3.5 Labour Market

Labour

Any physical or mental effort contributed by workers to the production of goods and services.

Labour market

The market in which labour is bought by firms and supplied by workers, with the price of labour being the wage rate.

Demand for labour

The quantity of labour that firms are willing and able to employ at a given wage rate.

Supply of labour

The quantity of labour that workers are willing and able to offer at a given wage rate.

Derived demand

The demand for a factor of production that arises from the demand for the goods and services that the factor helps to produce.

Why is demand for labour derived?

Firms demand workers because workers contribute to the production of goods and services; therefore, demand for labour depends partly on demand for the final product.

Example of derived demand

If consumer demand for smartphones rises, smartphone firms increase production and may therefore demand more workers to manufacture, design and market smartphones.

Relationship between demand for final products and demand for labour

An increase in demand for the final product increases the marginal revenue generated by workers and tends to increase firms' demand for labour; a decrease in final-product demand has the opposite effect.

Marginal Revenue Product (MRP)

The additional revenue generated by employing one additional unit of labour.

MRP formula

MRP = Marginal Physical Product (MPP) × Marginal Revenue (MR).

Marginal Physical Product (MPP)

The additional output produced by employing one additional unit of labour.

Marginal revenue

The additional revenue gained from selling one additional unit of output.

Why can the demand curve for labour be labelled MRP?

The MRP represents the maximum amount a profit-maximising firm is willing to pay for an additional worker, so the MRP curve represents the firm's demand for labour.

Profit-maximising employment

The profit-maximising firm employs labour up to the point where MRP = the wage rate, because it is worthwhile employing a worker while the additional revenue generated is at least as large as the additional cost of employing them.

Labour demand and wage rate

Ceteris paribus, an increase in the wage rate increases the cost of employing labour and therefore causes a contraction in the quantity of labour demanded.

Why does the demand for labour slope downwards?

As the wage rate rises, employing workers becomes more expensive, so firms generally demand fewer workers; as wages fall, firms generally demand more workers.

Factors influencing demand for labour

• The demand for the final product,

• productivity of labour,

• price of the final product,

• wages,

• prices of other factors of production,

• technology

• profitability of employing additional workers.

Demand for the final product as a determinant of labour demand

Higher demand for a firm's product increases the firm's desired output and therefore tends to increase its demand for labour.

Price of the final product and labour demand

A higher price for the final product increases the revenue generated by workers, increasing their MRP and potentially increasing demand for labour.

Labour productivity and labour demand

Higher labour productivity increases the output produced by each worker, increasing MPP and therefore potentially increasing MRP and demand for labour.

Productivity effect on MRP

If each worker produces more output, MPP increases; assuming other factors remain constant, this increases MRP and raises firms' willingness to employ workers.

Technology and labour demand

Technology can either increase or decrease labour demand depending on whether it complements labour or substitutes for labour.

Labour-complementing technology

If technology makes workers more productive, MPP and MRP may increase, causing demand for labour to increase.

Labour-saving technology

If technology replaces workers with machines, demand for certain types of labour may decrease.

Derived demand and technology

A technological change that increases productivity may increase demand for skilled labour while reducing demand for workers whose tasks can be automated.

Wage rate and demand for labour

A rise in the wage rate causes a movement along the labour demand curve rather than a shift in labour demand, ceteris paribus.

Increase in labour demand

A rightward shift of the labour demand curve caused by factors such as increased demand for the final product or increased labour productivity.

Decrease in labour demand

A leftward shift of the labour demand curve caused by factors such as reduced demand for the final product or falling labour productivity.

Difference between movement along and shift of labour demand

A change in the wage rate causes a movement along the labour demand curve, whereas changes in non-wage determinants such as product demand or productivity shift the entire labour demand curve.

Elasticity of demand for labour

The responsiveness of the quantity of labour demanded to a change in the wage rate.

PEDL formula

PEDL = percentage change in quantity of labour demanded ÷ percentage change in wage rate.

Elastic demand for labour

PEDL greater than 1, meaning a percentage change in the wage rate causes a more than proportionate percentage change in quantity of labour demanded.

Inelastic demand for labour

PEDL less than 1, meaning a percentage change in the wage rate causes a less than proportionate percentage change in quantity of labour demanded.

Unit elastic demand for labour

PEDL equal to 1, meaning the percentage change in quantity of labour demanded is equal to the percentage change in the wage rate.

