Economics (9708) | Labour market forces and government intervention

Study Notes: Labour Market Forces and Government Intervention (9708 Economics A Level)

Hello everyone! Welcome to the exciting world of the labour market. This chapter takes the basic supply and demand tools you learned in AS Level and applies them specifically to the market for workers. Understanding how wages are set and how government intervention (like minimum wages) affects employment is crucial for tackling real-world economic problems. Don't worry if this seems tricky at first; we'll break it down into clear steps!

1. The Demand for Labour: Why Firms Hire Us

1.1 Labour Demand as Derived Demand

The most important concept to start with is that the demand for labour is a derived demand.

• Definition: Demand for a factor of production (like labour) is derived from the demand for the final goods or services it is used to produce.
• Analogy: A bakery doesn't hire bakers because they enjoy paying wages. They hire bakers because people demand bread and cakes. If the demand for cakes suddenly falls, the derived demand for bakers will also fall.

1.2 The Marginal Revenue Product (MRP) Theory

How does a firm decide exactly how many workers to hire? They use the Marginal Revenue Product (MRP) theory. This theory assumes firms are rational and aim to maximise profit.

A firm will continue to hire workers up until the point where the cost of the last worker equals the revenue that worker generates.

Key Definitions:

• Marginal Physical Product (MPP): The extra physical output produced by hiring one more unit of labour.
• Marginal Revenue (MR): The extra revenue generated by selling one more unit of output.
• Marginal Revenue Product (MRP): The extra revenue gained by the firm when it employs one more worker.

The Formula:
\(MRP = MPP \times MR\)

The Profit Maximisation Rule

For profit maximisation, a firm hires labour up to the point where:

\(MRP = MFC\)

Where MFC (Marginal Factor Cost) is the cost of hiring one extra worker (which is usually the wage rate, W).

Simplified Rule: Hire until the extra revenue generated by the worker equals the wage paid: MRP = Wage (W).

Did you know? The firm's demand curve for labour is its MRP curve. Because the MRP curve is downward sloping (due to the Law of Diminishing Returns, meaning MPP falls as more labour is hired), the demand curve for labour is also downward sloping.

1.3 Factors Affecting the Demand for Labour (Shifts)

These factors cause the entire demand curve (the MRP curve) to shift left (less demand) or right (more demand).

1. Demand for the Final Product: Since labour demand is derived, if consumer demand for the product increases, the price (P) and Marginal Revenue (MR) increase, thus increasing MRP. (Demand shifts right).
2. Productivity of Labour (MPP): If workers become more productive (e.g., through training or better technology), MPP increases, thus increasing MRP. (Demand shifts right).
3. Price of Substitute Factors (Capital): If machines (capital) become cheaper relative to labour, firms substitute capital for labour. (Demand shifts left).
4. Price of Complementary Factors: If a factor used alongside labour becomes cheaper (e.g., cheaper electricity for machine operators), the firm might expand production and hire more workers. (Demand shifts right).

2. The Supply of Labour: Why People Work

2.1 Factors Affecting Labour Supply to a Firm or Occupation

The supply of labour relates to the number of workers willing and able to take a job at a specific wage rate. We divide the factors into wage and non-wage categories.

i) Wage Factors (Movement along the curve)

A change in the wage rate itself causes a movement along the supply curve.

• Substitution Effect: If wages rise, work becomes relatively more attractive than leisure. Workers substitute leisure for work, increasing hours supplied.
• Income Effect: If wages rise significantly, workers earn their target income more quickly. They might feel richer and choose to work fewer hours, substituting work for leisure.

Note: For the *entire market*, the supply curve is usually upward sloping (Substitution Effect dominates). For an *individual*, the curve can eventually become backward bending (Income Effect dominates at very high wages).

ii) Non-Wage Factors (Shifts of the curve)

These factors cause the entire supply curve to shift.

1. Non-monetary benefits: Attractive features of the job (e.g., generous holidays, good working environment, flexible hours). (Supply shifts right).
2. Required Qualifications/Training: Jobs requiring extensive, difficult, or expensive training have a restricted supply. (Supply shifts left).
3. Geographical and Occupational Mobility: Ease with which workers can move between locations (geographical) or change jobs/skills (occupational). High mobility increases supply.
4. Legislation/Regulation: Government rules (e.g., requirement to hold a specific license) restrict supply. (Supply shifts left).
5. Size and Age Structure of the Population: A larger working-age population increases overall supply.

3. Wage Determination in Different Labour Markets

3.1 Wage Determination in a Perfectly Competitive Labour Market

A perfectly competitive labour market has many small firms competing for identical labour, and perfect information/mobility. Neither the firms nor the workers can influence the wage rate.

