Labor Market:

Wages in Perfect Competition

Microeconomics
 Objectives

● Define labor market

● Identify the determinants of market
wage rates
● Explain why workers have different
wages
Circular Flow Diagram
 Labor Force
● Labor Force – refers to the population 15 years old and over who contribute to the
production of goods and services in the country. It comprises the employed and
unemployed.
○ Employed – consists of persons in the labor force who are reported either as
at work or with a job or business although not at work. Persons at work are
those who did some work, even for an hour during the reference period.
○ Unemployed – consists of persons in the labor force who are reported as
■ Without work
■ Currently available for work
■ Seeking work or not seeking work because of the belief that no work is
available, or awaiting results of previous job application, or because of
temporary illness or disability, bad weather or waiting for rehire or job
recall
 Labor Force
● Persons not in the Labor Force – persons 15 years old and over who are neither
employed nor unemployed according to the definitions mentioned. Those not in the
labor force are persons who are not looking for work because of reasons such as
housekeeping, schooling and permanent disability. (housewives, students, persons
with disability, or retired persons)
 Labor Market Equilibrium
● Labor Demand – when the price of labor increases,
the related quantity of labor decreases, which
makes the relationship inversely related.
● Labor Supply – if the price of labor increases, the
supply of labor will also increase.
● Individuals will work more when the wage is high,
while firms will prefer to hire when the wage is
low.
● The point of equilibrium is called the market
clearing wherein firms may hire an employee at
the existing wage rate and people who would like
to have that wage rate would be able to do so.
Labor Market Equilibrium
 What Determines Market Wage Rates?
● Firms set wages and offer a competitive package as this
can have an effect to the worker’s motivation and
retention ultimately benefiting the company.
○ Higher wages improve worker morale and effort
○ Higher wages reduce worker resignation and labor
turnover costs
○ Higher wages attract more applicants

● Compensation differential – the difference in wages

that arises to offset the nonmonetary characteristics of
different jobs (Mankiw, 2005).
 THE EFFICIENCY-WAGE THEORY
● Developed by economists Carl Shapiro and Joseph
Stiglitz (1984), explains that it would be beneficial for
firms to pay workers above the equilibrium wage rate to
encourage workers to work more efficiently and make
more profit firm.
○ Reduce worker turnover
○ Increased quality of the worker in terms of
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