Application of Demand and Supply curves in Factor price Determination: - Demand and supply forces also play dominant role in factor price (i.e., their reward) determination. According to the modern theory of distribution, the factor price is determined be demand and supply forces in the same way as commodity price is determined by demand and supply forces. In perfect competition, factor price is determined at that point where the demand for factor becomes equal to its supply. Hence, the modern theory of distribution is termed as ‘Demand and Supply Theory of Factor Price Determination.’
Demand for Factor – Factor demand is not direct demand but it is indirect demand i.e., demand for factors of production depends on the demand for goods which are produced with these factors for example, labour demand for cloth industry depends on the demand for finished cloth. Higher demand for cloth increases the demand for labour in cloth industry and vice-versa.
Supply of Factor - Supply of factor of production is determined by its opportunity cost. Opportunity cost is that money income which can be obtained by factor of production must get that award in its present use which it can obtain in next best alternative use. Higher the supply of factor, higher will be the supply of production. Hence the supply curve of a factor slopes upward from left to right.
Factor price: - Demand – supply Equilibrium: The reward to a factor of production will be determined at that point where factor demand becomes equal to factor supply. In fig. factor demand curve DD and factors supply curve SS cut each other at point E where factor price OP is determined If factor price increases to OP, factor supply exceeds factor demand which brings down factor to OP. On the contrary, if factor price comes down to OP2. factor demand exceeds factor.