Why does elasticity of labour demand matter?

It determines how strongly employment responds to wage changes and therefore helps predict the employment effects of changes such as minimum wages or trade-union wage demands.

Proportion of labour costs and PEDL

The greater the proportion of total costs accounted for by labour, the more elastic demand for labour is likely to be because wage changes significantly affect total costs.

Factor substitution and PEDL

If capital can easily and cheaply substitute for labour, labour demand is likely to be more elastic because firms can replace workers when wages rise.

PED of the final product and PEDL

If demand for the final product is price inelastic, labour demand is likely to be more inelastic because firms can raise prices to pass on higher labour costs without losing much demand.

Time period and PEDL

Labour demand tends to be more inelastic in the short run but more elastic in the long run because firms have more time to substitute capital for labour and change production methods.

Why is labour demand often more inelastic in the short run?

Firms may be unable to quickly replace workers with capital or change production techniques, so wage changes initially have a relatively small effect on employment.

Why does labour demand become more elastic in the long run?

Firms have more time to reorganise production, invest in automation and substitute capital for labour, increasing their responsiveness to wage changes.

Supply of labour to an occupation

The quantity of labour workers are willing and able to offer to a particular occupation at different wage rates.

Factors affecting supply of labour

Training requirements, wages in alternative occupations, migration policy, income tax, working conditions, trade union power, welfare benefits and social trends.

Training period and labour supply

A long training period acts as a barrier to entry, reducing the number of workers able to enter an occupation in the short run.

Example of training limiting labour supply

Doctors require extensive education and training, so even substantial wage increases cannot rapidly create a large increase in the number of qualified doctors.

Wages in other occupations and labour supply

Workers compare the wage and conditions available in alternative occupations; higher wages elsewhere can reduce the supply of labour to a particular occupation.

Substitute labour market

Another occupation that workers can enter using similar or transferable skills.

Comparative wage rates and labour supply

If substitute occupations offer higher wages for similar skills, workers may leave or avoid the original occupation, reducing its labour supply.

Migration and labour supply

An increase in net migration can increase the supply of labour, particularly in occupations where migrant workers have relevant skills.

Migration policy and labour supply

Policies that restrict or encourage migration can reduce or increase the supply of workers available to particular occupations.

Income tax and labour supply

Higher income tax can reduce the financial reward from working and may therefore reduce the incentive to supply labour, although the overall effect can depend on individual circumstances.

Working conditions and labour supply

Better working conditions and non-wage benefits can increase the attractiveness of an occupation and therefore increase labour supply.

Examples of non-wage benefits

Healthcare, childcare, flexible working, remote working, pensions, holidays and other employment benefits can increase the attractiveness of a job.

Trade unions and labour supply

Trade unions can increase the attractiveness of an occupation by negotiating higher wages and improved working conditions, potentially increasing the supply of labour.

Welfare benefits and labour supply

Higher welfare benefits can reduce the financial incentive for some low-skilled workers to enter employment, potentially reducing labour supply.

Opportunity cost of employment

The benefits of the next-best alternative forgone when a worker chooses to enter employment.

Net wage

The wage received after deductions such as income tax and National Insurance.

Social trends and labour supply

Changes in social attitudes and working patterns can alter the supply of labour to occupations, such as increased demand for flexible or home-based work.

COVID-19 and labour supply

The COVID-19 pandemic accelerated working from home in some occupations and changed workers' preferences regarding flexibility and working conditions.

Elasticity of supply of labour

The responsiveness of the quantity of labour supplied to a change in the wage rate.

PESL formula

PESL = percentage change in quantity of labour supplied ÷ percentage change in wage rate.

Elastic supply of labour

PESL greater than 1, meaning a percentage increase in wages causes a more than proportionate increase in labour supplied.

Inelastic supply of labour

PESL less than 1, meaning a percentage increase in wages causes a less than proportionate increase in labour supplied.

Why is supply of labour often elastic in low-skilled occupations?

Workers can usually enter low-skilled occupations relatively quickly because training requirements are limited, so higher wages can attract many additional workers.

Why is supply of labour often inelastic in highly skilled occupations?

Occupations requiring extensive training have significant barriers to entry, so wage increases cannot rapidly create many additional qualified workers.

