Markets for Factor Inputs

So far we have concentrated on output markets, i.e., markets for goods and services that firms sell and consumers purchase. In this chapter we discuss factor markets-markets for labor, raw materials, and other inputs to production. Much of our material will be familiar because the same forces that shape supply and demand in output markets also affect factor markets.

We have seen that some output markets are perfectly or almost perfectly competitive, while in others producers have market power. The same is true for factor markets. Wc will examine three different factor market structures: (1) perfectly competitive factor markets, (2) markets in which buyers of factors have monopsony power, and (3) markets in which sellers of factors have monopoly power. We will also point out instances in which equilibrium in the factor market depends on how much market power there is in output markets.

14.1 Competitive Factor Markets

A competitive factor market is one in which there are a large number of sellers and buyers of the factor of production. Because no single seller or buyer can afTcct the price of the factor, each is a pricc taker. For example, if individual firms that buy lumber to construct homes purchase a small share of the total volume of lumber available, their purchasing decision will have no effect on price. Similarly, if suppliers of lumber cach control a small share of the market, their supply decisions will not affect the pricc of the lumber they sell.

Wc begin by analyzing the demands for a factor by individual firms. These demands are added to get market demand. Wc then shift to the supply side of the market and show how market price and input levels are determined.

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