The Labour Market

The Labour Market
The labour market is an example of a factor market
Supply of labour – those people seeking employment (employees)
Demand for labour – from employers
A ‘Derived Demand’ – not wanted for its own sake but for what it can contribute to production
Demand for labour related to productivity of labour and the level of demand for the product
Elasticity of demand for labour related to
the elasticity of demand for the product

The Labour Market
At higher wage rates the demand for labour will be less than at lower wage rates
Reason linked to Marginal Productivity Theory
The demand for labour is highly dependent on the productivity of the worker – the more the worker adds to revenue, the higher the demand.
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Marginal Revenue Productivity
Productivity refers to the amount produced per worker per period of time
MRP = the addition to total revenue (TR) received from the sale of an additional unit
of output
Worker instrumental in producing that output
Marginal Physical Product (MPP) – the addition to total product as a result of the employment of one additional unit of labour
MRP = MPP x P
If a good sells for £1.00 and a worker produces 300 per day, the MRP of that unit
of labour is £300 per day

The Labour Market
Marginal Productivity Theory
Wage Rate
Number Employed
MRP = MPP x P
ARP
The law of diminishing returns would suggest that as successive units of labour are employed, the addition to total product will rise at first but then decline. The MRP represents the value added to total output by successive workers.
The ARP is the average revenue product – the average value added to total output through hiring successive workers. The MRP curve intersects the MRP curve at its highest point.

The Labour Market
Wage Rate (£ per hour)
Number Employed
MRP = MPP x P
ARP
In a competitive labour market, the individual firm is not big enough to influence the wage rate. The marginal cost of labour is a horizontal line at the existing market wage rate.
MCL
5.50
20
7.00
Employing the 20th unit of labour costs the firm £5.50 per hour but that labour adds £7.00 per hour to total revenue through their work. It is worth employing that extra unit of labour.
6.70
21
The 21st unit of labour adds slightly less to total revenue (£6.70) but still costs £5.50 and so is worth employing. There will thus be an incentive for the firm to continue to employ additional units of labour until the MRP = Wage rate
For the employer to be persuaded to employ additional workers, therefore, the wage rate must be lower to compensate for the fact that the extra worker adds less to total revenue than the previous one and to sell extra units, the firm must accept a lower price.

The MRP curve therefore represents the demand curve for labour illustrating the derived demand relationship.
Wage Rate (£ per hour)
Number Employed
DL
10
7
4
10
15
19
There is an inverse relationship between the wage rate and the number of people employed by the firm.
The Labour Market

The Labour Market
The Supply of Labour
The amount of people offering their labour at different wage rates.
Involves an opportunity cost – work v. leisure
Wage rate must be sufficient
to overcome the opportunity cost
of leisure

The Labour Market
Income effect of a rise in wages:
As wages rise, people feel better off and therefore may not feel a need to work as many hours
Substitution effect of a rise in wages:
As wages rise, the opportunity cost of leisure rises (the cost of every extra hour taken in leisure rises). As wages rise, the substitution effect may lead to more hours being worked.
The net effect depends on the relative strength of the income and substitution effects

The Labour Market
The elasticity of supply of labour depends upon:
Geographical mobility of labour:
The willingness of people to move
The cost and availability of housing
in different areas
The extent of social, cultural and family ties
The amount of information available to workers about jobs in other areas
The cost of re-location
Anxiety of the idea of re-location

The Labour Market
Occupational Mobility of Labour:
Lack of information of available jobs in other occupations
Extent and quality of remuneration packages
Extent of skills and qualifications
to do the job
Anxiety at changing jobs

The Labour Market
Wage Rate (£ per hour)
Number of Hours Worked
SL
5
10
An inelastic supply of labour –
a substantial rise in the wage rate only brings forth a small increase
in the amount of people willing
and able to do such work.
The reason may be the number
with those particular skills and qualifications, the time it takes to get those skills, geographical immobility etc.

The Labour Market
Wage Rate (£ per hour)
Number of Hours Worked
(per week)
SL
5
5.50
35
45
If the supply of labour is elastic, a small rise in the wage rate is sufficient to encourage more people to offer their labour. Geographical and occupational mobility are likely to be high and there is likely to be many substitutes.

The Labour Market
Wage Rate (£ per hour)
Number employed
DL
SL
6.00
Q1
The market wage rate for a particular occupation therefore will occur at the intersection of the demand and supply of labour.
The wage rate will alter if there is a shift in either or both the demand and supply of labour.
DL1
Q2
7.50
A rise in the demand for labour would force up the wage rate as there would be excess demand for labour.
Excess Demand

The Labour Market
Wage Rate (£ per hour)
Number employed
DL
SL
6.00
Q1
Q2
SL1
Excess Supply
An increase in the supply of labour would lead to a fall
in the wage rate as there would be an excess supply of labour.
5.00

The Labour Market
Economic Rent The value of the wage earned over and above that necessary to keep a factor in its current employment

Economic Rent
Wage Rate (£ per hour)
Number of hours worked
SL
The supply of labour curve shows the relationship between the wage rate and the number of people offering their labour in terms of the number of hours worked.
At a wage rate of £6.00 per hour, employees are willing to offer Q1 hours. Some in the market are not willing to work for any less than that and some would be willing to work for less than £5.00.
The area under the supply curve is referred to as the ‘Transfer Earnings’ of the factor.
6.00
Q1
Transfer
Earnings

Economic Rent
Wage Rate (£ per hour)
Number of hours worked
SL
6.00
Q1
Q2
4.00
Some individuals would have been prepared to work Q2 hours for £4.00 per hour.
Assume that £6.00 per hour is the current market wage rate for this factor.
DL
Those individuals earn £6.00 per hour – they therefore earn an amount in excess than they were prepared to offer their services for – this is termed ‘Economic Rent’.
Economic
Rent
The total value of economic rent is shown by the yellow shaded triangle.