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SUPPLY AND DEMAND IN THE LABOR MARKET
According to the principle of supply and demand, first introduced in Alfred Marshall’s book Principles of Economics in 1890 , the price of a productive factor is determined by the amount available on the market and the amount that consumers are willing to purchase. Based on these propositions, market equilibrium (or market clearing) will occur, such that the demand for the productive factor becomes equal to the supply from the market. This means that when the price is below the equilibrium point, there is a shortage in supply. When the price is above the equilibrium point on the other hand, there is a supply surplus. Equilibrium is therefore a balance between the supply and demand of a productive factor on the market. In light the recent economic crisis and the massive layoffs that have followed, I thought it would be interesting to examine to what extent the labor market functions according to the supply and demand model suggested by Marshall. Before having done any research, we can already state that there are forces in play that inhibit the labor market from functioning according to supply and demand. This has become apparent due to the ever increasing segment of the working population that is currently unemployed. This is supported by Bohlander & Snell , who state in their HR book that the impact of supply and demand in the labor market is reduced by various factors like unions and government regulations. I first became intrigued about the subject of supply and demand in the labor market by an article posted in the New York Times . In this article, a century old question forms the introduction of what follows: “Why doesn’t the labor market ‘clear’?”. The article states that the excess supply, in this case unemployment, is both prominent and persistent . It reasons that managers have
actually made the problem worse due to their actions to hold and protect their core employees. This is interesting, as it gives the impression that supply and demand is distorted in part by HR policies that are in place within organizations.
FACTORS INHIBITING SUPPLY AND DEMAND IN THE LABOR MARKET
In this section I will take the factors mentioned in the New York Times article as the starting point, and will add to that factors from two scientific publications on labor market rigidities [3, 4]. First of all, from the New York Times article, it can be derived that interviews conducted among hundreds of managers revealed that the actions of managers are influenced by their concerns with the emotional state of their core employees. This is why managers don’t cut wages and working hours of everyone during difficult times. Instead they utilize mass layoffs of non-core employees. The problem with this practice is that it hurt morale of the core employees, leading them to feel ”survivors guilt”. This again makes things worse, as these core employees with survivors guilt will have significantly lower consumption levels due to the guilt they feel . As managers are usually part of this core employee group, they will also invest less money buildings, equipment and software for the company , slowing down the economy even further. The second article we will be looking at, the scientific paper by Siebert from 1997 , compares the US labor market to the European counterpart. It shows that from about halfway the 1980s, unemployment rates have been structurally higher in Europe. The article reviews empirical evidence to show that the European labor market is less flexible than in the US . This results in a set of factors that contribute to this problem. The article starts with analyzing how the wage rates respond to unemployment. It is revealed that short-term wage elasticity is very low within Europe, which inhibits the equilibrium function in the labor market . The second factor mentioned is wage differentiation. Institutional arrangements have resulted in a drastically reduced
differentiation in wages, distorting the equilibrium, resulting in lower employment levels . The third factor is the high levels of union powers in Europe, bargaining for higher wages, again distorting the equilibrium . Also taxes play a role in higher unemployment, as an ever increasing part of the wage of an employee is designated for social security contributions, increasing labor costs and increasing unemployment on the long run . Next to this, job protection legislation has made firing employees a very expensive and complex process. This has caused organizations to take this into account and hire less people . Another factor is that the duration and wage level of unemployment benefits have increased (generous unemployment benefits). This has reduced the incentive for people to work, as the reservation wage does not differ much from the minimum wage . The article concludes by saying that due to these flexibility reducing labor market factors, the market does not function properly anymore. It is a vicious circle that a country can get caught up in, due to the fierce competition on a global scale . The last article, by Nickell , adds one important additional factor to the Siebert article. This is poor educational standards on the bottom end of the labor market . As countries have been shifting from a traditional production economy to a service oriented economy, the demand for skilled labor has increased. As a result of this, unemployment among unskilled labor has increased (surplus of unskilled labor on the market), while the supply of skilled labor has been insufficient.
It can be concluded that various factors contribute to the disruption of the labor market functioning according to the principles of supply and demand. This is due to the human aspect of this productive factor. Below we present a model which combines the factors identified in the various articles. Please note that possible existing causal relations between the factors have not been investigated.
(Actual Labor Market) Reduced Impact Supply & Demand Labor Market HIGH UNEMPLOYMENT Impact reducing factors (counter forces) Low Short-term wage rate elasticity Low wage differentiation High union power levels Low educational standards Extensive Job Protection Legislation Morale issues of management High unemployment benefits High tax levels
LOW UNEMPLOYMENT Full Impact Supply & Demand Labor Market (Free Market Labor Market)
 A. Marshall, Principles of Economics – Eighth Edition, Cosimo Classics, 2009  R. J. Shiller, The Survival of the Safest, New York Times, 2010  H. Siebert, Labor Market Rigidities: At the Root of Unemployment in Europe, Journal of Economic Perspectives, 1997  S. Nickell, Unemployment and Labor Market Rigidities: Europe versus North America, Journal of Economic Perspectives, 1997  G.W. Bohlander & S.A. Snell, Managing Human Resources, South-Western College Pub, 13th Edition, 2003