demand, elasticity, opportunity cost, economic rent and inferior goods to be treated this way, and expect the 'is/are correct' phrasing to be a genuine hint that a single item may be the whole answer.
Related PYQs
EPFO_APFC_2016_Q47Which of the following statements best describes the content of the theory of distribution ?
- (a) The distribution of income among different individuals in the economy
- (b) The distribution of income between the Centre and the State Governments
- (c) The principle of just distribution of wealth and income
- (d) The distribution of income between the owners of factor resources
Answer(d) The distribution of income between the owners of factor resources
The theory of distribution — this item supplies the demand side of that theory, since factor pricing depends on a demand that comes from the product market.
EPFO_APFC_2016_Q31Transportation plays a great role in any economy. Which of the following modes of transportation has the highest elasticity ?
- (a) Air
- (b) Rail
- (c) Road
- (d) Water
Answer(c) Road
The transport-elasticity item, answered by the same discipline of stating a technical term's meaning before reading the options rather than after.
Practice
- practice — not a real PYQ
The demand for cement by a construction firm is an example of
- (a)autonomous demand
- (b)derived demand
- (c)composite demand
- (d)joint demand
Answer(b) derived demand — cement is wanted not for itself but for the buildings it makes possible, so the demand for it comes from the demand for construction. The same reasoning applies to every intermediate good and to every factor of production.
- practice — not a real PYQ
Other things being equal, the demand for a factor of production is likely to be LEAST elastic when
- (a)the factor accounts for a very small share of the total cost of the final product
- (b)close substitutes for the factor are readily available
- (c)the demand for the final product is highly elastic
- (d)the supply of complementary factors is highly elastic
Answer(a) the factor accounts for a very small share of the total cost of the final product — a rise in its price then changes the final price very little, so very little demand is lost. This is the result sometimes called the importance of being unimportant. Ready substitutes and an elastic product demand both make derived demand MORE elastic.