3.5 Labour Markets
Derived demand- demand for a factor of production such as labour as a result of demand for the final predict that that
FOP can produce. National living wage- minimum level pay above the minimum wage, employer sign up to NLW
foundation
Labour demand - number of workers employers are willing and able to employ at a given wage rate a given time
period
Human capital- The amount of skill, knowledge talent, experience and ability of workers. Can be inc through education
and training
Incentive scheme- motivational scheme for employees- to encourage inc productivity / efficiency / working to the
company objectives. Examples = share schemes, bonuses, commission on sales, additional holiday, company car formal
awards.
Income- the flow of earnings to a factor of production. Labour earns wages. Capital earns interest. Land earns rent.
Enterprise earns profit.
Informal labour markets- Also known as 'grey* market, shadow economy, or black economy. This is the part of the
economy that’S not taxed or regulated by GOV- doesn’t feature in GDP statistics for that country. People working in
informal labour market = likely to be paid in cash, may undertake work such as domestic cleaning / gardening,
babysitting, car- washing and is characterised by unstable employer-employee relationships. Informal work is often
vitally important to the poor.
Discouraged workers- people out of work for a long time who may give up on job search and effectively leave the
labour market= become economically inactive. See hidden unemployment.
Geographical mobility of labour- the ability of labour to move around an area, region or country in order to work.
Geographical mobility is affected by things such as family ties, transport networks, transferable qualifications and
common language.
Labour supply (to an industry / occupation)- the labour supply is number of hours people are willing and able to supply
at a given wage rate. The labour supply curve for any industry or occupation = upward sloping. As wages rise, other
workers enter this industry attracted by the incentive of higher pay.
Compensating wage differentials- Higher pay may be earned for relatively low skilled jobs if working conditions are
unsociable, unpleasant or dangerous, whereas lower pay = earned for higher skill jobs if working conditions are nice,
flexible and safe.
Demographic changes- Any change in population e.g. in terms of average age dependency ratio, life expectancy,
family structures, birth rates etc.
Discrimination- the different treatment of people as a result of factors: age, gender, race, sexual orientation, ethnicity.
Earnings- earnings are made up of wages plus overtime pay, bonuses and commission.
Economic rent- any amount and by a FOP, such as labour, above minimum account they require to work in our current
occupation.
Economically inactive- These who are of working age but on neither in work nor actively seeking unpaid work.
Effective marginal tax rate- tax rate on each extra £1 of income –considers impact of direct taxes (such as income tax)
,Efficiency wage- as theory suggests it may benefit from support workers a wage higher than the marginal one of
your products. Paying a higher wage improves workers morale - can lead to a high quality of people applying for new
jobs as they become available.
Elasticity of labour demand- Elasticity of labour demand measures responsiveness of demand for labour
(employment) when there is a change in the wage rate.
Flexible labour market- Labour market that adjust quickly to changes in the demand for and supply of labour.
Economically inactive- These who are of working age but on neither in work nor actively seeking
Characteristics include flexible employment contracts and flexible pay.
unpaid work.
Full employment- when there are enough unfilled job vacancies for all the unemployed to take paid work.
Effective marginal tax rate- tax rate on each extra £1 of income –considers impact of direct taxes
Gender pay(such
gap-as income tax)
difference but also
between possible
male withdrawal
and female of means
earnings, usuallytested welfare
expressed as abenefits if people
percentage takeearnings.
of male a
paidgender
In the UK, the job. High
pay effective
gap is onmarginal
20% tax rate = root cause of the U/E trap - disincentives to find work.
Imperfectly competitive market- A Labour market in which workers or firms have the power to set and marginal
revenue product theory. Imperfections in the labour market can include monopsony trade unions, discrimination, poor
information and skills shortages which can transfer power to the workers (suppliers of labour) and allow them to
demand higher wages in return for the labour.
Labour market failure- A labour market in which there isn’t an efficient allocation of resources. Reasons for labour
market failure- Discrimination, Economic Inactivity, skills shortages, action of trade unions, action of monopsony
employers, Labour Immobility (geographical and occupational
Labour arket flexibility - speed and agility of a labour market to respond to a change in economy. Flexibility = essential
for good supply side performance in economy. Flexibility = flexibility in terms of occupations, skills, location, number of
hours work, pay arrangements etc.
