Reviewed by Aug 27, 2020| Updated on
In economics, a factor market is a place where production factors are purchased and sold. In exchange for making factor payments at factor prices, firms buy productive resources. The relationship between the commodity and factor markets include the derived demand theory.
The generated demand relates to the demand for productive resources, resulting from the demand for final goods and services or production. For example, if the demand from the consumer end for new cars increases, the suppliers will respond by increasing their demand for efficient inputs or services used to produce new cars.
Understanding Factor Markets
Production is the transformation of inputs into finished products. Companies obtain the inputs (manufacturing factors) on the factor markets. The goods are sold in the markets for the items. Both economies do operate in the same way complementing each other in certain respects.
The interaction of supply and demand determines price; companies try to maximize profits, and variables will affect and change the price of equilibrium. The quantities bought and sold, and the supply and demand laws hold. Industries in perfectly competitive markets will "buy" as many products at the market rate as they need.
Importance of Factor Markets
Labour is the most important factor in production. One of the defining characteristics of a market economy is the existence of factor markets for the allocation of the production factors, especially for capital goods.
Traditional models of socialism were characterized by replacing factor markets with some economic policy, believing commodity transactions would become obsolete in the production process if capital goods were controlled by a single entity representing society.
Assuming the product and factor markets are perfectly competitive in structure. The firms are price-takers in both markets. The price is set using the interaction of supply and demand at the market level. Because they are market-takers, companies will sell as much of the commodity as they want at the set price.