Labour markets

2 parts
1. supply, demand and wage determination
2. Labour market failure

Work vs Leisure
An alternative to work is leisure time.
For each hour an individual works there
is an OPPORTUNITY COST

If an hour of leisure time is chosen, the
WAGE is the OPPORTUNITY foregone

PART 1
DEMAND, SUPPLY AND WAGE
DETERMINATION
Supply of labour
The total number of hours that labour is willing and able to supply at a
given wage rate.
And
The number of workers willing and able to work in a given occupation or
industry for a given wage.

wage
Hours/quantity
The labour supply curve

The labour supply curve for any industry or
occupation will be upward sloping because
as wages rise, other workers enter this industry
attracted by the incentive of higher rewards.
They may have moved from other industries or
they may not have previously held a job, such as
housewives or the unemployed.
The extent to which a rise in the wage or salary
in an occupation increases labour supply
depends on the elasticity of labour supply.

Backward sloping labour supply curve!
In the short run the
individuals supply
curve may be
backward sloping
because of the
income and
substitution effects
Income effect
The income effect of a wage rise is to:

Reduce the number of hours people work

because as the wage rate rises, the worker
buys more goods and services including leisure.
They have enough money so if they can earn
the same for doing fewer hours they will.

Substitution effect
The substitution effect of a wage rise is to

Increase the number of hours people work

because as the wage rate rises, the worker gains
more from working and increases the opportunity
cost of leisure so the worker selects to work more
hours. I.e. As the wage rate rises, more labour is
supplied to earn more money.

If the wage rate is low, do you think there will be more of an
income effect or a substitution effect and why?
At a low wage rate there is more likely to be a
substitution effect as working more hours will
increase a workers living standards

Once the wage rate has reached a certain
level, the income effect may outweigh the
substitution effect and an individual will buy
more leisure

Q What is the problem with the income and
substitution effect theory in reality?

Many workers are unable to alter the number
of hours they work in their main jobs.

They have a fixed contract
Supply in the long run
In the long run people are able to change their
occupations - the supply of labour is
influenced by the net advantages of the job.

This means the
Pecuniary (financial) and
Non pecuniary (non financial) factors
Pecuniary factors
Wage rate
Opportunity to work overtime
Possibility of bonuses

Non-pecuniary factors
Convenience and flexibility of hours
Status
Promotion chances
Location (flexibility)
Qualifications and skills
Job security
Pleasantness of the job

Non-pecuniary factors cont
Holidays
Perks and fringe benefits
Quantity and quality of training on offer
Recent performance of the firm
The elasticity of supply of labour

The extent to which the supply of labour
changes as a result of a change in the wage
rate is measure by PES of labour

% change in Q of labour supplied
% change in wage rate
Influences n PES of labour
qualifications and skills required
Supply of skilled workers is more inelastic than the
supply of unskilled workers e.g. the supply of vets is
more inelastic than the supply of shop assistants
the length of training
A long period may discourage people from the
occupation. It will take some time for people to
qualify even if the wage rate rises. If it falls, people
who are a long way into their training may not leave
Influences on PES of labour
the immobility of labour
Depends on how easy it is for workers to switch jobs
(occupational mobility) or to move areas
(geographical mobility). Mobility means more elastic
supply.
the time period
Over a longer period of time, labour supply becomes more
elastic. In the short run, the wage rate can rise but with little
effect on the labour supply
How useful are these explanations?
Doctor
McDonalds worker
Economist
Solicitor
Nurse
Teacher
Firefighter

Summary supply of labour
The supply of labour is upward sloping the
higher the wage, the more labour is supplied
In the short run it may be backward sloping
owing to income and substitution effects
In the long run it is determined by the net
advantages of the job (pec and non pec)
It can be elastic or inelastic depending on
quals and skills required, length of training,
mobility of labour and time.
Demand for labour
In the recession, the UK housing market experienced a
downturn. Housing projects were delayed and scaled down
existing sites.