Living wage- wage that provides enough money for a working person to live decently and provide for their family the
wage rate is estimated to be £9 per hour outside of London and £11 per hour in London in 2019
Maximum wage- a wage set below equilibrium wage rate outcome would be excess demand for labour, labour
shortage . bilateral monopoly- single buyer faces a single seller in the market
Migration- movement of people especially workers between countries
Immigration- refers to people entering a country
Emigration-refers to people leaving a country
Net migration- refers to difference between number of people entering and leaving a country
Minimum wage- wage set above equilibrium wage rate outcome is excess supply
Monopsony employer- a labour market structure in which the single powerful buyer of a particular type of labour e.g.
main buyer of the nurses and doctors = NHS monopsony employer will tend to pay relatively lower wages unemployed
your people thn in highly competitive market
NEET- A young person (usually between 16 and 24) who is Not in Employment, Education or training. There are around
900 000 NEETs in UK
Nominal wages- also known as money wages: the actual hourly rate of pay - it is not adjusted for inflation.
Pension- payment made to people who have retired from work in UK.
Total physical product- total output of a given quantity of FOP
Marginal physical product- extra physical output of an extra unit of variable factor of productin
Marginal revenue product= p (MR) * Marginal physical product
,Reasons why the Labour Demand Curve Slopes Downwards
In in the short run the labour demand curve = downward sloping due to the law of diminishing returns. The law of
diminishing returns states that in the short run (where there is at least one fixed FOP, as variable factors of
production are added to a stock of fixed factors of production, total/marginal output will initially rise and then fall.
This is significant = marginal revenue product (MP) curve (MP of each worker * by MR) follows same pattern as the
marginal product curve. A profit maximising firm will only employ workers up until the MRP of the last worker hired
is equal to the wage rate. Therefore a worker's MRP determines whether they will be employed or not at a given
wage rate by a firm i.e. the MRP curve is the demand curve for labour in the short run.
In figure 1, as wage rate increases from W1 to W2= contraction of demand for labour with less employment from Q1 to
Q2 as only workers with a high MRP Will be employed whereas when wage rate decreases from W1 to W3= extension
of labour demand with greater employment from Q1 to 03 as workers with a lower MRP will be employed whilst still
meting the profit maximising condition for the firm.
In the long run all FOP= variable therefore demand curve labour is downward sloping due to substitutable nature
between workers and capital machinery in figure 2 as wage rate increases from W1 to W2 = contraction of labour
demand and less employment from Q1 to Q2 = find it more profitable to hire machine instead of workers whereas
when wage rate decreases from W1 want to W3 = extension of labour demand with greater employment from Q1 to
Q3 = more profitable for firms to hire workers instead of machines
Evaluation of Marginal Revenue Product (MRP) theory
MRP theory suggests that firms will only demand workers if the MRP of the worker is at least equal to the wage rate.
Measuring and mapping MRP provides information regarding employment at different wages. However this theory
does not always apply.
1. It’s very difficult in jobs such as teaching and nursing to measure productivity and MRP as nothing physical is
being produced - idea that employment is decided based on MRP does not hold
2. Many jobs in the real world aren’t individual; teamwork based= very difficult to measure the MRP of each
individual worker and therefore for firms to use MRP is to make efficient employment decisions
3. The existence of trade unions create imperfections in the labour market ignoring the profit maximising
condition which determines employment for firms instead forcing of wages using collective bargaining and
demanding more employment using strije action as a threat- trade unions work against the idea of a
downward sloping demand, employment is based on MRP at a given wage rate
4. MRP theory suggest a rational profit maximising employers will only pay workers a wage equal to their MRP
never more and sometimes less this doesn’t hold for self-employed who may pay themselves much more than
their MRP as their objectives are clearly different to a larger scale profit maximising corporation
, The labour market is a factor market. The supply of labour is determined by those who want to be employed (the
employees), whilst the demand for labour is from employers.
Labour is a derived demand. This means that the demand for labour comes from the demand for what it produces.
For example, the demand for people who make cars is derived from the demand for cars. With no demand for cars,
there will be no demand for car manufacturers.
