The Labour Market

The Supply and Demand

for Labour
 The Labour Market
• The labour market is an example of a factor market
• Supply of labour – those people seeking employment
(employees)
• Demand for labour – from employers
– A ‘Derived Demand’ – not wanted for its own sake but for what it can
contribute to production
– Demand for labour related to productivity of labour and the level of
demand for the product
– Elasticity of demand for labour related to
the elasticity of demand for the product
 The Labour Market
• At higher wage rates
the demand for labour
will be less than at
lower wage rates
• Reason linked to
Marginal Productivity
Theory
The demand for labour is highly dependent on the
productivity of the worker – the more the worker
adds to revenue, the higher the demand.
Copyright: iStock.com
 Marginal Revenue Productivity

• Productivity refers to the amount produced per worker

per period of time
• MRP = the addition to total revenue (TR) received from
the sale of an additional unit
of output
– Worker instrumental in producing that output
• Marginal Physical Product (MPP) – the addition to total
product as a result of the employment of one additional
unit of labour
• MRP = MPP x P
• If a good sells for £1.00 and a worker produces 300 per
day, the MRP of that unit
of labour is £300 per day
 The Labour Market
Marginal Productivity Theory
Wage Rate
The ARP is the average revenue product – the
average value added to total output through
hiring successive workers. The MRP curve
intersects the MRP curve at its highest point.
The law of diminishing returns would
suggest that as successive units of
labour are employed, the addition to total
product will rise at first but then decline.
The MRP represents the value added to
total output by successive workers.
ARP
MRP = MPP x P
Number Employed
 For the employer to be persuaded to employ
additional workers, therefore, the wage rate
The Labour must be lower to compensate for the fact that
the extra worker adds less to total revenue
Market than the previous one and to sell extra units,
the firm must accept a lower price.
Wage Rate (£ per hour) Employing the 20th
In a competitive labour
unit ofmarket,
labour the
costs
the
individual
firm £5.50
firmper
is not
hour bigbut
enough
that labour
to
7.00 adds
influence
£7.00the
perwage
hour rate.
to total
The revenue
marginal
6.70 through
cost of their
labour
st work.
is a It
horizontal
is worth line at
The 21 unit of labour
employing
the existing that
market
extra wage
unit ofrate.
labour.
adds slightly less to total
revenue (£6.70) but still
5.50 costs £5.50 andMCLso is
worthARP
employing. There
will thus be an incentive
for the firm to continue
to employ additional
units of labour until the
MRP =
MRP MPP xrate
= Wage P
20 21
Number Employed
 The Labour Market
Wage Rate (£ per hour)
The MRP curve therefore represents
the demand curve for labour
illustrating the derived demand
relationship.
10

There is an inverse relationship between

the wage rate and the number of people
employed by the firm.
7

DL

10 15 19 Number Employed
 The Labour Market
• The Supply of Labour
• The amount of people offering their labour at
different wage rates.
– Involves an opportunity cost – work v. leisure
– Wage rate must be sufficient
to overcome the opportunity cost
of leisure
 The Labour Market
• Income effect of a rise in wages:
– As wages rise, people feel better off and therefore may not feel a need
to work as many hours
• Substitution effect of a rise in wages:
– As wages rise, the opportunity cost of leisure rises (the cost of every
extra hour taken in leisure rises). As wages rise, the substitution effect
may lead to more hours being worked.
• The net effect depends on the relative strength of the income
and substitution effects
 The Labour Market
• The elasticity of supply of labour depends upon:
• Geographical mobility of labour:
– The willingness of people to move
– The cost and availability of housing
in different areas
– The extent of social, cultural and family ties
– The amount of information available to workers about
jobs in other areas
– The cost of re-location
– Anxiety of the idea of re-location
 The Labour Market
• Occupational Mobility of Labour:
– Lack of information of available jobs in other
occupations
– Extent and quality of remuneration packages
– Extent of skills and qualifications
to do the job
– Anxiety at changing jobs
 The Labour Market
An inelastic supply of labour –
Wage Rate (£ per hour) a substantial rise in the wage rate only
SL brings forth a small increase
10 in the amount of people willing
and able to do such work.
The reason may be the number
with those particular skills and
5
qualifications, the time it takes to get
those skills, geographical immobility etc.

Number of Hours Worked

 The Labour Market
Wage Rate (£ per hour) If the supply of labour is elastic, a
small rise in the wage rate is sufficient
to encourage more people to offer
their labour. Geographical and
occupational mobility are likely to be
high and there is likely to be many
substitutes.

