3.5.3 Wage determination in competitive and non-competitive markets


    a) Diagrammatic analysis of labour market equilibrium
    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 market equilibrium is determined where supply of labour and the demand for labour meet
    Determines equilibrium price of labour, i.e. the wage rate

    But in the real labour market, wages aren’t this flexible
    Keynes coined phrase ‘sticky wages’
    Wages in an economy don’t adjust to changes in demand
    Minimum wage makes wages sticky and means during a recession, rather than lowering wages of several workers, a few workers might be sacked instead
    Equilibrium wages and an outward shift of labour demand
    b) Understanding of current labour market issues

    UK government aims to have as near to full employment as possible
    They account for frictional unemployment by aiming for an unemployment rate of around 3%.
    The labour force should also be employed in productive work
    Unemployment is a problem because if consumers are unemployed, they have less disposable income and their standard of living may fall as a result
    There are also psychological consequences of losing a job – could affect mental health of workers
    If unemployment rate increases, government may have to spend more on JSA, which incurs an opportunity cost because money could have been invested elsewhere
    Government would also receive less revenue from income tax, and from indirect taxes on expenditure, since unemployed have less disposable income to spend
    Unemployment creates an opportunity cost to society, since workers could have produced goods and services if they were employed
    Could also be negative externalities in the form of crime and vandalism
    Youth unemployment is particularly damaging, because it could lead to hysteresis
    • This is a type of structural unemployment, where someone is out of work for a long time, so their skills deteriorate • Makes it harder to find a job, and leads to long-term unemployment • If young people find it hard to get a job, then they might be discouraged from participating in the labour market as an adult

    Trade unions mean monopsonies have to employ more workers at higher wages – still less than the markets
    Monopsonies suppress and employ fewer workers

    c) Government intervention in the labour market:
    Maximum and minimum wages
    The National Minimum Wage is an example of a minimum price
    The minimum wage has to be set above the free market price, just like other minimum prices, otherwise it would be ineffective

    No evidence of a rise in unemployment with a rise in NMW so far in the UK
    Some firms say because the NMW is still relatively low
    NMW will yield positive externalities of a decent wage – will increase standard of living of poorest, and provide incentives for people to work
    But could make it harder for young people to find a job, because their lack of labour experience might not be valuable to firms who are paying more for their labour
    Government might make more tax revenue, due to more people earning higher wages
    Higher wages could make the country less competitive on a global scale, since they cannot compete with countries that have lower wages
    A maximum wage is also known as a wage ceiling – limits how much income someone can earn
    Can be used as a means to redistribute wealth more equitably in society
    In theory, a maximum wage should limit inflation, since wages (and so consumer demand) is limited
    Maximum wages must be set below the free market equilibrium wage to be effective.
    One criticism of a maximum wage is that it could be a disincentive to innovate, and workers might opt for less demanding work

    The free market equilibrium is at P1, Q1
    Maximum wages controls market wage – but could lead to government failure if they misjudge where the optimum wage should be
    Can lead to a more equal distribution of wealth in society
    Public sector wage setting
    The public sector is the compilation of industries owned by the government
    In the UK, public sector pay is higher than private sector, in raw terms.
    Across the UK, public sector pay is more equal than private sector pay
    About half of government spending goes towards public sector pay

    Policies to tackle labour market immobility
    Flexibility of labour market is how willing and able labour is to respond to changes in conditions of the market
    Important for labour to be able to adjust to changes in demand – vital for supply-side of economy

    d) The significance of the elasticity of demand for labour and the elasticity of supply of labour
    Wage rate and level of employment is affected by shifting the demand or supply curve differently, depending on how elastic the other curve is
    If labour demand is inelastic, because there are few or no substitutes, strikes will increase the wage rate but not affect the employment rate significantly
    Where there is inelastic demand for labour, a lower supply will lead to a higher increase in the wage rate (P1 → P3), than where there is a more elastic demand (P1 → P2)

    Elasticity of demand
    Elasticity of demand for labour measures how responsive the demand for labour is when the market wage rate changes
    Affected by:
    How much labour costs as a proportion of total costs
    • The higher the cost of labour as a proportion of total costs, the more elastic the demand • Labour costs are high as proportion of total costs in the services
    The easier it is to substitute factors, the more elastic the demand for labour
    • Because firms can easily switch to cheaper forms of production, such as capital
    PED of the product also affects labour
    • The more price elastic the product, the more price elastic the demand for labour
    Time period
    • In the long run – easier for firms to switch factor inputs (bring more capital in perhaps replacing labour)

    Elasticity of supply:
    Elasticity of supply of labour is the responsiveness of the quantity of labour supplied to a change in the wage rate
    Affected by:
    Skills of the workforce
    • Skilled jobs have lower elasticities than unskilled jobs, because it is more difficult to attract workers, since only a few have the necessary skills
    Length of training
    • The longer the training period for a job, the lower elasticity of labour supply
    Sense of vocation
    • Some jobs have rewards which aren’t financial like teaching – will have inelastic supplies
    Time period
    • In the short run, the supply of labour is more inelastic than in the long run
    Geographical and occupational mobility
    • Labour supply will tend to be relatively elastic even in the short term when labour is geographically and occupationally mobil








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