The Labour Market
The demand for labour
Demand for labour as derived demand
• Demand for labour derived demand (demand good/factor production as consequence demand something else).
➢ Assuming profit maximising objective for firms, can be no demand for labour long-run unless firms employing labour sell
outputs produced for at least normal profits in goods market.
Marginal productivity theory and demand for labour
• Marginal physical product of labour (MPPL): addition to firm’s total output by employing one more worker
➢ Law diminishing returns/diminishing marginal productivity operates as firm employs more labour when capital held fixed.
• Marginal revenue product of labour (MRPL): money value addition to firm’s total output employing one more worker (MPPL x
MR).
➢ Assuming perfectly competitive goods/labour market, MR identical to price (horizontal MR curve).
Deriving the MRP curve of labour when the goods market is imperfectly competitive
• Perfect competition, slope MRP curve explained solely by diminishing marginal physical product labour (by law diminishing
returns).
• If output sold in imperfectly competitive goods market, MRP labour declines faster than perfectly competitive. As marginal
revenue earned selling extra worker’s output also falls as output increases.
• Firm faces downward sloping demand curve for its products, therefore reduce price product order sell extra output worker
produces. 2 reasons for MRPL curve fall as employment increases.
What the demand curve for labour shows
• Shows relationship between wage rate + no. workers employed. Lower wage rate, more employability.
• Whenever more than one employer in labour market, market demand curve labour in different position from single firm’s
demand. Since each firm’s demand labour shown by MRPL curve facing firm, addition all MRPL curves = market demand labour.
Shifts of market demand curve for labour in different labour markets
• A change in labour productivity: if labour productivity increases, more labour demanded at each wage rate and demand curve
for labour shifts right.
➢ Same occurs when MR increases (derived demand – demand increase good labour producing, raises price product,
increase demand labour).
➢ Market demand curve labour also shifts right.
• A change in technology: if technological progress makes labour more productive relative to other factors production, firms
likely substitute labour other factors production, demand increases.
➢ Technical progress likely improves productive/dynamic efficiency (reduce cost making product), if leads to lower prices +
higher demand product, likely demand labour increase.
➢ Opposite effect, causing firms substitute capital for labour (automated methods production), increases productivity
capital relative labour. Reduce demand labour, left shift.
➢ Also increase demand certain types labour at expense workers other skills (may lose jobs). Technological unemployment
part of process creative destruction.
The elasticity of demand for labour
E of D Labour: proportionate change in quantity labour demanded following proportionate change wage rate.
• Demand labour likely inelastic:
1) Relevant wage cost forms only small part total production costs (‘importance being unimportant’).
2) Demand for good/service being produced by labour inelastic
3) Difficult substitute other factors production or other types labour, for labour currently employed
4) Short run, often takes employers time adjust methods production
Influences of the supply of labour to different labour markets
Market supply labour: shows how much labour all workers in labour marker plan supply at different wage rates.
Monetary and non-monetary considerations
• 2 factors influencing amount labour workers willing supply: money wage rate + utility/economic welfare derived (non-
monetary benefits).
• Different types work yields different levels job satisfaction. Enjoy job, net advantage work greater than welfare yielded by
wage. Worker willing work money wage lower than wage acceptable if no satisfaction from work itself.
, • Supply labour reflects fact that wage rate must be high enough to compensate unpleasantness of some jobs (such as assembly-
line work).
• At the margin, to maximise personal welfare, worker must supply labour up to: Utility welfare last unit earned = Utility welfare
last unit leisure time sacrificed.
• Higher wage provides incentive work more hours. Higher wage rate, at margin, welfare derived from wage greater than welfare
derived last unit leisure time enjoyed.
• Maximise personal welfare at higher wage rate, worker expected supply more labour + enjoy less leisure time. Result upward
sloping supply curve for labour.
• Individual workers job choice depends on utility they expect derive from money wage rate + job satisfaction or dissatisfaction in
different occupations.
Shifts of market supply curve of labour
• Factors include: benefits of job security, promotion prospects, good working conditions, holiday entitlement + other
psychological benefits of work. Improvements these benefits shift supply curve labour to right.
• Generalising, if people decide they value leisure more highly, they’ll work fewer hours at each wage rate + supply curve labour
shifts to left. If decide want more goods + services, likely shift to right.
• Changes in income: rise in income increases demand for leisure, causes supply shift left. For few people, leisure time may be
inferior good: higher income reduces demand leisure time + supply more labour.
• Change in population: rise in population (perhaps immigration) increases supply labour; reduction lowers it. Fall in no. people
working age causes labour SC shift left; except if offset by those who’ve reached retirement age deciding work longer order
finance eventual retirement.
