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Theories of Product and Factor Pricing | Perfect Competition

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The upcoming discussion will update you about the difference between the theories of product and factor pricing.

1. In the product (consumer goods) market, the consumers or the households are the buyers and the firms are the sellers. In this market, the buyers aim at maximising utility and the sellers aim at maximising profit.

In the market for factor inputs, on the other hand, firms are the buyers and the households are the sellers. In this market, the buyers have the goal of profit maximisation and the sellers or households want to have maximum possible utility by way of earning an optimum income.

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We should remember that in the factor market, the sellers or the households do not want to maximise income through selling the inputs. For example, a worker does not want to maximise income by working 24 hours a day, because then he would not have any leisure.

Since a worker derives utility from both income and leisure, he wants to have a combination of income and leisure—he wants to have such a combination that would maximise his utility level. This is called optimisation of income through which the worker would have the maximum (possible) utility.

2. In the product market, demand for a commodity arises from the utility it provides to the buyer—the higher the utility the buyer derives from the consumption of a good, the higher would be its demand. On the other hand, the demand for a factor arises from the demand for the product it produces.

The demand for the factor increases or decreases as the demand for the product rises or falls. That is, the demand for a factor emerges from the demand for the product it produces. That is why the demand for a factor of production is called derived demand.

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3. The firm uses many inputs simultaneously to produce its output. That is why the demand for the inputs, in most cases, is a joint demand. In the case of product demand, on the other hand, a good is, in general, demanded singly, not jointly, although, in some cases of complementarity, goods are demanded jointly.

4. There is also a difference between the supply of a good or service and that of a factor of production. Barring some exceptions, the supply curve of the goods and services are upward sloping towards right, i.e., their supply rises or falls according to the law of supply, as the prices increase or decrease.

But the supply of all the factors of production does not rise or fall with their prices in the same way. For example, let us first take the case of land.

In all countries the total quantity of land is fixed, i.e., from the point of a view of a country as a whole, the supply of land is perfectly inelastic. Supply of land cannot be obtained in a larger quantity by means of a price rise. Therefore, law of supply does not operate in the case of land.

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Also, we may observe in the case of labour that supply of labour of an individual worker does not rise, it rather falls, as the rate of wage rises beyond a certain point. That is, the supply curve of labour of an individual worker rises to the right in the initial stages; but, after a certain point, it bends backwards to the left as the rate of wage rises.

Because, after a certain point, as the wage rate rises, and as the worker becomes sufficiently rich, he may prefer to have more of leisure by working less.

However, we shall assume that the aggregate supply curve of labour, generally, would be sloping upward towards right. This supply curve is a horizontal summation of all the individual supply curves, and it is assumed that all these supply curves would not bend at the same time towards left at any particular rate of wage.

We have seen that there are some peculiarities in the supply of land and labour. In the case of supply of capital and entrepreneurial services also, we observe certain peculiarities.

5. In product pricing, theories do not differ on the basis of the products, but they are influenced by the characteristic features of the markets. In the field of factor pricing also, the theories differ because of the differing market features. Not only that. Separate theories have been built up for different factors of production, owing to the differences in the nature of their supply.

We may note here that the demand for the factors of production may be analysed with the help of a common theory, although there may exist differences on the supply side. This com­mon demand theory is called the Marginal Productivity Theory.

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