The process of production needs several inputs. These inputs are known as the factors of production. In most cases, firms own some of the factors of production while some have to be bought from the market. For example, POSCO Ltd may own the factory buildings and machines necessary to produce steel but it has to purchase the services of workers from the labor market.
The analysis of a factor market in general follows the same principles we have seen in case of commodity market but there are certain distinguishing features. The demand in a factor market is derived demand. The demand for the input is derived from or depends on the demand for the output it helps produce. If the demand for steel in the world market increases, POSCO Ltd will want to increase its production. To do so, it could hire more workers, i.e., raise its demand for labor.
There are 4 possibilities for a firm:
1. It can be a perfect competitor in the product market as well as a perfect competitor in the factor market.
2. It can be a perfect competitor in the product market but not in the factor market. For example, a rice mill in a village could be sole employer for the villagers. There could be different brands of rice being sold in the village. A single buyer is known as a monopsonist.
3. A perfect competitor in the factor market but not in the product market. For example, a locality with one electricity supplier. This firm has monopoly in the product market. However, it is one of the many firms demanding the services of engineers.