Study Notes: The Labour Market (Economics 9214)

Welcome to the Labour Market!

Hi there! This chapter is all about the Labour Market—the place where employers (businesses) look for workers, and where workers (you and me) look for jobs. Understanding this market is crucial because it determines wages, employment levels, and ultimately, how rich or poor a country feels.
Don't worry if this seems tricky at first! We will break down supply and demand for labour using simple, everyday examples. Let's get started!

1. Defining the Labour Market

The Labour Market is where the exchange of labour services takes place. In this market:

  • Buyers: Firms (businesses) that demand workers.
  • Sellers: Individuals (people) who supply their time and skills.
  • Price: The Wage Rate (what the worker is paid).

Key Concept: Labour and Earnings

Labour refers to the human effort—both mental and physical—used in the production of goods and services.
The reward for labour is the wage or salary earned.

Quick Review Box: The Market Swap

In the market for products (e.g., buying a pizza): You are the demander.
In the market for labour (e.g., getting a job at the pizza shop): The business is the demander, and you are the supplier.

2. Demand for Labour (D\(_L\))

The Demand for Labour (D\(_L\)) shows the total number of workers firms are willing and able to hire at different wage rates.

Crucial Concept: Derived Demand

The most important thing to remember about D\(_L\) is that it is a Derived Demand.

What does Derived Demand mean? The demand for a worker is not wanted for the worker themselves, but for the goods or services that worker produces.
Analogy: A restaurant doesn't just want a chef; they want the meals the chef cooks. If people stop eating at restaurants (demand for meals falls), the demand for chefs will also fall.

Factors Affecting the Demand for Labour (Shifts in D\(_L\))

Anything that changes a firm's need for workers will shift the D\(_L\) curve (move it left or right).

  1. Consumer Demand: If demand for the final product increases, the firm needs more workers to make it (D\(_L\) shifts right).
  2. Worker Productivity: If workers become more productive (produce more output per hour), firms may hire more to increase total output, or hire less if fewer workers are needed for the same output. Generally, high productivity increases demand for skilled workers.
  3. Cost of Capital (Machinery): If machines become cheaper than hiring people, firms will substitute labour with capital (D\(_L\) shifts left).
  4. Technology: New technology often automates tasks, reducing the demand for specific types of labour (e.g., factory line workers).
Key Takeaway: Demand for Labour

Demand for labour slopes downwards: As wages fall, firms can afford to hire more workers, so the quantity demanded increases.

3. Supply of Labour (S\(_L\))

The Supply of Labour (S\(_L\)) shows the total number of hours or workers willing and able to work at different wage rates.

Factors Affecting the Supply of Labour (Shifts in S\(_L\))

The supply of workers comes from individuals. These decisions are affected by both wage and non-wage factors.

  1. Population Size and Migration: A rise in the working-age population or an increase in immigration (workers moving into the country) increases the S\(_L\) (shifts right).
  2. Training and Education Requirements: If a job requires a long, expensive university degree (e.g., medicine), the supply of available workers will be low (S\(_L\) is low).
  3. Non-Wage Factors (Net Advantages): These are all the benefits of a job that are not money. Workers will accept a lower wage for a job if it has great non-wage benefits like:
    • Good working environment
    • High job security
    • Long holidays or good flexible working hours
    • Low risk or danger
  4. Leisure Preference: If people value their time off (leisure) more highly than earning extra money, they might be less willing to work, reducing S\(_L\).
Did You Know? The Backward-Bending Supply Curve

For most jobs, as the wage increases, people want to work more hours (S\(_L\) slopes upwards). However, at extremely high wage rates, some very high earners decide they have enough money and prefer to use the extra high income to buy more leisure time, causing the S\(_L\) curve to start bending backwards!

4. Wage Determination and Equilibrium

Just like any other market, the wage rate is determined by the interaction of the Demand for Labour (D\(_L\)) and the Supply of Labour (S\(_L\)).

The Equilibrium Wage Rate

The Equilibrium Wage Rate (W*) is the wage at which the quantity of labour demanded by firms exactly equals the quantity of labour supplied by workers.

At this wage, there is no shortage or surplus of labour.

How Shifts Affect Wages (Step-by-Step)

Example 1: Increase in Demand (D\(_L\))

Imagine there is a huge increase in demand for renewable energy products.

  1. Demand for solar panel installers (D\(_L\)) increases (shifts right).
  2. At the old wage (W*), there is now a shortage of skilled installers (firms want more than are available).
  3. Firms must compete for the scarce workers by offering higher wages.
  4. The wage rate rises until a new, higher equilibrium (W**) is reached, attracting more people into the job.
Example 2: Decrease in Supply (S\(_L\))

Imagine many foreign nurses return to their home countries (a reduction in immigration).

