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Factor Market – Defination, Principles, Types, And More


The factor market oversees the sale and purchase of the goods used in the large production of the mean company. Therefore, it is called the factor market. Generally, we find anything in the market and buy it by looking at the price. But before a product comes to the market, there is a lot of work after the product will make, factoring in how to price it correctly and where to sell it.

Difference Between Product and Factor Market

One of the heavy lines of distinction between the two types of markets is the ability to separate primary functions. While product market goods serve as the main factor of production, the factor market is a scenario in which goods will replace the investment and labour cost incurred to purchase raw materials. The overall relationship between the product and factor markets focuses more on consumers’ demand for productive resources.

What Are The Basic Principles Of Factor Market?

Ideally, factor markets are the essential requirement of the hour. Everything we see or do today closely connects to the factor market scenario. Every person working today is a part of the total factor market. It forms an interweaving chain of factor markets – from wages to employees, dividends, households, businesses to everyone else. All these features mentioned above and the combination of various goods and services make a secure loop in which money flows easily. The entire relationship of the factor market will base on the simple rules of supply and

In this ever-growing economy, as the demand for labour increases, so does the cost of wages. In short, the firm’s workforce increases when there is an increasing demand for a product. However, in adverse situations such as recession and a declining economy, companies cut costs, freeze, and consumer demand for goods also falls rapidly.

Why Does The Current Market Scenario Depend On The Factor Market?

The main factor that sets the market apart from others is that it operates only on derived demand activity. When the demand for derived goods and services increases, the factor market also increases exponentially. The factor market has more influence in the current market scenario as the consumer base constantly expands. Today people depend more on essential goods and services for their needs.

Several types of constructs describe markets for production factors, described below.

The Perfectly Competitive Factor Market

The Competitive Factors Market is a market with an expressive number of sellers and buyers for a given production factor, which can be a raw material or a labour factor.

However, factor prices cannot determine either sellers or buyers, so they become price takers.

Demand curves for factors of production in the competitive market exhibit a downward slope. Where this demand for factors is derived, therefore, depends (and does) on the level of output of a firm and the costs of its inputs. For subsequent analysis, we can assign that the company obtains its production using two inputs, K (capital) and L (labour), which can contract in due order at prices r (capital rental cost) and w  (labour remuneration).

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A Shift in the Labor Supply

When the job offer faced by such a company is S1, the company will hire L1 units of Work for the remuneration w1. However, the supply curve can shift. In this way, the firm maximizes its profits by moving along the labour curve until the new income (w2) will equal the revenue from the marginal product of labour. As a result, more work units will hire the company. (indicated in L2). If the demand curve shifts upwards, there would be an increase in the price of workers’ wages, which would consequently lead to a reduction in the number of hired workers. (according to w3)

The Sector’s Demand For Work

For the sector’s demand for labour, the labour demand curve of a competitive firm (RMgPL) assumes that the price of the product does not change. However, demonstrating in values, as the remuneration of labour falls, for example, from $30 to $20 per hour, the product’s price will also show a reduction.

The Backward Bend Job Offer

If labour is the input, it will not be the companies determining the quantity supply but the workers. So we see that the labour supply curve generally has an upward slope. However, this curve can also curve backwards when a higher return may result in a lower labour supply.

The explanation for this backward curve is that a worker with a ‘high’ return has greater purchasing power; that is, the worker can spend more on leisure. In such a way, he can choose to work less time to have more peace because his remuneration allows such a choice.

To exemplify, we have a confectioner who has set the goal of producing 100 sweets and selling them daily. If the candy price goes from $5 to $10, she will have to pay/sell a smaller amount of candy to reach her daily goal. Therefore, she will need to spend less time working and use the rest for her leisure.

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 Factor Markets Where Buyers Of Such Factors Have Monopsony Power

For the monopsonist factor market, when the quantity of a product to be purchased will establish, that quantity will increase until the additional value of the latter, its marginal value is equal to its cost, that is, its marginal expense.

The factor supply curve for the monopsonist is the market supply curve. That is, the curve showing the input quantities in the case of the example, the Work that the suppliers are willing to sell as the price progressively increases. Since the monopsonist pays the same amount for each unit, the supply curve will be the average expenditure curve. In such a way, this curve has an upward slope, as the choice to buy more units increases the price to be paid – for all of them.

The Acquisition Decision with the Power of Monopsony

As explained earlier, the monopsonist hires L* units of Work, thus DMg=RMgPL. Workers’ income (w*) will find the point under the average expenditure curve or the supply curve with L* Work units.

Factor Markets Where Factor Sellers Have Monopoly Power.

In the case of a monopolistic factor market, the producer sets the price of the product. The most critical example of monopoly power in the factor market comes from the labour unions, so that the explanation will base on this example.

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Monopoly Power of Labour Suppliers

When a labour union is a monopolist, it is inclined to choose to supply at points on the labour buyers’ demand curve (DL). In such a way, the seller can maximize the number of hired workers (L*) by agreeing that the workers admit the given income (w*). The amount of work L1 that will maximize the income employed workers will receive will determine the intersection between the marginal revenue and labour supply curves. In such a way. The members of that union will then be receiving remuneration w1. Therefore, if the league wants to maximize the total value of the wages paid to its workers, it must allow an L2 number of unionized workers to accept jobs at wage w2. Consequently,


In this way, if the company hires a certain number of workers and wants to know whether it would be helpful to hire an additional worker. It will have the answer if the additional revenue resulting from the production of this hired worker is greater than the cost. This additional revenue from production is called the revenue from the marginal product of labour and will denot RMgPL. The price for this complementary unit of Work will give. That is, it is the remuneration of the Work. Therefore, if the RMgPL is greater than or equal to w, it is beneficial for the company to hire this worker.

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