4.1.6 - The labour market

Labour Market =

Consists of the demand for labour coming from employers (firms) combined with the supply of labour coming from individuals seeking work.

How does demand for product determine the demand for labour?

The demand for labour is derived from the demand for the product/service they are used to produce. (Derived demand for labour)

• Therefore, increase in demand for takeway coffees → increase demand for baristas

Show on Diagrams the result of an increase in demand for takeway coffees on baristas

Marginal Revenue Product (MRP) =

The addition to total revenue generated by the firm by employing one extra worker

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= MPP x MR

Marginal Physical Product (MPP)

The additional output that an extra worker produces

Demand for Labour =

The quantity of workers an employer is willing and able to hire at a given wage rate in a given time period.

What does the MRP curve represent?

MRP = D.

MRP is the demand curve for labour for an individual firm.

• MRP used for diagram for firm, not for industry diagram (which uses D)

Why is the Demand curve for Labour Downwards Sloping?

• Law of diminishing marginal productivity - As more workers are hired, the additional output produced by each new worker decreases → MRP decreases → firms willing to hire more only at lower wages

Where is the Profit-Maximising point for a firm on labour market

MRP = MC

Diagram for Competitive Labour Market (Firm & Industry)

• In competitive labour market, each firm can only hire workers if they offer the market-clearing wage rate, because if they offered less, they would work at other rival firms instead. → Supply curve is horizontal

Factors causing a MOVEMENT along a firm’s Demand for Labour

• Price of Labour (wage rate)

  • e.g. change in min wage

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Causes MRP to extend/contract

Factors causing a SHIFT in a firm’s Demand for Labour

• Consumer demand for product - DD4L

• Productivity of labour (e.g. from training/education) → ↑MPP → ↑MRP

• Price/productivity of other FoP - e.g. capital more expensive → swap labour in

• Market price of final product → change in MR → change in MRP

• Government employment subsidy → allows firm to employ more workers

Elasticity of Demand for Labour (definition + formula)

= Responsiveness of quantity demanded for labour to a change in the wage rate

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= % Change in Quantity Demanded of Labour / % Change in Wage Rate

Determinants of Elasticity of Demand for Labour

• Time period - In LR, easier to substitute in capital so more elastic

• Ease of capital subtitutiton - More elastic if labour can easily be substituted by capital

• Elasticity of Demand for Product - If product is elastic, firm cannot pass on higher wage costs to consumers without losing sales, so labour is elastic.

• Proportion of Total Costs - If labour is a large % of total costs, rise in wages have a larger impact on costs → more elastic

Supply of Labour =

The quantity of labour that a worker is willing and able to supply at different hourly wage rates

Why is the Supply curve of Labour Upwards Sloping?

• Substitution effect - ↑Wages → reward for working increases → Workers substitute leisure for labour by working more hours → Supply increases (extension)

Factors causing a MOVEMENT along a firm’s Supply of Labour

Monetary Factors

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• Wage Rate

• Bonuses

Factors causing a SHIFT in a firm’s Supply of Labour

Non-Monetary Factors

• Holidays - more holidays → ↑satisfaction → supply shifts right

• Occupational Mobility - increase in training/educaiton

• Geographical Mobility

• Wages in other jobs

• Changes in Population - rise in immigration → supply increases

Elasticity of Supply of Labour (definition + formula)

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

= % Change in Quantity Supplied / % Change in Wage Rate

Determinants of Elasticity of Supply of Labour

• Barriers to Entry:

  • Occupational Mobility - More skills & qualifications required, longer training period → more inelastic

  • Geographical Mobility - Higher house prices → more inelastic

• Time Period - In LR, more elastic

• Unemployment - When high u/e, more workers competing for same jobs → more elastic

Characteristics/Assumptions of Perfectly Competitive Labour Market

• Very large number of workers

• Workers are homogeneous

• Firms maximise profits, hiring workers up to MRP=MC

• No barriers to entry for workers

• Price-taking - no firm or worker can influence ruling wage rate

• Perfect information about workers’ skills; working conditions, outside wages

• Large number of firms/employers

Diagram for Perfectly Competitive Labour Market (Firm & Industry)

Why is Supply Horizontal for Firms in Perfectly Competitive Labour Markets?

• In competitive labour market, each firm can only hire workers if they offer the market-clearing wage rate, because if they offered less, they would work at other rival firms instead. → Supply curve is horizontal

• (firms are wage-takers)

Labour Market for High-Skilled Job vs Market for Low Skilled-Job (Diagrams + Chain of Analysis)

For this example, High-Skilled = Lawyer, Low-Skilled = McDonald’s Worker

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Elasticity of Supply:

• Supply of Lawyers is more inelastic - More barriers to entry, like rigorous qualification exams, education - need degree, training.