• Market Wage: Determined by the intersection of the total market supply (S) and total market demand (D).
• Firm's Position: Each individual firm is a wage taker. They must pay the equilibrium wage (\(W_E\)).
• At \(W_E\), the supply of labour to the individual firm is perfectly elastic (a horizontal line).
• Equilibrium occurs when the quantity of labour demanded equals the quantity supplied at the prevailing wage rate.

3.2 Wage Determination in Imperfect Markets

In reality, labour markets are imperfect. Wages are often influenced by powerful groups (trade unions) or powerful firms (monopsony).

i) Influence of Trade Unions

A Trade Union (TU) is an organisation that represents workers in bargaining with employers.

How TUs affect wages and employment:

1. Restricting Supply: TUs may restrict entry into the profession (e.g., demanding high qualifications or long apprenticeships). This shifts the labour supply curve to the left, raising the wage but reducing employment.
2. Bargaining Power: TUs use collective bargaining to negotiate a wage (\(W_{TU}\)) above the market equilibrium. This creates a wage floor.

Consequences of Union Bargaining: If the union successfully sets a wage above the market equilibrium, there will be a reduction in employment (firms hire less labour at the higher wage) and a pool of unemployed workers (excess supply).

ii) Influence of Government: National Minimum Wage (NMW)

The NMW is a minimum price (price floor) set by the government, below which wages cannot legally fall.

Impact in a Perfect Market:

• If NMW is set above the equilibrium wage (\(W_E\)), employment falls (\(L_2 < L_E\)) and unemployment rises (excess supply of labour).
• If NMW is set below \(W_E\), it has no effect.

Evaluation Points (NMW):

• Pro: Reduces poverty, increases equity, may increase productivity (via the "efficiency wage" theory—workers are happier and work harder).
• Con: Can cause unemployment if set too high, increases firm costs (potentially leading to cost-push inflation), and may reduce competitiveness.

iii) Influence of Monopsony Employers

A monopsony exists when there is only one dominant buyer of labour in a specific market (e.g., a single large factory in a small town, or the government being the primary employer of nurses).

• The monopsonist is a wage maker; they face the entire upward-sloping market supply curve.
• To hire more labour, they must offer a higher wage to *all* existing workers, meaning their Marginal Factor Cost (MFC) is higher than the average wage rate (Average Factor Cost or AFC).
• Outcome: A monopsonist hires less labour and pays a lower wage than in a perfectly competitive market, leading to inefficiency and lower employment.

4. Wage Differentials, Transfer Earnings, and Economic Rent

4.1 Transfer Earnings and Economic Rent

When a worker receives a wage, that payment can be split into two components: Transfer Earnings and Economic Rent.

• Transfer Earnings: This is the minimum payment required to keep a worker in their current job or occupation. It is the opportunity cost of the worker remaining in this job.
• Economic Rent: Any payment received by a factor of production above its transfer earnings. This is a surplus payment.

Example: A talented Economics teacher earns $5,000 per month. If the next best job they could get (say, a retail manager) pays $3,000 per month, then:

• Transfer Earnings: \$3,000 (minimum needed to stop them moving)
• Economic Rent: \$2,000 (the surplus they earn in teaching)

Link to Elasticity:
The shape of the labour supply curve determines the ratio of Transfer Earnings to Economic Rent:

• If the supply of labour is highly elastic (flat curve), the worker has many alternatives. Transfer earnings are high, and economic rent is low.
• If the supply of labour is highly inelastic (steep curve, e.g., specialist brain surgeons), the worker has few alternatives. Transfer earnings are low, and economic rent is high.

4.2 Determination of Wage Differentials

Why do some jobs pay vastly more than others? Wages differ primarily because of differences in demand and supply conditions across occupations.

i) Differences in Labour Supply (Non-monetary Factors)

The supply curve for highly skilled or unpleasant jobs is shifted to the left (resulting in higher wages).

• Skills and Qualifications: Occupations requiring long, costly training (doctors, lawyers) have restricted supply, leading to higher wages.
• Non-monetary Benefits/Disadvantages: Jobs with poor working conditions, high risk, or social stigma require higher wages (called compensating differentials) to attract workers.
• Mobility: Occupations where geographical or occupational mobility is low (immobile workers) tend to have less competition and potentially higher wages regionally, or lower wages nationally if supply is concentrated.

ii) Differences in Labour Demand (MRP Factors)

The demand curve is shifted to the right for occupations where workers are more productive or their output commands a high price.

• Productivity (MPP): Highly productive workers (e.g., specialist coders) generate a higher MRP, increasing demand and therefore wages.
• Value of Output (MR/P): Workers whose output sells for a very high price (e.g., CEO, professional athlete) generate a high MRP, increasing demand and wages.