What Is a Factor Market?
The term factor market refers to all the resources that businesses buy, rent, or hire to produce goods and services. These resources, known as factors of production, include raw materials, land, labor, and capital. In essence, the factor market is instrumental for obtaining the required inputs for economic activities.
The factor market is sometimes termed the input market. By this definition, all markets are either factor markets or goods and services markets, where consumers make their purchases. Here’s a breakdown:
- Markets are divided into factor markets (input markets) and goods and services markets (output markets).
- Factor markets supply the resources needed to produce finished products.
- Output markets are where these finished products are purchased and utilized.
- The demand in the goods and services market drives the factor market.
Understanding a Factor Market
Viewed as an input market, the factor market contrasts with the output market, which deals with finished products or services. Observing this, we see a closed-loop system where:
- In the factor market, households are sellers, and businesses are buyers.
- In the goods and services market, businesses are sellers, and households are buyers.
When individuals offer their labor for employment, they participate in the factor market. Similarly, job seekers are actively engaging with the factor market. Wages from employment contribute to the factor market but are typically spent in the goods and services market, completing the economic cycle. Moreover, businesses draw essential resources from the factor market, such as steel and plastic for appliance manufacturing.
Flow of a Factor Market
The closed-loop formation of factor markets and goods and services markets facilitates the flow of money. Here’s how it works:
Households supply labor to businesses, which compensate them with wages. These wages are then used to buy goods and services, initiating demand in the goods market. Businesses responding to this demand purchase more input resources from the factor market, perpetuating the cycle. When consumer demand rises, factor market production ramps up to keep pace.
Free Markets in a Factor Economy
The factor market is vital in a market economy, distinguishing it from socialist economies where central planning replaces free markets. In a market economy there are three core components:
- Factor Market: Supplies necessary resources for production.
- Consumers Market: Where consumers purchase goods and services.
- Producers: The companies that create products using resources from the factor market.
Monopoly and Monopsony in the Factor Economy
Monopolies and monopsonies illustrate significant market failures in factor economies. A monopoly features a single producer meeting the needs of many buyers, while a monopsony has many producers but only one buyer. Both disrupt the balance by inhibiting competition, essential for efficient market operations.
In particular, the labor market is adversely affected by local monopsonies, where a single employer’s dominance reduces employees’ bargaining power and choice. A monopoly in the factor market stifles the drive for innovation and better pricing, impacting the competitive equilibrium.
Factor Market FAQs
Here are insights into common questions about the factor market:
Why Are Factor Markets Important?
A market economy thrives on a synergistic relationship between three components: the factor market, the goods and services market, and the businesses. The factor market provides resources to businesses, which in turn produce and sell goods that fulfill consumer demand. This cycle sustains economic momentum, driven by derived demand.
How Do Supply and Demand Impact Factor Markets?
The factor market is inherently influenced by demand in the product market. Resources are procured and produced to align with the market’s needs. Essentially, the consumer market dictates activity within the factor market.
What Transactions Take Place in a Factor Market?
Within the factor market, businesses are primary buyers, securing raw materials, land, labor, and other necessary resources. Sellers range from raw material producers to individuals offering labor. Every jobholder is a part of the factor market, with their skills and labor constituting essential market products.
What Are the Types of Factor Market?
Economists classify the factor market into four main categories:
- Labor Market: Where laborers offer their services for hire.
- Capital Market: Provision of capital via loans and investments.
- Land Market: Encompassing all natural resources available for production.
- Entrepreneurship: Creators of businesses and innovation.
These categories together form the factors of production vital for any economy’s functioning.
Related Terms: economics, supply and demand, labor market, capital market, monopoly, monopsony.
References
- Higher Rock Education. “Factor Market”.
- Your Article Library. “How to Determine the Factor Prices under Monopsony Market”.
- Economics Help. “Derived Demand”.
