UNIT 9 – THE LABOUR MARKET: WAGES, PROFIT AND
UNEMPLOYMENT
§ Price-setting firms produce differentiated products (unit 7)
§ The principal-agent model can explain conflict of interest between the employer
and the employee over a worker’s effort (unit 6)
§ Even in equilibrium, the supply of labour exceeds the demand for labour
§ Those without work in this situation = involuntarily unemployed
§ This is different to the people that are unemployed by choice, but are looking for
a job
9.1 THE WAGE-SETTING CURVE, PRICE-SETTING CURVE AND LABOUR
MARKET
Unit summary
• Model the labour market of an entire economy – this determines the extent of
unemployment in the population
• Look at price-setting firms selling differentiated products (unit 7)
• Look at a large number of identical workers who may be employed by firms for
the same wage set by the firm (unit 6)
Simplified assumptions:
• Labour is the only input in production
Þ Therefore, the only cost to firms = wage
• Profit = f(nominal wage; price of good; average output per worker per hour)
• Nominal wage = the actual amount received in payment for work in a particular
currency (money wage)
The labour market
• The labour market brings together:
1. The firm and its employees (unit 6)
Þ Wage set by firm must be sufficiently high enough so that employee earns
an employment rent (motivation)
2. The firm and its customers (unit 7)
Þ Firms must find the profit-maximizing mark-up (markup over production
costs) to determine what price to charge for their good (tradeoff between
selling more goods and setting a higher price)
• Employment rent = difference between the net value of a job and the net value
of the next best alternative, which is to be unemployed and having to search for
another job (also known as cost of job loss)
, Wages and employment
• How is the real wage and the level of employment in the whole economy
determined?
• Real wage = the nominal wage adjusted to take account of changes in prices
between different time periods. It measures the amount of goods and services
the worker can buy
!"#$!%& (%)* 5
• Real wage (w) = +,$-* &*.*& "/ % 01%!2%,2 34!2&* "/ )""20 = 6
• Wages and level of employment are determined through a two-step process:
1. Each firm sets their price, decides how many workers to hire and what wage
to pay them each
2. Adding together all these decisions across all firms gives:
Þ Total employment for the economy and the real wage
Details of the two-step process to determine wages and employment
Step 1 – performed by each individual firm in the economy
• Human Resources department determines the lowest wage it can pay (without
having a negative impact on workers’ motivation levels)
Þ This wage = nominal wage = f(prices of other firms’ products; the wages that
other firms are paying; unemployment rate in the country)
Þ The info about the nominal wage is sent to the marketing department
• Marketing department sets the price, based on the:
Þ Nominal wage
Þ Shape and position of the demand curve (elasticity of demand plays a role –
the more elastic the demand for the product, the lower the price will be, and
vice versa)
• Marketing department determines amount of output firm will sell (based on
production function) and communicates all info to the production department
• Production department determines how many workers to hire to produce the
amount of output as determined by marketing department
Step 2
• After all firms have made their price or mark-up (P) and wage (W) decisions, the
output per worker in the economy is divided into the real wage a worker receives
and the real profits that the owner receives
• If all firms are charging the same price and setting the same nominal wage, then
5 5
a higher real wage ( 6 ) means a lower mark-up (1 − 6
) for firms
*Adding together the individual decisions of firms is actually more complicated,
but this method is used to keep it simple
UNEMPLOYMENT
§ Price-setting firms produce differentiated products (unit 7)
§ The principal-agent model can explain conflict of interest between the employer
and the employee over a worker’s effort (unit 6)
§ Even in equilibrium, the supply of labour exceeds the demand for labour
§ Those without work in this situation = involuntarily unemployed
§ This is different to the people that are unemployed by choice, but are looking for
a job
9.1 THE WAGE-SETTING CURVE, PRICE-SETTING CURVE AND LABOUR
MARKET
Unit summary
• Model the labour market of an entire economy – this determines the extent of
unemployment in the population
• Look at price-setting firms selling differentiated products (unit 7)
• Look at a large number of identical workers who may be employed by firms for
the same wage set by the firm (unit 6)
Simplified assumptions:
• Labour is the only input in production
Þ Therefore, the only cost to firms = wage
• Profit = f(nominal wage; price of good; average output per worker per hour)
• Nominal wage = the actual amount received in payment for work in a particular
currency (money wage)
The labour market
• The labour market brings together:
1. The firm and its employees (unit 6)
Þ Wage set by firm must be sufficiently high enough so that employee earns
an employment rent (motivation)
2. The firm and its customers (unit 7)
Þ Firms must find the profit-maximizing mark-up (markup over production
costs) to determine what price to charge for their good (tradeoff between
selling more goods and setting a higher price)
• Employment rent = difference between the net value of a job and the net value
of the next best alternative, which is to be unemployed and having to search for
another job (also known as cost of job loss)
, Wages and employment
• How is the real wage and the level of employment in the whole economy
determined?
• Real wage = the nominal wage adjusted to take account of changes in prices
between different time periods. It measures the amount of goods and services
the worker can buy
!"#$!%& (%)* 5
• Real wage (w) = +,$-* &*.*& "/ % 01%!2%,2 34!2&* "/ )""20 = 6
• Wages and level of employment are determined through a two-step process:
1. Each firm sets their price, decides how many workers to hire and what wage
to pay them each
2. Adding together all these decisions across all firms gives:
Þ Total employment for the economy and the real wage
Details of the two-step process to determine wages and employment
Step 1 – performed by each individual firm in the economy
• Human Resources department determines the lowest wage it can pay (without
having a negative impact on workers’ motivation levels)
Þ This wage = nominal wage = f(prices of other firms’ products; the wages that
other firms are paying; unemployment rate in the country)
Þ The info about the nominal wage is sent to the marketing department
• Marketing department sets the price, based on the:
Þ Nominal wage
Þ Shape and position of the demand curve (elasticity of demand plays a role –
the more elastic the demand for the product, the lower the price will be, and
vice versa)
• Marketing department determines amount of output firm will sell (based on
production function) and communicates all info to the production department
• Production department determines how many workers to hire to produce the
amount of output as determined by marketing department
Step 2
• After all firms have made their price or mark-up (P) and wage (W) decisions, the
output per worker in the economy is divided into the real wage a worker receives
and the real profits that the owner receives
• If all firms are charging the same price and setting the same nominal wage, then
5 5
a higher real wage ( 6 ) means a lower mark-up (1 − 6
) for firms
*Adding together the individual decisions of firms is actually more complicated,
but this method is used to keep it simple