Demand is related to how productive labour is and how much the product is demanded. The elasticity of demand
for labour is linked to how price elastic the demand for the product is. The wage rate will lead to movements along
the supply and demand curves for labour. All other factors will shift the curves.
Factors affecting demand for labour: how MRP will be impacted
The wage rate:
§ downward sloping demand curve shows inverse relationship between how the worker is paid and number of
workers employed. As wage rates increase, demand for labour contracts since MRP of labour must be higher for it
to be worthwhile employing more people, so less people are employed.
Labour Demand Curve - Non Wage Factors that Shift the Curve (Think PDPC)
1) Productivity directly affects an individual's MP by influencing marginal product. If labour productivity increases,
the MP of workers rise- increases willingness and ability of firms to hire workers at a given wage rate, shifting the
labour demand curve to the right from D1 to D2.
2) Demand for the final product. Labour is a derived demand, derived from the demand for goods and services
produced. If the demand for the final product produced increases, so will demand for labour, increasing the
willingness and ability of firms to hire workers at a given wage rate, shifting the labour demand curve to the right
from D1 to D2.
3) The price of the final product directly affects MRP by influencing marginal revenue. If the final price of a product
increases, the MRP of workers rise. This increases the willingness and ability of firms to hire workers at a given
wage rate, shifting the labour demand curve to the right from D1 to D2.
4) Cost of capital is an important of labour demand in the long run. If capital becomes more expensive, workers can
substitute for capital; a more profitable decision by firms, inc the willingness and ability of firms to hire workers at
a given wage rate, shifting labour demand curve to the right from D1 to D2. Substitutes for labour: If labour can
be replaced for cheaper capital, then the demand for labour will fall. This will shift the demand curve for labour to
the left:
5) How profitable the firm is- higher profit = more labour they can afford to employ
6) Wages in other countries: If wages are lower in other countries and therefore wages in the UK are relatively high,
people will be employed in other countries as it represents a lower cost for businesses. This means that demand in
the UK is low.
7) Technology: Improvements in computers and technology means that many jobs have been lost with the work being
done by machines. This means that there is less demand for labour, but demand for labour in technological based
industries is increasing. By 2040, about 47% of jobs could be lost to technology.
8) Regulation: As laws are passed some jobs disappear, such conductors, whilst other jobs are made. High regulation
within the labour market is likely to discourage firms from hiring since it can be very costly and time-consuming so
this will reduce demand for labour in these areas. France is a country that used to have high levels of labour
regulation and this is something the new president, Emmanuel Macron, is trying to change.
,Determinants of Wage Elasticity of Demand for Labour (Think SECT)- responsiveness of the quantity demanded of
labour to the wage rate. %change in QD/ %change in wage rate
1) Substitutability between labour and capital. As wages rise labour demand= responsive and fall proportionately
more than the wage increase if labour and capital machinery are easily substitutable wage elastic demand. High
skilled jobs tend to be more inelastic than low skilled jobs as the labour cannot be easily replaced.
2) Price elasticity of demand (PED) for the final product. If the PED for the final product is price inelastic, an increase
in wages for workers in the industry can be passed onto the consumer via a higher price as demand will not fall
considerably with revenue and profit increasing. Therefore labour demand will decrease but proportionately less
than the wage increase, wage inelastic demand in this case. Low PED- still inelastic demand for labour
3) Labour costs as a proportion of total costs. If labour costs are a large percentage of total costs, as wages rise, firms
need to reduce employment in order to stay profitable where the fall in labour demand will be proportionately more
than increase in wage; wage elastic demand.
4) Time period. In the short run normally two factors of production are fixed: land and capital. Therefore workers
cannot be easily substituted for capital as wages rise, making labour demand wage inelastic. However in the L/R
as wages rise, demand for labour will fall proportionately more than the increase in wage as all FOP = variable.
This means that capital can substitute for labour, thus labour demand is wage elastic.
Factors making demand for labour wage elastic:
§ If labour and capital are easily substitutable – an increase or decrease in the wage rate will have a proportionately
larger percentage increase or decrease in the demand for labour= wage elastic demand
§ If PED is elastic then an increase in the wage rate will mean that firms cannot easily pass on cost increases in the
form of higher prices – as PED is very responsive, labour demand will decrease but proportionately larger than the
wage increase= wage elastic demand
§ If labour costs are a large percentage of total costs, as wages rise, firms need to reduce employment in order to
stay profitable where the fall in labour demand will be proportionately more than increase in wage, wage elastic
demand.