• Whereas, supply of McDonald’s workers is elastic - low entry requirements - no education needed, little training

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Labour Demand:

• Demand for Lawyers exists at much higher wages - Lawyers produce higher MR → higher MRP → firms more willing and able to hire lawyers

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→ Equilibrium Wage for Lawyers is higher at W1 compared to W2 for McDonald’s workers

Reasons why Labour Markets may be Imperfectly Competitive:

• Monopsony

• Trade Union

• Imperfect Information

Monopsony =

A market with a single buyer

Monopsony Power =

Ability to influence wages, so they pay lower wages than would prevail in a competitive market.

Real World Examples of Monopsonies

• Sweatshops - workers have nowhere else to work

• NHS

• Space Agencies

• Mining company in a remote town

• Cafe in a remote town

Diagram of Monopsony (vs competitive)

Monopsony Chain of Analysis

• Monopsonist is the only employer in the industry

• So it must raise the wage offered to attract new workers if it wishes to employ more labour → supply is upwards sloping

• MC is not same as supply curve because when raising wage to hire new worker, the monopsonist has to raise the wage of all existing workers too (to the same rate as new workers) → MC is greater than AC (S)

• Assuming monopsonist aims to maximise profits, it will demand labour up to the point where MC = MRP

• At this point, wage paid to workers is lower at Wm compared to what would be prevail in a competitive market at Wc

• Quantity of labour is also lower at Qm compared to Qc

Trade Union =

A group of workers who join together to maintain and improve their conditions of employment, including their pay.

• have ‘collective bargaining’ power

Real World Examples of Trade Unions

Nation Education Union (NEU) - Teachers

British Medical Association (BMA) - Doctors

National Farmer’s Union (NFU)

Roles of Trade Unions

• Protecting & improving real wages

• Protecting workers against unfair dismissal

• Promoting improvements in working conditions

• Workplace training

• Protection of employment rights → right to a contract of unemployment, pensions

Factors affecting the Power of Trade Unions

• Unionisation Rate - % of workforce in the trade union

• Bargaining Power of workers - whether their jobs are a necessity to society

• Firm’s power - is firm profitable or struggling to survive?

• Government intervention

Diagram of Trade Union in Perfectly Competitive Labour Market

Impact of Trade Union in Perfectly Competitive Labour Market Chain of Analysis

• In a competitive labour market, wages were W1.

• Trade union acts as a monopoly supplier of labour → collectively bargains for a higher wage of W2 above the equilibrium wage rate

• Wages increase from W1 to W2 (trade union markup)

• But employment falls from Q1 to Qd

• As supply extends to Qs and demand contracts to Qd, there is real wage unemployment of Qs-Qd

• The labour supply curve is kinked - perfectly elastic up to Qs, but to raise labour supply beyond this, firms must offer higher wages.

Evaluations of Trade Union Impact on Wages & Unemployment

Counter:

• Unions may instead lobby for more workplace training → higher MRP → demand for labour shifts right → employment & wages increase

• Higher wages may induce higher demand for the products → Higher wages → more disposable income → Increase in spending → demand for product shifts right → demand for labour shifts right → employment and wage increase

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IDO:

• Level of wage rate imposed - the greater it is above equilibrium, the lower the level of employment

• Elasticity of Supply & Demand for labour - if inelastic, effect on u/e is smaller

Diagram of Trade Union in Monopsony Labour Market

Impact of Trade Union in Monopsony Labour Market Chain of Analysis

• In a monopsony, profit-maxing point where wages are at W1 and employment is Q1

• Trade union acts as a monopoly supplier of labour → collectively bargains for a higher wage of W2

• MC and AC is now perfectly elastic up to Q2 as hiring one extra worker up to this point costs the same wage rate.

• The profit-maximising point where MC=MRP is now at W2, Q2

• Wage has increased from W1 to W2 and employment has increased from Q1 to Q2

Imperfect Information

National Minimum Wage =

The lowest wage which a worker can be employed, set by the government.

• aka National Living Wage

Trade Union and National Minimum Wage

• They have the same diagrams & same chain of analysis on competitive and monopsony labour markets

Impact of NMW on Perfectly Competitive Labour Market Chain of Analysis

• In a competitive labour market, wages were W1.

• Government sets NMW of W2 above the equilibrium wage rate

• Wages increase from W1 to W2

• But employment falls from Q1 to Qd

• As supply extends to Qs and demand contracts to Qd, there is real wage unemployment of Qs-Qd

• The labour supply curve is kinked - perfectly elastic up to Qs, but to raise labour supply beyond this, firms must offer higher wages.

Impact of NMW on Monopsony Labour Market Chain of Analysis

• In a monopsony, profit-maxing point where wages are at W1 and employment is Q1

• Government sets NMW of W2

• MC and AC is now perfectly elastic up to Q2 as hiring one extra worker up to this point costs the same wage rate.

