Labor Market Equilibrium

Labor market equilibrium is just another fancy way of saying that the prices of
labor and quantity of labor in the market have stabilized and will not change the
price or quantity. The labor market will reach equilibrium when the supply of labor
equals the demand for labor.

Video Transcript

Theory of Labor Market Allocation

A labor market is a market where people offer their skills to employers in

exchange for wages, salaries and other forms of compensation. Participants in the
labor market include any person who is seeking to work for compensation and any
person or organization that is looking for people to perform labor.

Under the standard labor market theory, labor is like any other resource. Generally
speaking, the market determines the allocation of labor and its costs. In other
words, the market determines where people will work and how much they will get
paid. Let’s take a look at the theory of labor market allocation.

Labor market theory is a model, and a model is a simplification of reality that we

use to try to understand a complex concept. A model will make some assumptions
to make things simple. The labor market theory is no different, and it makes a few
important assumptions:

 The most important motivation in the labor market for people is a wage or
other monetary compensation.
 Workers are pretty much fungible – you can substitute on another and it
makes little difference.
 Workers are mobile-they can move to where there is a demand for work
 Wages are flexible – they can go up or down

Now that we have our assumptions, it’s time to see how sellers (people seeking
employment) and buyers (employers) behave in the labor market under these
assumptions. But always keep in mind that these assumptions oversimplify reality
so that we can understand the way things work in general. If the assumptions are
not true for a particular set of circumstances, the model will not predict the correct
outcome. For example, some people consider the nature of the work more
important than the compensation being offered and may actually choose a lower
paying offer.

Explanations of how wages are determined and workers allocation to different

jobs. They provide explanations of why one group of workers, such as skilled
workers, earns more than another group, such as the unskilled. They also provide a
basis for the understanding of labor market problems such as discrimination,
poverty, and unemployment, and suggest policies that could alleviate them. The
current neoclassical theory of the labor market represents the mainstream approach
to labor market analysis. This theory had its origins in the work of the early
neoclassical economists such as Alfred Marshall and John Bates Clark during the
late nineteenth century. The concept of a market for a particular good is something
of a theoretical abstraction which enables economists to analyze exchange between
those people or firms who wish to buy the good, and those who wish to supply it.
In the labor market this exchange relationship is between firms who wish to
employ labor to produce output, and workers who are prepared to work at the
going wage rate.

Demand and Supply

The demand for labor follows the general economic law of demand. The price for
labor is inversely related to the quantity of labor available in the market. This is
just a fancy way of saying that employers will hire more people when wages go
down, and will hire fewer people when wages rise. In other words, demand for
labor increase as wages decrease, and demand for labor decreases as wages
increase.

It’s probably t too surprising to find out that the general economic law of supply
also applies to labor market. If the price of labor increases, then the supply of labor
increases. On the other hand, if the price of labor decreases, the supply of labor
will decrease. In other words, as wages increase, more people will enter the labor
market and compete for the higher-paid jobs, but if wages decline, fewer people
will seek to compete.

This is one of the reasons why overtime works-people are willing to give up some
of their leisure time if they are paid enough to do it.