In recent years, the digital economy based on the new generation of information technology has become the most active field in China. In this context, how cities utilize digital economy development to improve factor market distortions is an important practical issue. However, there is little literature to investigate the impact of the digital economy on factor market distortion from the perspective of the city administrative level, especially the lack of in-depth research on the sources of impact of digital economy development on factor market distortion in cities of different administrative levels. This paper uses data from China City Yearbook, China Labor Statistics Yearbook, China Statistical Yearbook, and National Economic and Social Development Statistical Bulletin of prefecture-level cities. By referring to the calculation method of urban factor market distortion proposed by Jin Laiqun (2018) and Bai Junhong, et al. (2022), capital factor market distortions and labor factor market distortions are calculated for cities. At the same time, the level of urban digital economy development is measured by using the methods of Liu Jun, et al. (2020) and Zhao Tao, et al. (2020) to examine how digital economy development in cities at different administrative levels affects factor market distortions. The empirical study result shows that the influences of digital economy development on factor market distortion are significantly different among cities at different administrative levels. The digital economy developments of high administrative level cities are not conducive to improving factor market distortion, while the digital economy developments of low administrative level cities help to improve factor market distortion. After considering endogeneity, changing digital economy development indicators and factor market distortion indicators, the regression results are still robust. Further tests on the sources of influence show that the development of the digital economy in high administrative level cities is not conducive to improving the distortion of the labor factor market, while that in low administrative level cities is beneficial to improving the distortion of the capital factor market. Moreover, the development of digital economy in high administrative level cities will not help to improve the distortion of the labor factors market because of the excessive concentration of labor factors. Compared with previous literature, the main expansions of this paper are to include the administrative level into the scope of research on factor market distortion, broaden the scope of research on the relationship between the digital economy and factor market distortion from a new perspective, and preliminarily explore the impacts of digital economy development of cities at different administrative levels on factor market distortion and the influence sources. This paper to some extent reveals the inherent logic of heterogeneity of urban administrative levels in the impact of the digital economy on factor market distortion, which helps relevant departments of cities at different administrative levels to formulate more targeted policies and measures on how to use the development of the digital economy to improve factor market distortion, providing new ideas for improving factor market distortion in China during the digital era.