Interdependence of goods and factors

A rise in demand for a good will raise its price and profitability. Firms will respond by
supplying more. But to do this they will need more inputs. Thus the demand for the inputs
will rise, which in turn will raise the price of the inputs. The suppliers of inputs will respond to
this incentive by supplying more. This can be summarized as follows:

Goods market

Demand for the good rises.

This creates a shortage.
This causes the price of the good to rise.
This eliminates the shortage by reducing demand and encouraging firms to produce
more.

Factor market

The increased supply of the good causes an increase in the demand for factors of
production (i.e. inputs) used in making it.
This causes a shortage of those inputs.
This causes their prices to rise.
This eliminates their shortage by reducing demand and encouraging the suppliers of
inputs to supply more.

So changes in goods markets will lead to changes in factor markets.

The below graph explains the interdependence of goods and factor market

Explanation of the figure

Goods market
As the demand of the product increases (i.e. demand exceeds supply) then a shortage of
goods is created which results in increase in price of product until the demand and supply of
the product is equal

Factor market

As the supply of goods increases (i.e. production increases) then the producers will need
more resources (i.e. factors of production), which will create a shortage of resources which
will further result in increase in demand of the factors of production (i.e. labour, raw material
& capital).

Due to the increase in demand of factors of production, the price of factors of production will
increase until the demand and supply of factors of production are equal

The interdependence of different goods markets.

A rise in the price of one good will encourage consumers to buy alternatives. This will drive
up the price of alternatives. This in turn will encourage producers to supply more of the
alternatives