§ Long run - FOP become variable- land and capital. As wages increase workers can be easily substituted for
capital, leading to a proportionately larger decrease in the demand for labour= wage elastic demand
Factors making demand for labour wage inelastic
§ If labour and capital aren’t easily substitutable – an increase in the wage rate will lead to a fall in demand for
labour but proportionately less than the wage increase= wage inelastic demand
§ If the PED for the final product is price inelastic, an increase in wages for workers in the industry can be passed
onto the consumer via a higher price as demand will not fall considerably with revenue and profit increasing.
Therefore labour demand will decrease but proportionately less than the wage increase,
§ If labour costs are a small percentage of total costs, as wages rise, firms do not have to reduce employment to stay
profitable thus labour demand will fall but proportionately less than the wage increase= wage inelastic demand
§ short run normally two factors of production are fixed: land and capital. Therefore workers cannot be easily
substituted for capital as wages rise, making labour demand wage inelastic
When demand for labour is elastic, small wage changes can cause large changes in the quantity of labour demanded.
When it's inelastic even large wage changes only cause small changes to the quantity of labour demanded.
,Labour supply- number of workers willing and able to work in a profession at a given wage rate in a given time period
Individual Backward Bending Labour Supply Curve
Individuals = make decisions over the number of hours they are willing to work at given wage rates based on their
willingness to work or enjoy leisure time. There are two effects that determine the final decision and explain the shape of
the individual labour supply curve:
§ Income Effect where incomes rise as the wage rate rises, increasing the incentive to work more hours and earn a
higher income but given the notion that individuals can have target incomes, the income effect can be negative at
very high wage rates where workers choose to work to less hours to reach their target income.
§ Substitution Effect where the OC of leisure time increases as the wage rate rises always providing an incentive to
work. The substitution effect is always positive.
The shape of the individual labour supply curve can be explained by breaking it up into three sections.
Section 1 shows - wage rate increases, hours
worked increase quickly too- income effect is
positive where individuals need to work to earn
an income and boost living standards.
The substitution is positive also where the
opportunity cost of leisure time increases as the
wage rate increases providing the incentive to
work instead of taking leisure time. The overall
wage effect is therefore positive where hours
worked increase as the wage rate rises
Section 2 shows that as the wage rate increases hours worked increase but at a slower rate- income effect becomes
slightly negative as workers start to reach their target incomes at higher wage rates therefore as wages continue to rise
they can work less hours and still hit their target income this is just starting to happen in section 2 but is dominated by a
larger positive substitution effect. Therefore the overall wage effect remains positive where hours work increase as the
wage rate increases but not as strongly as in section 1. W1 to W2- positive substitution effect > negative income effect
Section 3 shows that as wage rate increases, hours worked decrease= income effect become strongly negative as
workers- hit target income= comfortably reduce number of hours work to remain at target. At very high wage rates,
even as the substitution effect becomes positive the negative income affect outweighs it meaning overall wage effect
is negative where hours worked decrease as wage rate increases and the individual labour supply curve bends back on
itself. Negative income effect > positive substitution effect
Reasons why the labour supply curve slopes upwards:
income effect is always positive where incomes rise as
the wage rate rises, incr incentive to work more hours
and earn a higher income. The idea that individuals
have a target income and thus may work less at a
higher wage rate is offset in the market.
Substitution effect is always positive where the
opportunity cost of leisure time increases as the wage
rate rises, always providing an incentive to work
instead of enjoying leisure time
,Labour supply curve- non wage factors that shift the curve (THINK SIMBAPOV)
1. Substitute's wage. If the wage in substitute occupations decreases, more workers will be attracted into the
market as the earning capacity is greater. The willingness and ability to work increases at the same wage rate,
shifting the labour supply curve to the right from S1 to S2
2. Incentives. If there are non monetary benefits to the job as well as a suitable wage, workers will be attracted
into the market. Such perks could include a company car, private healthcare, a good pension plan, flexible
holiday leave, free lunches etc which increase the willingness for workers to enter a profession, shifting the
labour supply curve to the right from S1 to S2.
