Factor Market

A factor market is a resource market that allows business firms to purchase factors of production such as land, labor, and raw materials with which they produce goods and services. In simple words, it is a market for aspects of production.

For example, a pizza cafe is a product market selling finished products such as pizza. Likewise, the factor market would be selling pizza raw materials such as cheese, olives, etc., used for making a pizza. Together, they help understand the demand, supply, and prices of the finished products and factors of production.

• A factor market is where business firms purchase different resources or production factors needed to produce goods and services. Most business firms purchase these lucrative resources to offer goods and services to consumers.
• In simple words, it is a market for factors of production such as land, labor, and raw materials. Some examples of factor markets include a job fair, an owner selling his land to a shopping mall, or banks loaning money to entrepreneurs.
• As opposed to that, a product market is where consumers are offered goods and services produced by producers or firms. Hence, producers purchase factors of production from the factor market to deliver goods and services for consumers sold at the product market.
• The demand for the factors of production depends on the need for the finished products. Therefore, less demand for tea, labor, plantation plots, and leaves will also sink.

We know that the price of a finished product like tea depends on the market forces of demand vs supply. When the need for tea increases, its supply falls short; together, they escalate the tea price. The supply increases after the price rise to make most of it for higher profits.

The price of the production factors depends on the demand for the finished products. For example, if the price of houses is on the rise, the cost of cement will also increase. Similarly, tea leaves and plantation grounds will increase if tea gets expensive. As such, the demand of the factors of production is a derived demand dependent on the need for another item.

Let us look at some important aspects to understand how it's working. Below is a graphical representation of how a firm arrives at the labor wage it employs in perfect competition.

1. The wage is fixed at W, which is the equilibrium in the market based on the demand and supply of laborers. W becomes the wage rate, and every firm will be required to hire workers at this specific rate for a given industry, say tea plantation.
2. The supply curve is a straight line in the second image because the firms will hire the labor at one fixed rate. The fixed-rate will be MRC = MRP.
3. MRP is the additional revenue generated by each worker. MRC is the wage paid to each worker.
4. So, how many workers does a firm hire? As long as the MRP is greater than MRC, the firm can hire more workers. When MRP < MRC, the firm needs to stop hiring more workers.
5. Let us understand this with a simple example. The fixed-wage = $30. The price for one box of tea = $20

The firm will stop hiring after three because the 4th worker brings in marginal revenue of $20 while the company pays $30 in wages, which is higher. So, MRP = $20 and MRC = $30, which makes MRP < MRC. Also, the 5th one had negative productivity, so that option was gone anyway. As such, it should stop hiring after the 3rd point.

In the factor market, the demand for a factor of production is also dependent on the requirement of the firms. When there are recessionary conditions, the need for goods will be low; unemployment will be high, so the wages will probably fall. With this condition, most business firms will stop hiring and even lay off employees, which will reduce the demand for labor.

Remember the circular flow of income? In a circular flow of revenue, households provide factors of production to the firms. The firms employ these factors by paying rent, wages, and salaries in return. Using these factors of production, they produce goods and services. Households then purchase goods and services with the money paid by firms as wages or rent. That is how money flows in a circular motion in society. Both the markets of finished products and factors of production depict this circular flow of money.

Every person around the globe primarily takes part in a wide- range of factor markets. The simplest example can be the brands seeking a piece of land to set up their factories or showrooms. The land can be purchased or taken at lease from a household or the government if it is state-owned. Recently, smartphone giant Samsung Electronics decided to provide $492.31 million to set up a display unit in India. Another example is the job-seekers.

The product market is where goods and services are sold and bought, while the factor market is where different factors of production like land, capital, and labor are bought and sold.

#1 - Product market 

• Different business firms offer goods and services for sale to consumers.
• They acquire factors of production such as land, machinery, raw materials, labor, etc., to produce goods and services.
• The needs and wants of the consumers are fulfilled in the product market.
• Examples include the farmers market, Amazon selling various products, a Lenovo showroom, a bakery, a movie theatre, etc.

#2 - Factor markets  

• It is a great place where all production factors such as capital, labor, and land are sold and purchased.
• In most scenarios, the demand for money and work is usually derived. Business firms mainly employ more workers with extensive needs for their manufacturing products. For example, whenever the demand for takeaway tacos increases, the company will be forced to hire more workers.
• Some examples of factor markets include – a community leasing out its community land to a builder of a shopping complex, listing out vacancies for labor and workers, a bank lending capital to entrepreneurs, etc.

This article has been a guide to factor market in economics and its definition. Here, we discuss factor market vs product market and how it works with an example. You can learn more from the following articles: -

• Infant Industry Argument
• Market Failure
• Currency Market
• Commodity Market