  1. The Supply of Nurses (S\(_L\)) decreases (shifts left).
  2. At the old wage (W*), there is now a shortage of nurses.
  3. Hospitals must offer higher wages to attract the fewer available nurses.
  4. The wage rate rises, potentially encouraging local students to train as nurses.
Common Mistake to Avoid

Students often confuse the Demand for Labour with the Demand for Products. Remember: D\(_L\) is derived from product demand! If product demand increases, D\(_L\) increases.

5. Wage Differentials (Why Pay Varies)

If you look at different jobs, the wage rate varies dramatically—a top footballer earns far more than a cleaner. These differences are called Wage Differentials.

These differences exist because the D\(_L\) and S\(_L\) for various jobs are very different.

Key Reasons for Wage Differentials

  1. Skills and Training (Human Capital):

    Jobs requiring long training, expensive qualifications (e.g., doctors, architects) have a very low Supply of labour. Low supply meets high demand, resulting in high wages. This investment in training is called Human Capital.

  2. Non-Monetary Advantages and Disadvantages:

    Jobs that are dirty, dangerous, or have unsocial hours (e.g., deep-sea fishing, working night shifts) must offer higher wages (a 'compensating differential') to attract workers. Conversely, highly desirable jobs (e.g., museum curator) can offer lower wages because the non-monetary perks are high.

  3. Geographical Immobility:

    If people are unable or unwilling to move to an area where jobs are available (e.g., housing costs are too high in the city), this restricts S\(_L\) in that area, pushing wages up.

  4. Occupational Immobility:

    Some workers cannot easily switch between jobs because they lack the required skills. This restricts the S\(_L\) for highly specialised jobs.

  5. Trade Unions:

    Workers in unionised industries often earn more than those in non-unionised sectors (covered in the next section).

  6. Discrimination:

    Unfortunately, some groups (e.g., based on gender or ethnicity) may be paid less for the same job, even though this is illegal in many countries.

6. The Role of Trade Unions

In many labour markets, workers decide to band together to increase their bargaining power. This collective organisation is called a Trade Union.

How Trade Unions Operate

Unions represent workers in negotiations with employers. This process is called Collective Bargaining.

Analogy: Imagine you want a pay rise. Asking alone is easy to ignore. If you and 1,000 colleagues ask together (and threaten to stop working), the employer must take the demand seriously.

Impact of Trade Unions on the Labour Market

1. Increasing Wages

Unions effectively reduce the supply of labour available to the firm (S\(_L\) shifts left) or increase the overall demand (D\(_L\) shifts right, by lobbying for better working conditions which can boost morale/productivity). By restricting supply or enforcing a minimum wage higher than the equilibrium, unions can successfully raise the wage rate for their members.

2. Improving Working Conditions

Unions negotiate non-wage benefits such as improved safety, longer holidays, better pensions, and protection against unfair dismissal.

Potential Downsides

If unions force wages too high above the equilibrium (W*), the firm may be forced to:

  • Reduce the number of workers hired (leading to unemployment for non-union members).
  • Increase the price of the final product to cover the higher labour cost.

7. Government Intervention: Minimum Wage

Governments often intervene in the labour market, usually to protect low-income workers and reduce poverty. The most common intervention is setting a National Minimum Wage (NMW).

The National Minimum Wage (NMW)

The NMW is a legal wage floor—employers cannot pay workers less than this amount. It is set above the market equilibrium wage (W*).

Arguments For (Advantages) the NMW

  1. Reduces Poverty: It guarantees a basic income for the lowest paid workers, helping reduce income inequality.
  2. Increases Motivation: Workers may feel more valued, leading to increased productivity and efficiency (the 'incentive effect').
  3. Increces Consumer Spending: Low-income workers are likely to spend any extra money they receive, boosting overall aggregate demand in the economy.

Arguments Against (Disadvantages) the NMW

  1. Unemployment: Because the NMW is set above W*, the quantity of labour demanded by firms falls, while the quantity supplied increases. This creates a surplus of labour, which economists define as unemployment.
  2. Inflation: Firms may pass on the higher labour costs to consumers by increasing the price of their goods, potentially causing cost-push inflation.
  3. Reduced Competitiveness: If labour costs are high, domestic firms may struggle to compete with foreign firms that pay lower wages.
Quick Summary: The Minimum Wage Impact

If the minimum wage is too high, the cost (unemployment) outweighs the benefit (less poverty). Most governments try to set the minimum wage close to the equilibrium to minimize job losses.

Note: A Maximum Wage is a legal ceiling, set below the equilibrium. It is rarely used in the private sector but sometimes imposed on very senior public officials to limit executive pay.

Chapter Review: Key Takeaways

The labour market operates on D and S, but D is derived from the demand for the final product.
Wages differ due to skills, risk, and non-monetary factors.
Trade unions and the minimum wage are interventions designed to shift power towards workers, but they can sometimes lead to job losses if the wage is pushed too high.