Labour Market
What determines the wage rate in a labour market?
In a competitive labour market the wage rate is determined by the
interaction of demand and supply. The demand for labour is undertaken by firms,
which require workers to help produce goods and services. The supply of labour
comes from the general population and, in particular, the workforce of an
economy.
In practice there are many different types of labour market: for
example, shop assistants, kitchen chefs and lawyers. Labour markets also
include public sector workers where the government is a major employer of
labour: for example, teachers, nurses and police officers.
The demand for labour
The demand for labour is a derived demand. It is derived
from the demand for the goods and services it makes. For example, the demand
for building workers is derived from the demand for new housing.
The figure below shows how an increase in demand for new housing
will cause an increase in demand for building workers, such as bricklayers and
carpenters. The effect is to increase the wage rate from We to W1
and the quantity employed from Ne to N1.
There
are several key determinants of the demand for labour:
● Demand
for the final product. An increase in demand for a good or service is likely
to cause an increase in demand for the labour involved in making it. Firms have
a profit incentive, if demand and prices increase, to supply more of a good or
service.
● The
wage rate. A fall in the wage rate means that labour becomes more
affordable and so firms are likely to demand more labour.
● Other labour costs. For example, a fall in employers’
national insurance contributions on behalf of their staff is likely to raise
the quantity demanded.
● Price of other factor inputs. An increase in the price of
capital might encourage firms to employ more labour and cut back on the use of
machinery and equipment where possible. This is because labour and capital may
be substitutes in the production process.
● Productivity of labour. An increase in output per worker
may lead to higher revenue and profits, encouraging firms to employ more
people.
● Government employment regulations. The fewer the number of
regulations, the greater the demand for labour is likely to be. For example, if
it becomes easy to hire and fire staff or to change working conditions, then
the increased labour flexibility may encourage firms to employ more people.
However, a national minimum wage (NMW) set above the free-market wage may cause
a decrease in the quantity of labour demanded.
The supply of labour
This refers to the quantity and quality of labour hours offered for
work over a given time period. There are various factors which determine the
supply of labour, namely:
● The wage rate. An increase in the wage rate will encourage
more people to offer their services for work. A higher wage rate means the
opportunity cost of leisure time increases, encouraging people to work longer
hours.
● Other net advantages of work. Improvements in working
conditions will also tend to increase the supply of labour: for example, a good
pension, paid holidays, job security and promotion prospects.
● Net migration. Over recent years the UK has experienced a
significant increase in immigration from central and eastern Europe, helping to
boost the economy.
● Income tax. A reduction in income tax will increase
disposable incomes and so offer a greater incentive for people to work. Many
people will substitute work for leisure time, increasing the supply of labour.
● Benefit reform. A reduction in benefits (e.g. incapacity
benefit, housing benefit and the jobseeker’s allowance) may provide a greater
incentive for people to look for work and so increase the supply of labour.
● Trade unions. Trade unions act to increase wage rates and
improve other working conditions through collective bargaining with employers.
This may encourage an increase in the supply of labour.
● Government regulations. An increase in employment
protection or the introduction of a national minimum wage will tend to improve
working conditions and so increase the supply of labour. However, it is also
possible that government regulations reduce the supply of labour (for example,
the EU Work Time Directive limits the maximum hours of work per week to 48 for
most employees).
● Social trends. There has been a significant increase in
the number of women in the workforce over the past 40 years. This reflects an
improvement in equal opportunities, childcare facilities and social attitudes.
Labour market and wage determination
The price of labour is known as the wage rate.
If wages are too high, then there is more labour supplied than demanded
— we have unemployment. If this occurs in a free labour market, then workers
will have to accept lower wages or go without a job; thus the wage rate will
tend to fall to the market clearing rate. If wages are too low, then
demand for labour will be high but supply will be low so there will be a labour
shortage, ie workers will not work if they are paid too little (an hour of
their leisure time is more valuable than a hour of work). Firms will have to
pay workers more as an incentive to work, and so the wage rate will be bid up
to the market clearing wage.
National Minimum Wage
National Minimum wage is the legal minimum pay that employers must
pay to workers. Minimum wage is imposed by the government in order to raise the
income of the very low people to a minimum level. A minimum wage will lead to
increase in the workers incentive to work. However, it will also lead to
increase in cost of production of the sellers.
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