4.1.6 – the Labour Market

    74 – Demand for Labour – Marginal Productivity theory
    Demand for Labour is a Derived Demand
    • The demand for labour is driven by the demand for goods that the labour produces
    o So, if demand for good increases demand for labour does aswell
    Firms Only Demand Workers if they Make Money by Employing them
    • Marginal productivity theory states – demand for any factor of
    production is dependent on its MRP
    • Marginal Revenue Product = Marginal Product x Marginal Revenue
    o MP – additional output an extra worker gives
    o MR – Price per Unit of output
    • Marginal Cost of Labour – Cost of hiring one additional worker
    o In a perfect Market MC= wage paid to additional worker
    o The equilibrium wage on the diagram is We,Q1
    ▪ At this point the firm has the optimum number of workers to maximise profits

    Firms Demand for Labour is affected by Productivity
    • Firms Demand for Labour decreases if wages rise. However, it depends if the wage increase is accompanied by
    an increase in productivity
    o Higher levels of productivity reduce unit labour costs (costs per unit of output)
    • If wages increase but productivity rose the same amount,unit labour costs and Demand for labour stay constant
    o A worker’s wage is £10 and produces 10 cakes (unit labour cost = £1)
    o The worker gets a 10% wage rise but also has a 10% productivity rise
    o The worker’s wage is now £11 and produces 11 cakes (unit labour cost = £1)
    • High unit labour costs mean Low Productivity so reduce international competitiveness
    • Low unit labour costs mean High productivity so increase international competitiveness
    o If an industry in a country has high unit labour costs they will stop production due to the high
    international competition
    MRPL is the Demand curve for Labour
    • Anything Affecting MP or MR will Affect MRP
    o Changes in Labour Productivity – new tech or training increases demand for labour so shift MRP right
    o Changes in Cost of Labour – change in wages, training, uniforms and NI contributions shift MRP left
    o Changes in Price of goods sold – if demand for product falls and price falls then demand for labour falls
    Demand for Labour can be Elastic or Inelastic

    • When demand is elastic – small wage changes cause large changes in Quantity of Labour Demanded
    • When demand is inelastic – large wage increase will cause small changes in Quantity of Labour Demanded
    • Several Factors can Influence the Elasticity of Demand
    o If labour can be easily substituted with capital
    o Demand for labour more elastic in long run and inelastic in short run
    o PED of product has impact as a price elastic product means price elastic labour
    o If wages are a small percentage of total cost, then demand for labour is inelastic – Labour Supply

    Labour Supply can refer to an Individual or Occupation
    1. An individual’s labour supply = number of hours person will work at wage rate
    a. In short run, labour supply depends on individual’s decision to do work or leisure at given wage rate
    2. For an occupation, labour supply is number of workers willing to work in the occupation at the wage rate
    3. As the wage rate for an occupation rises, the quantity of labour supplied increases:
    a. Normally, individuals work more hours as wage rate increases
    b. Although individual workers have a limit to amount of labour they’re willing to supply
    i. High wages attract workers in occupation and increase the labour supply
    c. This causes supply to slope upwards

    Other Factors Affect Supply of Labour to a Particular Job or
    Factors affecting Supply of Labour Include:
    • Size of Working Population in an area or country
    • Competitiveness of wages – workers choose job paying highest
    • Publicising of Job Opportunities – Difficulty attracting sufficient workers to a job if not advertised
    Quantity of Labour Supplied Depends on Elasticity
    • Main determinant of labour supply elasticity is the level of skills and qualifications needed for a job
    o Low-skilled Jobs – supply of labour is elastic, so small wage rise causes a larger rise in labour
    supplied. As theres a large pool of low skilled workers, wage increases attract workers
    o Skilled Jobs – supply of labour is inelastic, due to large training time but increasing wages make
    more people attracted to study high skilled jobs
    • Mobility of Labour also affects Labour Elasticity
    o If Workers are occupationally mobile, then wage rises will cause greater increases in labour supply
    ▪ Labour supply will be elastic
    o If workers are geographically mobile, then wage rises will cause greater increases in labour supply
    ▪ Labour supply will be elastic
    Net Migration of Labour can Increase the Supply of Labour
    1. Net migration of workers into UK raises labour supply and reduced shortages of skilled workers
    2. It also helps with increased demand for seasonal workers i.e. agriculture and construction – Wages Rates & Employment Levels (perfect market)