• Changes in expectations: if older people expect live longer yet become less optimistic about future pensions, may increase
labour supply. Rise in proportion people staying in further/higher education tend reduce supply labour.
Elasticity of supply of labour
E of S labour: proportionate change quantity labour supplied following proportionate change wage rate.
Factors determining wage E of S labour:
• Supply unskilled labour usually more elastic than supply particular type skilled labour (training period unskilled short, innate
abilities required unlikely restricted to small proportion total population).
• Factors reducing occupational/geographical mobility labour tend reduce elasticity labour supply
• Supply labour likely more elastic in long run than short run
• Availability pool unemployed labour increases elasticity supply labour, full employment opposite effect.
Perfectly competitive labour markets
• Perfectly competitive labour market, if were to exist, have to meet all following conditions at same time
1) Large no. buyers/sellers
2) Unable influence ruling market wage
3) Operating conditions perfect market info
4) Employers/workers free enter labour market in long run, but unable influence ruling market wage through independent action.
• Impossible for these requirements be met simultaneously, hence don’t exist real world.
• Some labour markets, such as market for fruit pickers in region/district (very large no. orchards), approximate to perfect
competition, but nevertheless not perfectly competitive.
How ruling market wage affects perfectly competitive firms
• Firm employing workers in perfectly competitive labour market, firm ‘buy’ as much labour as
wishes employ at ruling market wage. Hence each employer face perfectly elastic supply labour,
passively accept ruling market wage.
• Supply labour also average (ACL)/marginal cost labour (MCL) at ruling market wage.
Equating MRPL with wage rate
• To maximise profit when selling output produced by labour, each firm have to demand labour up to point which: MRPL = MCL
• Marginal revenue product labour (MRPL) is marginal benefit accruing to employer when hiring extra worker.
• Marginal cost of labour (MCL) is marginal private cost incurred by each firm. Since in perfectly competitive labour market, MCL
= W (wage rate).
• Considering if firm willing employ labour force larger than Q: additional workers MCL>MRPL, total profit fall (employ less).
• Workforce below Q, MRP>MCL, total profit increase if more employed.
• MRP facing each firm = firms demand curve labour
The role of market forces in determining relative wages
The demand for labour
Demand for labour as derived demand
• Demand for labour derived demand (demand good/factor production as consequence demand something else).
➢ Assuming profit maximising objective for firms, can be no demand for labour long-run unless firms employing labour sell
outputs produced for at least normal profits in goods market.
Marginal productivity theory and demand for labour
• Marginal physical product of labour (MPPL): addition to firm’s total output by employing one more worker
➢ Law diminishing returns/diminishing marginal productivity operates as firm employs more labour when capital held fixed.
• Marginal revenue product of labour (MRPL): money value addition to firm’s total output employing one more worker (MPPL x
MR).
➢ Assuming perfectly competitive goods/labour market, MR identical to price (horizontal MR curve).
Deriving the MRP curve of labour when the goods market is imperfectly competitive
• Perfect competition, slope MRP curve explained solely by diminishing marginal physical product labour (by law diminishing
returns).
• If output sold in imperfectly competitive goods market, MRP labour declines faster than perfectly competitive. As marginal
revenue earned selling extra worker’s output also falls as output increases.
• Firm faces downward sloping demand curve for its products, therefore reduce price product order sell extra output worker
produces. 2 reasons for MRPL curve fall as employment increases.
What the demand curve for labour shows
• Shows relationship between wage rate + no. workers employed. Lower wage rate, more employability.
• Whenever more than one employer in labour market, market demand curve labour in different position from single firm’s
demand. Since each firm’s demand labour shown by MRPL curve facing firm, addition all MRPL curves = market demand labour.
Shifts of market demand curve for labour in different labour markets
• A change in labour productivity: if labour productivity increases, more labour demanded at each wage rate and demand curve
for labour shifts right.
➢ Same occurs when MR increases (derived demand – demand increase good labour producing, raises price product,
increase demand labour).
➢ Market demand curve labour also shifts right.
• A change in technology: if technological progress makes labour more productive relative to other factors production, firms
likely substitute labour other factors production, demand increases.
➢ Technical progress likely improves productive/dynamic efficiency (reduce cost making product), if leads to lower prices +
higher demand product, likely demand labour increase.
➢ Opposite effect, causing firms substitute capital for labour (automated methods production), increases productivity
capital relative labour. Reduce demand labour, left shift.
