6.3 - Perfectly competitive labour markets

What are the conditions of a perfectly competitive labour market?

- large number of buyers, each unable to influence age ruling market price and operating in conditions of perfect market information

- Employers and workers would be free to enter the labour market in the long run, but an individual employer or firm could not influence the ruling market wage through its independent action

How the ruling market wage affects perfectly competitive firms?

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In a perfectly competitive labour market, each employer would have to passively accept the ruling wage. The ruling wage, determined in figure b, is also the perfectly elastic supply curve of labour facing each of the firms in the labour market. This means it is also the average cost of labour (ACl) curve and the marginal cost of labour curve (MCl) curve facing each firm in the labour market. This is shown in figure a. At the ruling market wage, each firm would be a passive price taker, able to hire as many workers as it wished to hire at ruling market wage, but unable to influence the ruling wage by its own actions

At what point is labour market equilibrium?

Labour market equilibrium is determined where the supply of labour and the demand for labour meet. This determines the equilibrium price of labour, i.e. the wage rate.

What is average cost of labour?

Total wage costs divided by the number of workers employed

What is marginal cost of labour?

The addition to a firm's total cost of production resulting from employing one more worker

How does a firm demand labour to maximise profit?

The addition to sales revenue resulting from employment of an extra worker = the addition to production costs resulting from employment of an extra worker

or

MRPl = MCl

What is the marginal revenue product of labour (MRPl)?

The marginal benefit accruing to the employer when hiring an extra worker

What is the marginal cost of labour (MCl)?

The marginal private cost incurred by each firm

What does MRP>W mean?

more workers should be hired

What does MRP < wage mean?

fewer workers should be employed

What does MRP=W mean?

the firm is employing the number of workers consistent with profit maximisation

What is the role of market forces in determining relative wage rates?

Each employer is able to hire however many workers it wants in a perfectly competitive market, provided only that the ruling wage was offered to all employees taken on.

Once market forces in the labour market have established the ruling market wage, each worker in the labour market is a passive wage raker at market determined wage rate.

Applying the 'law of one price', if labour markets were perfectly competitive and in equilibrium, workers with the same skills and performing similar tasks would be paid the same wage rates.