3. Mobility of Labour. If more workers gain skills and qualifications necessary to work in a given profession, labour
supply will increase or if the workforce generally becomes more educated the willingness and ability of workers
to take jobs in a profession increases, shifting the labour supply curve to the right from S1 to S2
4. Barriers to Entry. If barriers to entry into a profession are high, it becomes more difficult for workers to enter
that industry. If to become a hotel receptionist for example, requirements are for individuals to able to speak a
variety of languages, experience required is high and computer proficiency expectations- high, several people
who want to work in this job may not be able to, shifting the labour supply curve to the left from S1 to S3.
5. Ability to work overtime. Overtime opportunities = lucrative as an extra earner for workers. such opportunities
exist, willingness of workers to enter profession increases, shifting labour supply curve the right from S1 to S2
6. Size of the working population. If the size of the working population increases due to immigration of people of a
working age for example, the number of people who are willing and able to work in a given profession
increases, shifting the labour supply curve to the right from s1 to 52.
7. Value of leisure time. If individuals value leisure time less and consider working and earning income to be
important, the willingness and ability to work inc in labour market- shifting labour supply to the right from S1 to
S2
8. Trade unions: Trade unions may be able to restrict the supply of labour by introducing barriers to entry, for
example you have to have a degree for teaching.
9. Wages and conditions of other jobs: If many jobs in a local area are considered to be unpleasant and offer low
wages, then supply for alternatives will be higher.
10. Legislation: government rules can affect supply of labour, for example school leaving age and the retirement age.
11. Education/training/qualification: More educated workers means there is a higher supply of workers
Determinants of Wage Elasticity of Supply (Think POLVOTS)- responsiveness of supply to a change in wage rates.
1. Pool Of potential workers that could enter the profession is high, as wage increases= proportionately greater
increase in labour supply than the increase in wage- labour supply wage elastic
2. Length of the training period strongly determine responsiveness of workers to higher wage rates. If length of the
training period is high to enter a profession, higher wage rates will attract workers to enter but such a long
training period will detract the majority from actually entering. Therefore as wages rise, labour supply will increase
but proportionately less than the wage increase; wage inelastic labour supply.
3. Vocational element to the job. Professions -, vocational element - teaching, holidays reps for example - tend to
have more wage inelastic supply= wage isn’t a fundamental consideration when deciding to take the job or not,
thus if wages fall, supply will decrease but proportionately less than wage decrease = wage inelastic labour supply
4. Time. Professions where it takes time to exit the industry - influence workers responsiveness to lower wages or
higher wages in other occupations. If wages decrease but notice times needed are long- can force a worker to
remain the job for a period of time before leaving. short run therefore as wages fall, supply will decrease but
proportionately less than the wage decrease implying wage inelastic labour supply.
5. Nature of skills required. This again can strongly determine the responsiveness of workers to higher wage rates. If
the nature of skills required is high to enter a profession, higher wage rates will attract workers to enter but such a
strict skills requirement will detract the majority from actually entering. Therefore as wages rise, labour supply will
increase but proportionately less than the wage increase; wage inelastic labour supply.
,Wage elastic supply:
1) Large pool of potential workers
2) Small training period
3) Non vocational elements
4) Low skills
5) L/r- easier for people to respond to wages
Wage inelastic supply
1) Very specific skills required
2) Little pool of potential workers
3) Long training period
4) Working in vocational professions
5) S/r – immediately after a wage decreases- labour supply may decrease but proportionately less than wage
decrease- contracts
,Market failure:
§ The labour market should operate in the same way as any other. An increase in wages should attract labour to
the industry and a fall in labour should mean labour leaves industry. However, labour is not a perfectly free
market.
Immobility:
§ Labour can suffer from either occupational or geographical immobility.
§ They can suffer from occupational immobility where workers find it difficult to move from one job to another
because of a lack of transferable skills. It is particularly difficult in S/T when workers need to get new training
but in the L/R it may only be possible at a high cost.
§ Moreover, they can suffer from geographical immobility where they find it difficult to move from one place to
another due to the cost of movement, family etc. There may be no jobs available in Glasgow, but jobs in London.
