Mona
Assistant Professor (Guest Faculty)
Department of Economics
Maharaja College
Veer Kunwar Singh University, Ara
B.A. Economics
B.A. Part :1
Topic : Factor Pricing Analysis Under Perfect Competition
Factor Pricing Under Perfect Competition
According to the modern theory of pricing of factors of production, under condition of perfect
competition. It is the forces of demand for and supply of factors which determine their prices.
The demand for the factors service is derived demand which is derived from the demand for
the product that it helps to produce. Thus, the demand for the factor ultimately depends upon
the the demand for goods it helps to produce. The greater the demand for goods a particular
type of factor helps to make, the greater the demand for that type of factor.
Just as demand for a good depends upon its utility, the demand for a factor depends
upon the Marginal revenue productivity of the factor. In fact, under perfect competition in
the factor market downward sloping part of the marginal revenue productivity curve of the
factor is the demand curve for that factor.
Assumptions :
The analysis of factor pricing under perfect competition is based on the following
assumptions:
● There is perfect competition in product market and the factor market.
● The number of buyers and sellers of factors services is large.
● All units of a factor are homogeneous.
● There is perfect substitutability between factors and their units
● All factor- units are divisible.
● Buyers and sellers of factor services have complete knowledge about market
conditions.
● Buyers and sellers of factor services have complete freedom to enter and leave the
market.
The supply of a factor service means the number of units which a resource on a sales at a
particular price. There is a direct relationship between price and the supply of a factor
service.this is in the short run when the supply of productive service is not perfectly elastic.
Mole of it will be supplied at a higher price and less at a lower price. Thus,the shape of the
supply curve of a factor service is upward sloping from left to right (that is it has a
positive slope.)
Under a perfectly competitive factor market there are many buyers of a productive service so
that a single firm purchases only a small portion of the total factor service and in no way
influences its market price. It takes the price of the factor service as given and employs as
many units as it needs at that price. Thus, the supply of a factor service to the firm is
perfectly elastic in the long run at the given market price. As a designed for a firm working
under perfect competition in the factor market, the extra cost of hiring an extra unit of the
factor will be equal to the price of the factor which remains unchanged. Thus, marginal factor
cost under perfect competition in the factor market is equal to the price of the factor i.e;
Pf = MFC. (Shown in Figure 180)
Determination of factor price
Given the demand and supply condition of factor service as enumerated above the firm will
continue to employ more units of a particular factor service so long as the additional revenue
obtained from an additional revenue obtained from an additional unit of the factor service
(MRP) exceeds the extra cost of employing it (MFC). It will be earning maximum profits at
the point at which the MRP equals the MFC. It will be earning maximum profits at which the
MRP = MFC. If the firm employs less than this, MRP would be higher than MFC and it would
be its advantage to hire more units of the factor service because they would add to revenue
more than costs. In case the firm decides to hire beyond the point of equality of MRP and
MFC, it would be a loser because costs would rise more than revey. Thus, in a perfectly
competitive factor market the firm will be in equilibrium when MRP>MFC or MRP= MFC
which implies two conditions:
1. MRP mast equal MFC
2. The MRP curve must cut MFC curve from above at the equilibrium point.
In the above given graph; VMP equals MRP is the demand curve and AFC= MFC is the
supply curve of the factor service. Since the price of the factors and which is given and
constant at OP for the firm, the MRP curve cuts the MFC curve at E from the above. This is
the equilibrium point for the firm at which it employees OQ units of the factor service. The
MRP curve also cuts MFC curve at R. But this can not be the equilibrium point because
MRP cuts MFC from below . It is not the point of maximum profit for the firm because MRP is
higher than MFC beyond this point R. Thus E is the point of equilibrium in a perfectly
competitive factor market when
MRP = VMP = MFC = AFC = Price
Note:
Under perfect competition in both factor and product markets, a firmr may be at a profit or at
a loss in the short run. But in the long run it must earn normal profits.
