Labour markets are markets for workers. Firms demand labour because labour is part of the production process. Workers supply labour to earn an income. The price of labour is the wage rate. At equilibrium, labour demand equals labour supply, the wage rate is W* and L* labour is employed.
Labour demand is the quantity of labour hours demanded by firms. The labour demand curve slopes down. As wages fall, the quantity of labour demanded rises, ceteris paribus. Labour demand slopes down because: – As wages fall, labour becomes relatively cheaper than machinery so firms use more labour and less machinery in the production process. – As wages fall, firms’ costs fall, firms can produce more goods so more labour is needed.
Labour supply is the quantity of labour hours supplied by workers. The labour supply curve slopes up. As wages rise, the quantity of labour supplied rises, ceteris paribus. Labour supply slopes up because the substitution effect is greater than the income effect. – The substitution effect: As wages rise, workers are incentivized to work more because they can earn more. – The income effect: As wages rise, workers can earn the same income as before by working less, so workers work less to enjoy more leisure time.
Market forces will push the labour market back to equilibrium if wages are too high or too low.
If wages are too low there is excess labour demand because firms demand more labour than workers want to supply. At W’, firms want more labour so firms bid up wages to attract more labour until equilibrium is restored at W*.
If wages are too high there is excess labour supply because workers want to work more than firms want to employ them. At W’, unemployed workers want to work, and current workers want to work more, so workers compete and bid down wages until equilibrium is restored at W*.
Labour demand may increase (decrease), causing the labour demand curve to shift right (left), wages to rise (fall) and employment to rise (fall).
Many factors could cause labour demand to increase:
1) Alternative Input Costs.
A change in the price of machinery could make labour demand increase or decrease. If machinery becomes cheaper relative to labour then firms could switch to using more machines and less labour. Although, if machines become cheaper and firms use more machines, they may need more labour to use the machines.
2) Technological Advance.
New technology could make labour demand increase or decrease. Machines could become so productive that machines replace labour so labour demand falls.2 Although, new machinery could make labour more productive and lower unit labour costs so firms demand more labour.
3) Labour Productivity.
As workers become more productive, unit labour costs fall, firms can produce more at the same cost so labour demand rises.
4) Output Demand.
Labour is a derived demand, that is, labour demand depends on the demand for the good it produces. A rise in the demand for a good means more labour is required to produce more of that good, so labour demand rises. Labour supply may increase (decrease), causing the labour supply curve to shift right (left), wages to fall (rise) and employment to rise (fall).
Many factors could cause labour supply to increase:
1) Working Conditions/Environment.
Better health and safety regulations, holidays, job security and promotion prospects all incentivize people to work and increase labour supply.
2) Income Tax.
As income tax rises, wages fall, the incentive to work falls so labour supply falls.
3) Unemployment Benefits.
Unemployment benefit is money given by the government to the unemployed. As unemployment benefits rise, the income from being unemployed rises so workers are discouraged from working and labour supply falls.
Migration means the population size increases and there are more economically active people so there are more workers in the labour market and labour supply increases.
Labour Mobility Geographical labour mobility refers to the ability of labour to move between areas to find/obtain work.
Occupational labour mobility refers to the ability to move between different types of jobs. For example, a footballer changing jobs to a university lecturer.