SL

5.50

35 45 Number of Hours Worked

(per week)
 The Labour Market
• Economic Rent The value of the wage earned
over and above that necessary to keep a factor
in its current employment
 Economic The supply of labour curve shows the relationship
between the wage rate and the number of people
offering their labour in terms of the number of
Rent hours worked.
At a wage rate of £6.00 per hour, employees are
Wage Rate (£ per hour) willing to offer Q1 hours. Some in the market are
not willing to work for any less than that and
some would be Swilling to work for less than
L
£5.00.
The area under the supply curve is referred to as
the ‘Transfer Earnings’ of the factor.
6.00

Transfer
Earnings
Q1 Number of hours worked
 Some individuals would have been
prepared to work Q2 hours for £4.00

Economic Rent
per hour.
Assume that £6.00 per hour is the
current market wage rate for this
Wage Rate (£ per hour) factor.

The total value of economic rent is shown

SL by the yellow shaded triangle.

Those individuals earn £6.00 per hour – they

therefore earn an amount in excess than they
were prepared to offer their services for – this is
6.00 termed ‘Economic Rent’.

Economic
Rent
4.00

DL
Q2 Q1 Number of hours worked
 Labor Supply Determinants
• Other wage rates
– If wages in other occupations rise (fall), then
labor supply will fall (rise).
• Nonwage income
– If nonwage income rises (falls), then labor supply
will fall (rise)
• Preferences for work versus leisure
– If preferences for work increase (decrease), then
labor supply will increase (decrease).
 Labor Supply Determinants
• Nonwage aspects of job
– If the nonwage aspects of a job improve
(worsen), then labor supply will increase
(decrease)
• Number of qualified suppliers
– An increase (decrease) in the number of
qualified workers will increase (decrease)
labor supply.
 Labor Demand Determinants
• Product demand
– Changes in product demand that increase
(decrease) the product price, will
increase (decrease) labor demand.
• Productivity
– An increase (decrease) in productivity will
increase (decrease) labor demand,
assuming that it does not cause an offset
in the product price.
 Labor Demand Determinants
• Prices of other resources
– For gross substitutes, an increase
(decrease) in the price of a substitute
input will increase (decrease) labor
demand.
– For gross complements, an increase
(decrease) in the price of a complement
input will decrease (increase) labor
demand.
 Labor Demand Determinants
• Prices of other resources
– For pure complements, an increase
(decrease) in the price of a complement
input will decrease (increase) labor
demand.
• Number of employers
– An increase (decrease) in the number of
employers will increase (decrease) labor
demand.
 Allocative Efficiency
• An efficient allocation of labor is
obtained when society gets the largest
possible amount of output from a
given amount of labor.
• Efficient allocation requires the VMP
of labor for each product be equal to
the price of labor.
• Perfect competition in the product
and labor markets creates allocative
efficiency.
Unions and Wage
Determination
 Unions and Wages
• Unions can increase the wages of
their members by:
– Increasing the demand for union
labor.
– Restricting the supply of labor.
– Bargaining for an above equilibrium
wage.
 Increasing Labor Demand
• To the extent that unions can Wage rate
increase the demand for union S
labor from (D0 to D1), they can
gain both higher wages and
employment W1
W0

D1
D0

Q0 Q1 Quantity of
Labor Hours
 Methods to Increase Union Labor Demand
• Increasing product demand
– Lobbying for tariffs on foreign goods.
• Enhancing productivity
– Participation in labor-management
committees on productivity
• Influencing the prices of related inputs
– Lobbying for minimum wage hikes as
they raise the price of substitutable less-
skilled, nonunion labor.
Methods to Increase Union Labor
Demand
– Davis-Bacon Act, which requires
federal contractors pay the
“prevailing” union wage scale.
• Increasing the number of
employers
– Attempts to pass requirements for
domestic content for autos sold in
the country.
 Methods to Decrease Labor Supply
• Reducing the number of qualified
suppliers of labor
– Lobby for laws that reduce immigration,
child labor, and length of the workweek.
– Limit entry into occupation through
long apprenticeships.
– Occupational licensing which are laws
that require practitioners to meet certain
requirements.
 Methods to Decrease Labor
Supply
• Raising nonwage income
– Lobby to increase nonwage income
sources such as Social Security in
order to decrease labor supply.
 Bargaining for an Above-
Equilibrium Wage
• By organizing all workers and Wage rate
having a union shop (requiring SL
all new hires to join the union),
the union may achieve a wage b d
WU that is above the competitive WU MWC
wage WC. c
WC
• The effect is to make the labor
supply curve perfectly elastic at a
WU until point d.
• The employment level will fall DL
from QC to QU.
• An efficiency loss of abc will
also result.
• The more elastic is DL, the
larger is the employment
loss. As result unions try to QU QC Quantity of
reduce the elasticity of DL. Labor Hours