The labour market trades work for wages
Definition
Labour market: the market in which workers supply their labour and employers buy it, with the wage acting as the price.
Wage rate: the price of labour, usually expressed per hour, per week or per year.
- Labour is one of the four factors of production in 1.1.2, and like any factor it is bought and sold in a market.
- This is a factor market rather than a product market, so it sits on the other side of the economy from 2.2 and 2.3, as set out in 2.1.3.
- The wage does the same job here that a price does anywhere else: it signals, it rewards and it rations, as described in 2.4.5.
Households supply labour and firms demand it
- The roles are the reverse of a product market, because here the household is the seller and the firm is the buyer.
- Labour supply comes from households deciding how many hours to offer at a given wage, and it slopes up because a higher wage attracts more people into the work.
- Labour demand comes from firms deciding how many workers to hire, and it slopes down because labour becomes dearer relative to machinery as the wage rises.
- The two are still plans rather than outcomes, so the number actually employed is settled where they meet.
Demand for labour is derived from demand for goods
Definition
Derived demand: demand for a good, service or worker that exists only because there is demand for something else they help to produce.
- No firm wants workers for their own sake, so the demand for labour exists only because buyers want the output those workers make.
- A fall in demand for a product therefore reaches the workers who make it, which is how a change in a product market becomes a change in jobs.
- It works the other way too, so a boom in a product market raises the wage employers will pay to attract the workers.
The wage settles where the two plans meet
- Above the market wage more people want the work than employers will hire, so there is excess supply of labour and the wage is pushed down.
- Below it employers want more workers than are willing to come, so there is excess demand and the wage is bid up.
- The wage settles where the number of hours offered equals the number wanted, exactly as a price does in 2.4.2.
Example
- A local warehouse labour market, with quantities in hours a week.
| Hourly wage | Hours demanded | Hours supplied |
|---|---|---|
| £13 | 1,100 | 500 |
| £15 | 800 | 800 |
| £17 | 500 | 1,100 |
Step 1: at £13, subtract the hours supplied from the hours demanded:
1,100−500=+600 hours a week 1{,}100 - 500 = +600\text{ hours a week} 1,100−500=+600 hours a week- A positive answer is excess demand, so at £13 the warehouse cannot fill its shifts and has to offer more.
- At £17 the same subtraction gives −600, an excess supply of labour, so the wage would be pushed back down.
- The market clears at £15 with 800 hours a week, which is the wage and the employment level this market settles at.
Workers and employers interact through the wage
- Neither side sets the wage alone, because an employer offering too little gets no applicants and a worker asking too much is not hired.
- Each side responds to the other through the wage, which is why the labour market is described as an interaction rather than a decision.
- How that interaction produces different wages in different jobs is analysed in 2.7.2.
Exam technique
- Put the wage on the vertical axis and the quantity of labour on the horizontal axis, since it is a demand and supply diagram like any other.
- Say who is supplying and who is demanding, because getting the two sides the wrong way round makes the whole answer wrong.
Self review
- Who supplies labour and who demands it?
- Why does the labour supply curve slope upwards?
- What does it mean to say demand for labour is derived?
- Using the warehouse table, what is the excess supply of labour at £17?
- Why can neither workers nor employers set the wage on their own?
