Factor Services

The resource markets only exchange factor services, not the actual factors. This is probably obvious for labor services. The buying and selling of human workers has not existed (legally) since the abolition of slavery. The resource markets trade only the services of labor.

This also holds for the other factors of production. For example, resource markets only trade the services of capital goods not the capital. Capital goods (newly produced ones) are traded through the product markets.

Buyers and Sellers

• Household Supply: The household sector owns all four factors of production. This sector supplies the services of these factors through the resource markets in exchange for payment. This payment for factor services is also the income of the household sector.

  The critical point is that all resources are owned by someone in the household sector. People obviously own their own labor and entrepreneurial abilities. However, capital and land are also ultimately owned by members of the household sector, often indirectly through the ownership of a business enterprise.



• Business Demand: The business sector combines the four factors of production to produce the goods and services. To produce output it must acquire the factors of production from the household sector, which it does through the resource markets. It hires factor services based on expectations of selling the resulting output through the product markets. The more production sold, the more factor services demanded.

One of Three

• Product Markets: The product markets exchange the production of final goods and services, what is formally termed gross domestic product. The buyers of this production are the four macroeconomic sectors--household, business, government, and foreign. The seller of this production is primarily the business sector. A substantial part of macroeconomics is devoted to explaining how and why gross domestic product exchanged through the product markets rises or falls.
• Financial Markets: The commodities exchanged through financial markets are legal claims. Legal claims, or financial instruments, represent ownership of physical assets, capital as well as other goods. Because the exchange of legal claims involves the counter flow of income, those seeking to save income buy legal claims and those wanting to borrow income sell legal claims.

The Circular Flow

The Circular Flow

A basic representation of the circular flow is displayed to the right. The four components of this simple model are: household sector, business sector, product markets, and resource markets. The household sector at the far left contains the consuming population of the economy. The business sector at the far right includes all of the producers.

The resource markets at the bottom of the flow direct factor services from the household sector to the business sector in exchange for payment flowing in the opposite direction. The product markets at the top of the flow direct production from the business sector to the household sector in exchange for payment flowing in the opposite direction.

The circular flow indicates that the income used by the household sector to purchase goods through the product markets is obtained by selling factor services through the resource markets. It also indicates that the revenue used by the business sector to pay for factor services obtained through the resource markets is generated by selling goods through the product markets.

Aggregate Equilibrium

Equilibrium in the aggregate resource market is an essential aspect of macroeconomic analysis. In particular, overall macroeconomic equilibrium, especially what is termed long-run equilibrium, requires aggregate resource market equilibrium. This exists if the total quantity of productive resources that businesses seek to employ is equal to the total quantity of productive resources seeking employment.

However, this does not mean that every individual resource market is in equilibrium. One might have a bit of a shortage and another a bit of a surplus. As long as the shortages and surpluses balance out, meaning total quantity demanded is equal to total quantity supplied, then the aggregate resource market is in equilibrium.

Although equilibrium in the aggregate resource market is essential to long-run equilibrium, short-run equilibrium exists even without resource market equilibrium. Short-run equilibrium is a key aspect of business-cycle instability and the macroeconomic problems of unemployment and inflation. In fact, unemployment and inflation occur when the aggregate resource market is not in equilibrium.

Spotlight on Labor

• One reason for this special attention is that labor constitutes a majority of resources used in production (around 60 percent). Any activity transpiring in resource markets, such as unemployment, is most likely to affect labor.


• Another reason is that the employment of labor has a direct bearing on individual living standards and the well-being of a large segment of the population. If problems, like unemployment emerge, many members of society (especially voting citizens) are likely to suffer.

Natural Unemployment