    Market Forces can Determine Wages in a Labour Market
    • Theres many reasons why wage differences exist like:
    o Highly Skilled workers are paid more
    o Wages vary in different regions and between industries – (wages in London are higher)
    o A trade union influence wage rate paid to a group of workers
    • Wages higher if demand for labour is high and inelastic and supply is low and inelastic
    – Lawyers are paid high wages as they aren’t easily replaced, so supply is low
    – They have high MRP
    • Wages lower if demand for labour is low and elastic and supply is high and elastic
    – Office cleaners are paid low wages as they are easily replaced, so supply is high
    – They have low MRP
    Firms in a Perfectly Competitive Labour Market are Price Takers
    • The diagram shows equilibrium wage rate and level of employment for a perfectly competitive labour market
    and an individual firm:
    o In Diagram 1 the ruling market is determined by forces of demand and supply
    o Individual firms have no power to influence the wage level, so are price takers
    o The supply curve for a firm is AC&MC
    ▪ It’s perfectly elastic as firms can hire as many workers at the same wage rate
    ▪ The firm maximises profit where MC=MR so uses a quantity of Q1


    Monopsony Labour Market is an Imperfect Market
    • There is one buyer of labour so there’s one choice of
    employer to work for
    • A Monopsonist can pay a wage less than the workers
    MRP and less than that paid in a perfect market, they
    also employ less than a perfect market would
    • The wages and employment levels in a monopsony labour market are show in the diagram below:
    o MCL is above ACL, so the cost of one more worker is
    more than the AC
    o This is because each time an extra worker is hired they
    pay the worker a higher wage to attract them, but have
    to increase existing workers wage aswell
    o ACL curve shows the number of workers prepared to
    work at different wage levels (supply curve)
    o Firms hire where MCL=MRPL (W2, E2)
    o The wage (W3) is lower than the MRPL , the Monopsonist
    could pay a higher wage but doesn’t need to
    o So, Monopsonist are price makers

    Not all Economic Inactivity is Labour Market Failure
    • Economically inactive people are those who aren’t working so are a waste of labour
    • However, it can be good to be economically inactive e.g.
    o People in education add value to the economy when their skills increase
    o People looking after family members save the government money
    • But people with long term illness represent market failure
    • Discouraged workers who gave up finding a job are a waste of resources
    All Labour Markets suffer from Imperfect Information
    • Imperfect information is a source of labour market failure
    o Many workers aren’t in jobs that fit them best / or don’t pay enough
    o Employers have unproductive workers raising costs of production
    • Imperfect information increases frictional unemployment as longer time is spent researching other
    jobs but with perfect information its easier
    Skill Shortages Increases Cost of Production for Firms
    1. Shortages push prices up, therefore shortages of skilled labour raise wage costs for firms
    2. A shortage means firms are forced to employ unqualified workers reducing productivity and quality
    3. Training increases employee skills and make them more productive but firms don’t always do this
    4. Encouraging immigration will tackle skill shortages
    Unemployment Exists when Labour Supply > Labour Demand
    • Unemployed workers are a waste of resources and in an economy theres always unemployment
    o This helps keep wages low
    • The replacement ratio is how much a person would earn if unemployed to if employed
    o If the unemployment benefit is too high then the replacement ratio is too high so people stop
    working – this is the unemployment trap
    Geographically and Occupational Mobility
    • Geographical immobility is when workers can’t move location and this causes market failure as they
    accept a job they are overqualified for
    • Reasons for this
    o House prices too high
    o Friends and Family Ties
    • Geographical immobility leads to shortages
    o Areas with surplus – low wages
    o Areas with shortage – high wages
    • Occupational Immobility is when workers can’t change occupations
    • Reasons for this
    o Age
    o High level qualifications for some jobs (lack of transferable skills)
    o Automation

