DEFINITION of ‘Factor Market’
A marketplace for the services of a factor of production. A factor market facilitates the purchase and sale of services of factors of production, which are inputs like labour, capital, land and raw materials that are used by a firm to make a finished product. A factor market is distinct from the goods and services market, which is the market for finished products or services.
INVESTOPEDIA EXPLAINS ‘Factor Market’
For example, in the appliances market, the market for refrigerators and dishwashers would be the goods market. The market for workers who are skilled in refrigerator and dishwasher assembly would be an example of a factor market. Another example of a factor market would be the market for raw materials like steel and plastic, which are two of the materials used for refrigerators and dishwashers.
Households and firms are a vital part of the economy. While households are essentially buyers and firms are sellers in the goods and services market, these roles are reversed in factor markets. In factor markets, households are the sellers of factors of production like their labour and capital (in the form of their savings), while firms are the buyers of these factors.
The combination of the factor markets, and the goods and services market, forms a closed loop for the flow of money. Households supply labour to firms, which pay them wages and salaries that are then used to buy goods and services from the same firms. This is a symbiotic relationship that benefits the economy.
A factor’s price represents an income to its owner, for example, wages received by a worker, or the rent on land. The price for each factor is based on supply and demand, and is “derived demand,” in that it is based on the demand for output. In a booming economy with a tight labour market, wages will rise because demand for workers is high; conversely, in recessionary conditions where unemployment is high, wages will remain stagnant or even fall.