Do Market Conditions Determine Factor Earnings?

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Empirical evidence suggests that certain factor prices and incomes move in response to market forces.

Consider the following cases:

1. Raw Materials:

There is ample evidence to suggest that when there is a rapid increase in the demand for important raw materials like paper, cement, or an internation­ally traded commodity like oil, their prices increase and to that extent the income earned by their owners also soar.

We also see speculative price movements in case of the short-supply items like aluminium, steel and agricultural raw materials used in indus­try.

A glance at any financial daily like The Economic Times will reveal daily fluctuation in the prices of copper, tin, rubber and various other materials in response to changes in demand and supply. Moreover, material prices increase in the upswing of the business cycle as they did during the world commodity boom of 1972-73 and fell on the downswing when their derived demand falls.

2. Land Values:

Look at the Salt Lake area of Calcutta or at the New York City. Land values are increasing day by day in response to increasing demand. In the words of Calvo and Waugh, “Like most other commodities, land values are deter­mined by the forces of supply and demand. There is only a fixed supply of land in the central city areas, so rents are determined by the pressure of demand for city sites. With the growth of cities and increased pressure of demand for central areas, rents are bound to rise”.

It is often observed that durable buildings are destroyed and land is used to build skyscrapers as in London, New York, Tokyo, Mumbai, Calcutta and other important cities of the world. This is a desirable venture (move) because of the high price of urban land.

The increase in the price of land in the adjoining areas of every growing city is another example of the workings of the market forces. The productivity of land in central places is determined by two factors: revenue potential per square meter of land and opportunities for economies of scale which are all greater than for non-urban areas.

Rent depends on productiv­ity and productivity on accessibility and nearness to complementary activi­ties, generating external economies. That is why the price of land declines from the centre of city towards the periphery of the urban area. The greater the distance from the city, the lower the rent.

However, there is one counter evidence. Ricardo and other classical economists believed that with the growth of population and the consequent increase in the demand for food, the price of the fixed supply of land would increase in the sharply. This, however, has not happened.

Empirical evi­dence suggests that the price of agricultural land in, say, the Burdwan district of West Bengal or the Anand district of Gujarat has not increased much over a decade or so. Ibis is because the problem of food shortage was tackled by raising the productivity of the soil through the use of improved machineries and techniques. This has partly or fully neutralised the rise in the price of agricultural goods.

So, the hypothesis that the price of agricultural land is determined by market forces has not been falsified. Rather some of the market forces could not be correctly foreseen.

3. Mini Buses in Calcutta:

The supply of mini buses in Calcutta and other major cities is rigidly controlled by a licensing system. This keeps the number of buses well below ascertain limit. In the free market the number would have been much greater The license which permits one to operate a bus acquires a scarcity value of Rs.30,000 or more. With an increase in the demand for transport services the price of a licence in the open market also rises.

So, through competitive forces new entrants are enabled to earn only the opportunity cost of capital or the money they invest in mini buses. If the government approves any proposal for fare rise and the demand is inelastic, the gross income from operating a bus rises. And there is a corresponding rise in the price of the licence. So, the fare increase is just like a windfall gain to the old licence holders. New bus operators get no extra income.

4. Labour:

In the labour market two sets of complications arise. Firstly, labour markets show elements of both competition and monopoly. Secondly, since labour is the human factor of production, non-monetary factor form an important part of incentives that can be provided to labourers.

We have already noted that a strong union can cause wages to rise above the equilibrium level by restricting the supply of labour or excursing its collective bargaining power.

The following statement of Lipsay is quite relevant in this context:

“Unions can and do succeed in raising wages and incomes when they operate in small sections of the whole economy; the high earnings do attract others to enter the occupation or industry; and the privileged position can be maintained only if entry can be effectively restricted. Closed-shop laws are the most obvious way of doing this.”

Although unions can prevent incomes from falling they can do practi­cally nothing if demand disappears overnight. This happened in case of silent movie stars. But if demand declines slowly over a span of say 20 to 30 years, unions can prohibit new entry into the industry and can hold wages up even in the face of declining demand. This has happened in case of steam engine drivers and coal miner.

Competitive forces also explain fluctuations in wages. With the introduc­tion of national T.V. programme many news readers of Calcutta are unable to find alternative assignments in radios and have to compete in a greatly reduced market for television talent. So, a fall in the demand for a product or service will lead to a corresponding fall in the derived demand for the factors needed to make the product, a decline in their income and the exit of factors to other uses.