Factor markets

From Hobson's Choice

A hypothetical concept in economics, viz., that there exists a [reasonably] free market for each of the major factors of production. In real life, factor markets are usually heavily constrained by numerous factors described below. However, orthodox economics treats the market for factors almost exactly the same as for the products of the economy itself.

1 Equilibrium
2 Real Life Constraints
3 See Also
4 External Links

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Equilibrium

Classical economics differed most from neoclassical economics in its treatment of factors: classical economics was concerned with the returns to producers which was thought to result from the absolute productive efficiency of a producer's endowment of productive factors; in neoclassical economics, production ceased to be a major consideration, and attention was redirected to allocative equilibrium instead. The initial, or classical, concept of an upwardly sloping supply curve arose from the idea of land made available for the cultivation of a particular type of crop. When prices were low, only the best land would be used since it could be cultivated easily. As prices rose, farmers would recover inferior grades of land, use more fertilizer, and produce lower yields. Hence, output would rise. Those landlords whose property was either geographically close to population centers, or else of high productivity, enjoyed high rents.

In neoclassical economics, land ceased to be regarded as a separate and distinct factor of production (for a discussion of why, see main article). Instead, the analysis focused on two factors only, labor and capital.

Here, labor demand is convex because the same firm is facing a production function in which capital can be substituted for labor. When prices are high, then not only are customers restricted by budget, they have the option of replacing labor with equipment. Likewise, the supply curve is usually understood to become much less elastic as wages rise. Put another way, as wages and hours rise, leisure becomes more valuable to workers as well. Of course, these things are dependent on many things, such as the demand curves for many products, the exposure to foreign markets, and so on. But here, we're using the simple assumption that the demand curves for products are straight & diagonal, and that it's not difficult for managers to substitute capital for labor.

The slope of the demand curve for labor is determined by two things: one is the marginal rate of technical substitution, or rate at which capital equipment (most obviously, industrial automation) can be replaced with more labor hours—and vice versa. The other is the demand function for products produced by the industry or the nation. Under the assumptions of classical economics, it's possible for the price of labor to be so high that wages times the amount of labor hours worked (i.e., the national payroll) could shrink in absolute terms; this would mean a much larger share of GDP was going to capital, perhaps reflecting an extremely high rate of automation. More realistically, if the payroll were sharply reduced as a result of massive automation or extraordinary aggressive labor unions, then domestic consumption would likewise shrink, pushing the demand curve further to the left.

Under conditions of oligopsony, the demand for factors like land and capital reflect their marginal revenue product, as does the demand for the industry's product at each level of Q.

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Real Life Constraints

More realistic depictions of industrial systems suggest that there are constraints on the liquidity or the responsiveness of factor markets. For example, the labor market is and always has been limited by the social relations relevant to the workplace. Wages must often move in formation, since it may be untenable to pay scarce flunkies the same as numerous experts. It's been pointed out that there is no labor market, but rather, a job structure. Movements of positions in this structure, relative to each other, change only with difficulty. Moreover, often managers have decisive control over their own relative position, meaning that market correction of the system is unlikely to occur. Indeed, if anything, there is a tendency for large firms to allow more prolonged defiance of the labor market by preserving a fixed pecking order.

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