Though, like the pricing of goods, the factor pricing is also based on market demand and supply, the essential difference between these two lies in the forces operating behind demand and supply of these factors. Demand for goods is a direct demand; the consumer buys goods because they give him utility or satisfy his Wants. Thus, the demand for goods is for the goods themselves. But the demand for factors is not for factors themselves, it is for the services that these factors provide. A labourer is employed not for his own sake, but for the services that he provides in producing goods. And the payment to labour, wages is, thus, a payment for his services and not for himself as such.
How much will be the demand for a factor, would depend upon the quantity of goods that it helps to produce and the extent demand for these goods in the market. There is a high demand for cloth, the textile industry would like to shut out some labour from its employment. Thus, in brief, the demand for a factor of production depends upon the demand for its products in the market. This type of demand is known as derived demand; the demand for a factor of production is derived from and is dependent on the demand for goods which the factor helps to produce.
The concept of derived demand explains that firms require factor inputs not for their own sake but for using them as a means to produce goods and services that these factor input help to produce. Derived demand thus provides a link between the output of goods market and inputs or factor market.
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