Short-run versus long-run PESL

The supply of highly skilled labour may be inelastic in the short run because training takes time, but can become more elastic in the long run as more workers obtain the necessary qualifications.

Why does a long training period make PESL inelastic?

Even if wages rise significantly, potential workers cannot instantly acquire the qualifications required to enter the occupation.

Geographical mobility of labour

The ability of workers to move between different geographical areas in response to employment opportunities.

Geographical immobility of labour

The inability or unwillingness of workers to move from one geographical area to another to obtain employment.

Causes of geographical immobility

Family ties, housing costs, lack of information, transport difficulties, differences in regional house prices and attachment to a particular area.

Family ties and geographical immobility

Workers may be unwilling to relocate because they have family responsibilities or social networks that they do not want to leave.

Housing costs and geographical immobility

High property prices or rents in areas with employment opportunities may prevent workers from relocating.

Information gaps and geographical immobility

Workers may lack information about vacancies and wages in other geographical areas, preventing them from moving to better employment opportunities.

Transport infrastructure and geographical mobility

Poor transport links can make commuting or relocation difficult, reducing workers' geographical mobility.

How can working from home reduce geographical immobility?

Remote working allows workers to accept jobs without physically relocating, reducing the importance of geographical location for some occupations.

Occupational mobility of labour

The ability of workers to move from one occupation to another.

Occupational immobility of labour

The inability or unwillingness of workers to change occupation, often because their skills are not transferable.

Causes of occupational immobility

Long training periods, lack of transferable skills, qualification requirements, lack of information and differences in occupational conditions.

Transferable skills

Skills that can be applied across multiple occupations, increasing a worker's occupational mobility.

Structural unemployment and occupational immobility

Structural unemployment can arise when workers' skills do not match the requirements of available jobs, meaning they cannot easily move into expanding occupations.

Labour market failure

Labour market failure occurs when resources are not allocated efficiently because workers cannot easily move between jobs or occupations, creating labour shortages in some markets and unemployment in others.

Mismatch in the labour market

A situation where there are unemployed workers while firms simultaneously experience shortages of labour because workers do not have the required skills or are in the wrong geographical location.

Consequences of labour immobility

Labour immobility can create occupational shortages, unemployment, regional disparities, structural unemployment and inefficient allocation of labour.

Labour shortages

A situation where firms demand more labour than is available at the prevailing wage and conditions.

Skills shortage

A shortage of workers with the qualifications or skills required by employers.

How can labour immobility cause unemployment?

Workers may be unemployed in one region or occupation while vacancies exist elsewhere because they cannot move geographically or occupationally.

How can labour immobility cause inflationary pressure?

Skills shortages can force firms to increase wages to attract workers, raising labour costs and potentially contributing to cost-push inflation.

Policies to improve occupational mobility

Education, vocational training, apprenticeships, retraining programmes and policies targeting specific skills shortages.

Policies to improve geographical mobility

Relocation subsidies, improved transport infrastructure, affordable housing and better information about employment opportunities.

How can education improve occupational mobility?

Education increases workers' skills and gives them a broader skill base that can be transferred across occupations.

How can vocational training reduce occupational immobility?

Vocational training provides workers with specific skills required in occupations experiencing shortages, allowing unemployed workers to enter those markets.

How can relocation subsidies increase geographical mobility?

Financial assistance with moving costs makes it easier for workers to move to areas with more employment opportunities.

How can job centres reduce geographical and occupational immobility?

Improved information about vacancies, wages and required skills reduces information gaps and allows workers to identify suitable opportunities.

How can reducing discrimination improve labour mobility?

Reducing discriminatory hiring practices can increase employment opportunities for groups who may otherwise face barriers to entering particular occupations.

Labour market equilibrium

An equilibrium occurs where the demand for labour equals the supply of labour.

Equilibrium wage

The wage rate at which the quantity of labour demanded equals the quantity of labour supplied.

Equilibrium quantity of labour

The quantity of labour employed where labour demand equals labour supply.

Competitive labour market

A labour market with many employers and workers where individual firms and workers have little influence over the market wage.

Price taker in a labour market

A firm or worker that accepts the market wage because it lacks sufficient market power to determine the wage itself.

Why is a competitive firm's labour demand relatively straightforward?

The firm accepts the market wage as given and chooses the quantity of labour that maximises its profit, typically where MRP equals the wage.