Unfortunately, someone from Glasgow will struggle to get a job in London as they may not know about the
vacancies, it would be expensive to attend interviews and they would have to leave their family behind. Housing
is also a big issue because people may not be able to afford to buy a house in their new area. They may also
struggle if they need to find social housing and it is difficult for young people, since they often do not have the
money to move out of their parents’ home. In general, those on lower incomes are more geographically
immobile.
§ Immobility can mean that there can be excess supply of labour in one area/occupation and excess demand in
another. Even if wages are higher where there is excess demand, people will be unable to leave where there is
excess supply to get a job in that area/occupation because of their immobility.
§ Low wages. Poverty. Discrimination. Underemployment. Unemployment. Lack
Labour market issues: of skills. Decrease in productivity, monopsony, trade unions
§ Skills shortages: The UK suffers from geographical and occupational immobility, which means that even if there
are enough engineers, there aren’t enough engineers in certain areas.
§ Young workers: Workers who join the workforce during recessions tend to receive lower lifetime earnings than
those who enter the labour force in better times. Youth unemployment can be a particular issue; during hard
times, firms are unlikely to employ new workers but are reluctant to let go of their current workers and so the
young struggle to get a job.
§ Retirement: Rising life expectancy and an increase in the number of people reaching retirement age, as the ‘baby
boomers’ reach retirement, has negative effects on the government budget. Pensioners now makeup over 50% of
welfare spending. The
§ Wage inequality: Over time, those on the highest wages have seen their wages grow by a bigger percentage
than those on the lowest wages. This is a contentious issue and raises questions over relative poverty and the
level of redistribution required.
§ Zero-hour contracts: There has been a rise in zero-hour contracts and this causes problems for employees who do
not know how much they will earn a week and receive little notice of when they will be required to work.
§ The ‘Gig economy”: Many more people are now self-employed and undertake short term contracts, working for
companies such as Uber and Deliveroo. There are concerns over the rights of these workers and the unreliability
of their pay each week.
§ Migration: Many people suggest that migration causes a fall in wages but it allows employers to recruit from a
larger pool of workers and helps to fill skills shortages. There are also issues over the correct level of
unemployment, underemployment, the minimum wage, conditions in work etc.
, Perfectly Competitive Labour Market Characteristics
1) There are many (infinite) suppliers of labour (workers) to the market and many hirers of workers (employers). -
firms must compete with one another to offer wages that attract workers they need and that workers do not
have excessive bargaining power to push up wages as there’s alternative, competing supply.
2) All workers in the industry are homogenous with identical skill sets. Together with many workers and
employers, firms = wage takers - no ability to exercise power in market by setting own wages. Makes no sense
for firms to offer a wage higher than equilibrium market wage - workers are homogenous and so firms will be
paying higher when other workers could’ve been hired at a lower wage. Offering a lower than equilibrium
wage, firms - not able to attract workers to work for them- workers move to substitute employer offering
higher equilibrium wage= MC and AC for firm operating in perfectly compe firm = wage - drawn horizontally.
3) There is perfect knowledge of market conditions for both workers and employers/ perfect mobility of labour.
Workers know wages on offer in all professions and requirements with perfect mobility of labour between
professions, wage differentials in economy won’t exist in l/r. Higher wage rates= signal for workers to leave
industry and enter profession where wages are higher, lowering supply in the lower wage industry and enter
profession where wages are higher, lowering supply in higher wage profession closing wage differential
4) Firms are profit maximisers- choosing only to employ workers where they’re needed- only employ workers up
until where the MRP= marginal cost of labour (MRP= MC1). Hiring beyond this point- cost of employing
workers = higher than the revenue workers make for firm = reducing profit. Employing at a level below this –
will not maximise profit as further employment= generate revenue from workers greater than cost of
employment thus more profit is possible with more employment up until MRP=MC1
5) There are no barriers to entry/ exit. No extra skills/ qualifications needed. - no cost, time periods= free to exit
Wage Determination in a Perfectly Competitive Market
Firms operating In a perfectly competitive labour market are wage takers, taking the wage from the market itself
and offering that to its worker. Thus wage rate is also MC, AC and supply curve. A profit maximising firm will employ
workers up until MRP=MC1. If all labour markets were perfectly competitive there’d be no wage differentials at all.
Thus existence of wage differentials between professions, genders and ethnic group suggest labour market
imperfections in the real world
