An Introduction to Factor Markets

Resources are Bought and Sold in Factor Markets Factor markets bring together buyers and sellers of resources Resources are productive (real) resources –Land: any natural resource –Labor: any human resource –Capital: any product used further in production (e.g., machines) –Entrepreneurship (risk taking, like Holden)

Resources are Scarce Resources are limited Firms need resources to produce shoes –They demand resources –They will pay a price to get them because they are scarce Rent for land Wages for labor Interest for capital Households sell their labor to firms –They supply resources –They receive payment for them

Money Helps Resource Markets Operate Smoothly Money is a medium of exchange: it facilitates trading for resources Without money, trade would be barter –Individuals would be paid for their work with the products they made (shoes) –Individuals might not work (supply no resources) because of the “pay” Money makes it easier for firms to get the resources they want

Consumers Determine Resource Use Resources are used only if individuals want what is being produced –Resources will NOT be used to produce a good if individuals are unable or unwilling to pay for it –Resources will be used to produce a good if individuals are able and willing to pay it If firms produce shoes, they need labor and capital that can be used in shoe production. If firms produce cars, they need a different type of labor and capital

Prices in Product Markets Determine How Resources are Used Expensive production methods mean high prices –Using “overly productive” resources (like producing shoes in San Francisco or Manhattan or a MD to dig ditches) –Wasting resources Cheaper production methods mean prices will be low –Efficiently using resources –Not wasting resources Fewer people buy shoes at a higher price Low cost production methods used since fewer individuals buy at higher prices (if all shoes the same)

Productivity Determines How Much Firms will Pay for Resources Firms can produce more if resources are more productive Firms will pay more for resources that produce more –Firms get more out of a resource it is worth more –Firms will bid up the price of productive resources Wages are higher for more productive workers

Competition Establishes the Price of Resources If firms cannot get the resources they need to produce, they will compete against other firms to get them by bidding up the price (e.g., wages increase) As the price of resources goes up, price of product goes up If firms can get lots of a resource (say labor), unemployed workers will compete with other individuals for a job by lowering their asking wage As wages go down, the price of the product goes down