• The profit-maximising point where MC=MRP is now at W2, Q2

• Wage has increased from W1 to W2 and employment has increased from Q1 to Q2

Evaluations of NMW Impact on Wages & Unemployment

IDO:

• Level of wage rate imposed - the greater it is above equilibrium, the lower the level of employment

• Elasticity of Supply & Demand for labour - if inelastic, effect on u/e is smaller

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Counter:

• ‘Corporate Flight’ - if NMW set too high, firms may just leave and move to other locations with lower NMW

• Combination of Policies required to reduce poverty - need to also do investment in training, reforms to welfare system

Advantages of a National Minimum Wage

Poverty alleviation:

• Ensures a fair wage, reduces wage inequality, reduces social deprivation & crime

• UK NLW = At least 67% of median hourly wages

• ‘Relative Poverty’ defined as 60% of median income

• Therefore, NLW prevents relative poverty

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Greater incentives to work:

• Earnings/poverty trap reduced as it makes taking a job more beneficial/worthwhile

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Increases productivity:

• Workers on higher wages tend to work harder

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Reduced government spending:

• on in-work benefits (universal credit)

• & on out-of-work benefits via lower earnings trap effect

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Prevents monopsonist exploitation:

• Higher wages & higher employment in monopsonist markets

Disadvantages of a National Minimum Wage

Increases unemployment in competitive labour markets:

• Employment falls from Q1 to Qd

• Real wage unemployment of Qs-Qd (from contraction along D and extension along S)

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Increases firms costs & raises prices:

• SRAS left → increase prices → less internationally competitive + products more expensive for consumers

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Increases inequality further:

• Reduces income of the workers who lose their jobs in competitive labour markets (Q1-Qd)

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Difficulty in targeting & setting the correct wage:

• Different wages in every industry

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Inflexibility:

• Firms cannot reduce wages in a recession, so have to lay off workers instead

Types of Discrimination in Labour Market

• Perfect Wage Discrimination

• Labour Market Discrimination

Perfect Wage Discrimination =

The firm pays each worker the minimum wage that worker is willing and able to supply labour at.

Perfect Wage Discrimination Diagram

• Original Wage Bill without Discrimination = Area OBCD

• New Wage Bill = OACD

• Area that monopsony gains = ABC

Advantages of Perfect Wage Discrimination (for Workers, Employers, Economy)

Workers:

• Lower wage bill may lead to higher employment

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Employers:

• Lower wage bill → lower costs → higher profits

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Economy:

• Lower costs → lower prices → more internationally price competitive

Disadvantages of Perfect Wage Discrimination (for Workers, Employers, Economy)

Workers:

• Vulnerable workers exploited by being paid lower wages → lower living standards

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Employers:

• Admin cost - must estimate optimal wage for each worker

• Risk of industrial unrest (e.g. strikes)

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Economy:

• Inequality - lower income workers have higher MPC

Labour Market Discrimination =

Firms pay different wages to different groups of workers for reasons unrelated to their willingness & ability to supply labour.

• e.g. due to prejudice

Positive Discrimination =

Firms pay workers more than their true MRP

Negative Discrimination =

Firms pay workers less than their true MRP

Examples of Labour Market Discrimination

Think demographics:

• Gender

• Ethnicity

• Age

• Appearance

• Class

Conditions necessary for Labour market Discrimination

• Firm has some wage-making power

• No seepage - lower paid workers cannot access the higher paid jobs

• Willingness & ability to supply labour is different for different workers

Positive vs Negative Discrimination Diagram & Chain of Analysis

• Employers profile employees by their demographic factors, such as wearing glasses or not

• Each demographic factor has its own market segment - employees wearing glasses have a separate segment to employees not wearing glasses

• Firms mistakenly believe that workers who wear glasses are more productive than those who don’t

• → the perceived MRP of those wearing glasses is higher than their true MRP, shown by MRP (+) → their wage is W3 at Q3

• The perceived MRP of those not wearing glasses is lower than thier true MRP, shown by MRP (-) → their wage is W2 at Q2

• The result is that those with glasses are paid higher wage of W3

Disadvantages of Labour Market Discrimination (for Workers, Employers, Economy)

Workers:

• Negatively discriminated workers get exploited by being underpaid and underemployed → lower living standards

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Employers:

• ‎Overall firms have a higher wage bill:

  • Pay higher wages to a higher quantity of positively discriminated workers.

  • Increases average wage more than negative discrimination decreases average wage

  • → higher wage than before discrimination

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Economy:

• Inequality within society

  • → Poverty trap → no incentive for people to work

  • → Low access to g&s

    • → ↑Gov spending on welfare benefits

Advantages of Labour Market Discrimination (for Workers, Employers, Economy)

Workers:

• Positively discriminated‎ workers benefit from higher wages → higher welfare + living standards‎

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Factors causing a Gender Pay Gap

Breaks from working:

• Maternity leave → harder to achieve promotions when re-entering labour market

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Access to education:

• In many developing countries, opportunity for women to undertake education is limited

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Employer discrimination:

• Employers negatively discriminate against women