The Labor Market

What is the labor market?

A market where employers demand labor and workers supply labor in exchange for wages.

How is the labor market different from typical goods markets?

• Instead of buying/selling goods, workers sell their time.

• The wage is the "price" of labor.

• The quantity refers to hours worked rather than physical units of goods.

Who are the suppliers in a labor market?

Workers—they supply their labor in exchange for wages.

Who are the demanders in a labor market?

Firms and businesses—they demand labor to produce goods and services.

What does the law of labor supply state?

As wages increase, workers are willing to supply more labor (work more hours). The labor supply curve slopes upward.

What does the law of labor demand state?

As wages decrease, firms are willing to hire more workers. The labor demand curve slopes downward.

What is the Rational Rule for Employers when hiring workers?

A business should hire additional workers as long as the marginal benefit (revenue from worker's output) is greater than or equal to the marginal cost (wage paid).

What is the Rational Rule for Workers when choosing to work?

A worker should supply more labor (work additional hours) as long as the marginal benefit (wage) is greater than or equal to the opportunity cost (value of leisure or other activities).

What is the labor-leisure trade-off?

Workers must choose between working (earning wages) and leisure (free time, hobbies, relaxation).

What is the opportunity cost of work?

The lost value of leisure—each additional hour worked reduces the time available for relaxation, family, or education.

What is a reservation wage?

The minimum wage at which a person is willing to enter the workforce.

Why do some individuals not participate in the labor market?

• Low wages compared to personal costs (e.g., childcare, school).

• Non-wage benefits (e.g., spouse's income, retirement, government assistance).

• Preference for leisure or education over work.

What happens when wages increase? (Two effects)

Substitution and Income effect

What is the Substitution effect?

Work more because the opportunity cost of leisure increases.

What is the income effect?

Work less because higher income allows for more leisure.

What happens if the substitution effect dominates?

• Higher wages = more work.

• People choose to work more since leisure is now "more expensive."

What happens if the income effect dominates?

• Higher wages = less work.

• People "buy" more leisure by reducing work hours.

How does the labor supply curve behave at different wage levels?

• At low wages, the substitution effect dominates, and people work more.

• At high wages, the income effect dominates, and people work less.

• This creates a backward-bending labor supply curve.

What factors shift the labor supply curve?

• Changes in population (more workers shift supply right).

• Changes in worker preferences (social trends, education levels).

• Alternative opportunities (better job options reduce supply).

• Non-wage benefits (healthcare, flexibility).

• Cost of working (childcare, transportation).

Why does the market labor supply curve slope upward?

• Higher wages attract more workers.

• Existing workers increase hours.

• Workers switch from other jobs to the higher-paying job.

How is equilibrium determined in the labor market?

• The wage adjusts until labor supply = labor demand.

• The equilibrium wage is the market-clearing wage.

What happens if the wage is above equilibrium?

Labor surplus (unemployment): More people want jobs than businesses want to hire.

What happens if the wage is below equilibrium?

Labor shortage: Businesses want more workers than are available.

Why do wages vary across jobs and industries?

• Skill level and education requirements.

• Job desirability and working conditions.

• Market demand for certain skills.

What are the two sides of the labor market?

• Workers supply labor in exchange for wages.

• Businesses demand labor to produce goods and services.

What are the main influences on a worker's labor supply decision?

• Wage rate (higher wage = stronger work incentive).

• Leisure preference (more valued leisure = less work).

• Job benefits (healthcare, flexibility).

• Alternative income sources (spouse's income, government benefits).