➢ Also increase demand certain types labour at expense workers other skills (may lose jobs). Technological unemployment
part of process creative destruction.
The elasticity of demand for labour
E of D Labour: proportionate change in quantity labour demanded following proportionate change wage rate.
• Demand labour likely inelastic:
1) Relevant wage cost forms only small part total production costs (‘importance being unimportant’).
2) Demand for good/service being produced by labour inelastic
3) Difficult substitute other factors production or other types labour, for labour currently employed
4) Short run, often takes employers time adjust methods production
Influences of the supply of labour to different labour markets
Market supply labour: shows how much labour all workers in labour marker plan supply at different wage rates.
Monetary and non-monetary considerations
• 2 factors influencing amount labour workers willing supply: money wage rate + utility/economic welfare derived (non-
monetary benefits).
• Different types work yields different levels job satisfaction. Enjoy job, net advantage work greater than welfare yielded by
wage. Worker willing work money wage lower than wage acceptable if no satisfaction from work itself.
, • Supply labour reflects fact that wage rate must be high enough to compensate unpleasantness of some jobs (such as assembly-
line work).
• At the margin, to maximise personal welfare, worker must supply labour up to: Utility welfare last unit earned = Utility welfare
last unit leisure time sacrificed.
• Higher wage provides incentive work more hours. Higher wage rate, at margin, welfare derived from wage greater than welfare
derived last unit leisure time enjoyed.
• Maximise personal welfare at higher wage rate, worker expected supply more labour + enjoy less leisure time. Result upward
sloping supply curve for labour.
• Individual workers job choice depends on utility they expect derive from money wage rate + job satisfaction or dissatisfaction in
different occupations.
Shifts of market supply curve of labour
• Factors include: benefits of job security, promotion prospects, good working conditions, holiday entitlement + other
psychological benefits of work. Improvements these benefits shift supply curve labour to right.
• Generalising, if people decide they value leisure more highly, they’ll work fewer hours at each wage rate + supply curve labour
shifts to left. If decide want more goods + services, likely shift to right.
• Changes in income: rise in income increases demand for leisure, causes supply shift left. For few people, leisure time may be
inferior good: higher income reduces demand leisure time + supply more labour.
• Change in population: rise in population (perhaps immigration) increases supply labour; reduction lowers it. Fall in no. people
working age causes labour SC shift left; except if offset by those who’ve reached retirement age deciding work longer order
finance eventual retirement.
• Changes in expectations: if older people expect live longer yet become less optimistic about future pensions, may increase
labour supply. Rise in proportion people staying in further/higher education tend reduce supply labour.
Elasticity of supply of labour
E of S labour: proportionate change quantity labour supplied following proportionate change wage rate.
Factors determining wage E of S labour:
• Supply unskilled labour usually more elastic than supply particular type skilled labour (training period unskilled short, innate
abilities required unlikely restricted to small proportion total population).
• Factors reducing occupational/geographical mobility labour tend reduce elasticity labour supply
• Supply labour likely more elastic in long run than short run
• Availability pool unemployed labour increases elasticity supply labour, full employment opposite effect.
Perfectly competitive labour markets
• Perfectly competitive labour market, if were to exist, have to meet all following conditions at same time
1) Large no. buyers/sellers
2) Unable influence ruling market wage
3) Operating conditions perfect market info
4) Employers/workers free enter labour market in long run, but unable influence ruling market wage through independent action.
• Impossible for these requirements be met simultaneously, hence don’t exist real world.
• Some labour markets, such as market for fruit pickers in region/district (very large no. orchards), approximate to perfect
competition, but nevertheless not perfectly competitive.
How ruling market wage affects perfectly competitive firms
• Firm employing workers in perfectly competitive labour market, firm ‘buy’ as much labour as
wishes employ at ruling market wage. Hence each employer face perfectly elastic supply labour,
passively accept ruling market wage.
• Supply labour also average (ACL)/marginal cost labour (MCL) at ruling market wage.
Equating MRPL with wage rate
• To maximise profit when selling output produced by labour, each firm have to demand labour up to point which: MRPL = MCL
• Marginal revenue product labour (MRPL) is marginal benefit accruing to employer when hiring extra worker.
• Marginal cost of labour (MCL) is marginal private cost incurred by each firm. Since in perfectly competitive labour market, MCL
= W (wage rate).
• Considering if firm willing employ labour force larger than Q: additional workers MCL>MRPL, total profit fall (employ less).
• Workforce below Q, MRP>MCL, total profit increase if more employed.
• MRP facing each firm = firms demand curve labour
The role of market forces in determining relative wages
