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The Labour Market

The Supply and Demand

for Labour

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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

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The Labour Market

• At higher wage
rates the demand
for labour will be
less than at lower
wage rates
• Reason linked to
Marginal
Productivity The demand for labour is highly dependent on the
productivity of the worker – the more the worker
adds to revenue, the higher the demand.
Theory Title: Last California steel mill perseveres. Copyright: Getty
Images, available from Education Image Gallery

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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

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The Labour Market

Marginal Productivity Theory
The law of diminishing returns would
Wage Rate The ARPthat
suggest is the
as average
successive revenue product –
units of
the average
labour value added
are employed, the to total output
addition to
through
total product will rise at first but thenThe
hiring successive workers.
MRP curve
decline. Theintersects the MRPthe
MRP represents curve at its
value
highest point.
added to total output by successive
workers.

ARP

MRP = MPP x P

Number Employed

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The Labour Market

For the employer to be persuaded to
Wage Rate (£ per hour) TheIn 21
employ
Employing
st
unitthe
of labour
additional
a competitive 20workers,
labour
th
unit adds slightly
therefore,
ofmarket,
labour less
the
coststhe
to
wage
thetotal revenue
rate£5.50
individual
firm must
firmper(£6.70)
be lower
is not
hour but still
toenough
bigbut costs
compensate
that labour
to
7.00 £5.50
for
adds and
the £7.00
influence so
fact that
the is worth
the
perwagehourextra employing.
rate. worker
to total The There
adds
revenue
6.70 will
less thus
through
marginal be
to total an
their
cost incentive
revenue
work. is for
Itthan
of labour the
worth
is the firm to
a previous
horizontal
continue
one and
employing
line to sell
to
at the employ
that extra
existing
extra additional
units,
market
unit of the units
wage of
firmrate.
labour. must
labour until
accept a lowerthe price.
MRP = Wage rate

5.50 MCL
ARP

MRP = MPP x P
20 21
Number Employed

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The Labour Market

Wage Rate (£ per hour) There is an inverse relationship between
theThe MRP
wage curve
rate and therefore
the numberrepresents
of people
the demand curve
employed by the firm. for labour
illustrating the derived demand
relationship.
10

DL

10 15 19 Number Employed

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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

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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

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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

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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

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The Labour Market

Wage Rate (£ per hour)
SL
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
5 those skills, geographical immobility
etc.

Number of Hours Worked

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The Labour Market

Wage Rate (£ per hour)
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.

SL

5.50

35 45 Number of Hours Worked

(per week)

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The Labour Market

Wage Rate (£ per hour)
SL
A rise
The in the demand
market for labour
wage rate for a
would force occupation
particular up the wage rate as
there would will
therefore be excess
occur atdemand
the
forintersection
labour. of the demand
7.50 and supply of labour.
The wage rate will alter if
there is a shift in either or
6.00 both the demand and supply
of labour.

Excess Demand

DL1
DL
Q1 Q2
Number employed

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The Labour Market

Wage Rate (£ per hour)
SL 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.

SL1
6.00

5.00
Excess Supply

DL

Q1 Q2
Number employed

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The Labour Market

• Economic Rent
The value of the
wage earned over
and above that
necessary to keep
a factor in its
current
employment
For soccer players on £50,000+ per week, how much
would their earnings have to fall before they switched
to an alternative form of employment?
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Economic Rent
Wage Rate (£ per hour)
The supply of labour curve
shows the relationship between
the wage rate and the number
SL 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
6.00 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
Transfer factor.

Earnings
Q1 Number of hours worked

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Economic Rent
Wage Rate (£ per hour) Some individuals would have been
Those
totalindividuals earn £6.00 per hour –
The
prepared value of economic
to work Q2 hoursrentfor is shown
£4.00
they
thetherefore earn an amount in excess
byper yellow shaded
hour. triangle.
than they were prepared to offer their
services
Assumefor – this
that £6.00is termed
per hour‘Economic
is the
SL Rent’.
current market wage rate for this
factor.

6.00

Economic
Rent
4.00

DL
Q2 Q1 Number of hours worked

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Wage Rate (£ per hour)

Economic Rent
SL1 The total earnings of the factor is
Thethelower
wagethe
rate x the hours
elasticity worked
of supply
indicated by the grey rectangle.
of labour, the greater the economic
These
rent earnings
– think are in
about this made up of
relation
SL an element
to soccer stars!of transfer earnings
and an element of economic rent.
W2

Economic
W1 Rent

Total Factor Earnings

DL
Q1 Number of hours worked

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