  – Influence of Trade Unions in Determining
    Wages and Employment Level

    Trade Unions Increase Bargaining Power of Workers
    • Trade unions represent the interests of a group of workers e.g. national union of teachers or Football Association
    • One main purpose of a trade union is to bargain with employers and get the best outcome for its members
    o The bargain for better pay, working conditions and job security
    • Collective bargaining = unions bargain with employers
    o Productivity bargains can be made, where unions agree to specific changes increasing productivity in
    return for higher wages or other benefits
    o Unions ensure health and safety requirements are met and help protect members from discrimination
    Trade Union Membership in the UK Peaked in 1970s
    • Trade unions are most powerful when they have a large membership
    • Their power has been reduced by the government but theres still 7 million members with unions
    o It reduced as workers now get flexible contracts and part time work
    Trade Union Wage Negotiations May cause Unemployment
    1. Trade unions can cause labour market failure by forcing wages above the equilibrium wage
    a. The increased wages raise cost of production
    b. The effect of trade union wage negotiations in a perfect market is shown below

    Pay Rises Negotiated by Trade Unions May Not Cause Unemployment
    1. Trade unions can help increase wages without causing unemployment
    a. To do this productivity of union members must rise
    b. This will prevent the excess supply of labour described
    2. Trade unions help persuade members agree more efficient working practices which increase worker productivity
    a. This could increase firms’ profits
    b. Increases in labour productivity shift MRP right so if a trade union raises the MRP of workers, then an
    increased wage is justified

    In Monopolistic Labour Markets Trade Unions Can Increase
    Wages and Jobs

    Monopolistic Employers Pays Workers a Wage Lower than their
    o A trade union would increase the wage rate and increase level of employment
    o When a trade union enters a monopolistic labour market it’s an example of a bilateral monopoly where
    theres one buyer (Monopsonist) and one seller (Union)

    • Presence of a trade union brings wage rate and employment levels closer to a free market, lowering welfare lose
    Trade Unions Less Likely to Cause Market Failure Today
    • Governments have given them less power so less influence
    • Trade unions made big changes in the workplace
    o In return for higher wages and better working conditions firm have benefited from a more productive
    and flexible workforce
    Increase in productivity may lead to increased demand for workers – reduces unemployment – National Minimum Wage

    Effects of a Minimum Wage
    1. In a perfectly competitive labour
    market, setting an NMW above market rate would cause
    2. In a monopsonistic labour market, an NMW will raise both wage rate
    and level of employment as long as it’s not above where MC=MR – Discrimination in the Labour Market

    Wage discrimination can Cause Lower Wage Costs for Firms
    1. Wage Discrimination is similar to Price Discrimination
    2. Wage discrimination takes place when employers with monopsony
    power pay different wage rates based on different workers willingness to supply labour
    a. Without wage discrimination all workers in a competitive market are paid We
    b. Total wage cost for firms is OWeALe
    c. When employers start to pay the minimum, each worker is prepared to work for (their transfer earnings)
    the total wage cost is reduced to OBALe (green area)
    d. Employers gain (economic profit) BAWe while workers lose out
    3. Wage discrimination is common when employees negotiate their own pay and conditions
    a. Some negotiate a higher wage than others (demand higher transfer earnings)
    4. People who might work for lower wages are normally:
    a. Young
    b. Part time
    c. Immigrants

    Labour Market Discrimination is a Cause of Labour Market Failure
    • Workers are discriminated due to race, gender, sexuality, religion, disability, age e.g.
    o Racial discrimination when employers want a particular ethnic background so pay a price for this
    o Gender gap pay is where average pay is higher for males than females
    • Discrimination can cause unequal distribution of wealth and income leading to misallocation, reduced efficiency
    and increased costs
    Workers Suffering from Discrimination Earn Less
    • Discrimination could mean finding a job is hard to accept one for a wage lower than there MRP
    Employers who Discriminate can Incur Increased Costs
    • Discriminated workers MRP value is incorrect
    • When demand falls MRP/Demand shifts left, so wages decrease for discriminated group
    o This discrimination means less workers to choose from, and they may not be as efficient so this
    raises cost of production. This cost is passed on in the price
    • The diagrams show the discrimination

    Discrimination Leads to Increased Costs for the Government and Economy
    • The government way increases welfare payments to support them
    • Workers with a low wage lower governments tax revenue
    • If workers are overqualified for a job allocative and productive productivity levels fall





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