A factor market is a market where means, or factors, of production are exchanged. Another term for factor market is input market. Typically, companies will buy and sell the resources that they need to produce goods and services for their end-users.
The price at which companies or individuals purchase resources from the factor market is known as factor prices, which are paid in factor payments. Also, factor markets are different from product markets, which are where finished products or services are sold to end-users. Whereas in the factor market, it is typically a business-to-business transaction, in the product market, it is typically a business-to-person transaction.
Additionally, it is important to note that the labor market is also a type of factor market; people are resources that are needed to produce finished goods or services, just like any other input.
How It Works
Factor markets are driven by the demand in the product market. If no one in the world wants to buy any more cars, there would be no need for the machines and people who design, conceptualize, and manufacture cars. However, if there was a massive need for cars suddenly, the demand for the resources that make cars will increase. Thus, the resources and means to build end products are determined by the needs and demands for the end products themselves.
The concept above is also known as derived demand. Derived demand is when the demand for resources used to make finished products or services is derived from the demand for those products or services. However, factor markets work just like most markets. The supply and demand for resources dictate pricing, and external factors can influence prices.
Additionally, factor markets work within capitalism or a market economy. A market economy supports factor markets and leaves the allocation of factor resources to the market. However, with socialism, factor markets are determined by economic planning.
An example of this is employee wages. In a factor market, employee wages can vary significantly based on the complexity of the job required, i.e., a doctor versus a fast-food worker, and wages vary accordingly. However, within a socialist system that replaces factor markets with economic planning, wages are established such that everyone earns a decent wage, and there are fewer disparities in wage rates between jobs.
Monopsony in Factor Markets
The labor market is an essential piece of the factor market. Most products and services need the input of a human being. However, just like in any market, market failures can occur. A monopsony is a market failure where there are many sellers and only one buyer. It typically occurs in the labor market but can occur elsewhere.
A common occurrence of monopsony in labor markets is when there is only one employer (the buyer of labor) in a town where everyone is seeking work (the sellers of labor). In such a case, and in the absence of government intervention or unions, the employer will be able to control the price of labor and will likely pay less in wages than they would in a competitive market.
This means that the factor prices for labor are less and that the margins for the employer will be greater than if it were in a competitive market. It will also hold true for any other source or cause of monopsony in factor markets.
Monopoly in Factor Markets
A monopoly is another form of market failure that can occur and affect factor markets. It is a situation where there are only one seller and multiple buyers in a factor market, and unless regulated, the prices of the resources can be far higher than in an efficient market. Producers will charge more for the finished goods and services purchased by end-users in a monopoly situation.
However, premium prices can affect demand for the finished product. Thus, the derived demand for the factor resources can also decrease, which may overall adversely affect the monopoly selling the factor resources.