What is most likely to have happened to the employment of
plasterers and bricklayers? (they will experience lower demand
for their services)
Demand for labour is DERIVED (demand
for one depends on demand for another)
Factors influencing demand for labour
Demand and expected future demand for a product
The expected revenue from increasing/decreasing
production can change demand for labour
Productivity
The higher the output per worker, the more attractive
labour is as a resource
Wage rate
If the wage rate rises about productivity, costs rise and
could contract demand for labour

Factors influencing demand for labour
Complementary labour costs
A change in any other costs associated with labour
e.g. National insurance contributions could change
the demand for labour
The price of other factors of production
When other factors of prod. change demand for
labour can change e.g. If capital becomes cheaper,
workers could be replaced by machines


Question
Why is demand for migrant workers still high
despite the recession?

Demand for firms products means labour still
needed?
Skills shortages in the UK?
Migrant workers more productive?
Cheaper?
More flexible about hours, working conditions etc?
Marginal revenue product of labour
a theory about demand for labour and about the price
of labour
MRP theory states that demand for labour depends
upon 2 things
Productivity of labour
the demand for the good they produce (which
determines price)

MRP Calculation
MPP (marginal physical product)

Marginal revenue (this is the price of the
product in perfect competition)

MRP of labour = MPP x Price
Marginal Revenue Product Theory:
MRP is important in determining wages.

Workers with higher productivity will tend to get higher wages. Also,
workers who help produce profitable goods will get higher salaries. For
example, lawyers and professional footballers get high salaries
because the marginal revenue of their goods are high



Criticisms of MRP theory
it can be difficult to determine the MRP of workers, for
example, many in the service sector do not produce a
tangible output e.g. nurses and teachers
It assumes that workers are homogenous they are
not, they have differing abilities and productivities
It ignores that fact that some businesses have
monopsony power and can dictate a lower wage rate
than MRP suggests
It assumes that workers are geog and occ mobile and
that the supply of labour is perfectly elastic - in reality
it is not

Elasticity of demand for labour

% change in quantity of labour demanded
% change in the wage rate

inelastic
elastic
Factors affecting elasticity of demand for labour
1. The proportion of labour costs in the total costs of a business:
When a businesses labour expenses are a high proportion of total costs, labour
demand can be expected to be more elastic than a business or industry where
fixed costs of capital are the dominant business expense


2. The ease and cost of factor substitution:
The demand for labour tends to be more elastic when labour and capital are easily
substitutable.
This depends on the nature of the production process, the added human value
that the labour input provides (particularly in service industries) and the flexibility
of the labour market (for example the ease and cost of hiring & firing labour is
influenced by existing employment laws). When labour is considered a necessity in
the production process, the demand will be inelastic in responsive to wage
changes. Think about the difference between a car manufacturer and a hotel
Factors affecting elasticity of demand for labour - cont
3. The price elasticity of demand for the final output produced by a
business:
If a firm is operating in a highly competitive market where final
demand for the product is price elastic, they may have little power
to pass on higher wage costs to consumers through a higher price,
the demand for labour may therefore be more elastic as a
consequence

4. The time period under consideration:
In the short run, at least one factor of production is assumed to be
fixed so the demand for labour as an input will be more inelastic
compared to the long run when a business has a much greater
opportunity to vary the factor mix between labour and capital


Summary demand for labour
Demand for labour is DERIVED
Factors that affect it are: demand for the product,
productivity, wage rate, complementary labour
costs
MRP is a theory of demand for labour that
depends on productivity the more productive a
worker, the greater the MRP
Elasticity of demand for labour depends on: Ease
of factor substitution, Time, PED for the product
(final output) and the proportion of labour costs
to total costs


Wage determination
Supply and demand interact to determine the
wage rate
Demand and supply
could be elastic e.g.
cleaners, fast food
worker (lower wage
rate)
Demand and supply
could be inelastic
e.g. brain surgeons,
barristers (higher
wage rate)
Wage determination 2
MRP(L) also explains the wage rate

A worker is paid according to his/her MRP. A
barrister would have a higher MRP than a
cleaner therefore would be paid a higher
wage.
As the MRP of a worker increases, they can be
paid a higher wage
Wage differentials
Why are there differences between the wages earned
in alternative occupations
This occurs because of
Skill levels
Length of time to train
Demand for labour (PED, substitutes)
Public opinion
Government policy
Relative bargaining strength (trade union)
MRP
OTHER FACTORS FOLLOW IN THE NEXT SLIDES
Male vs Female
Male (paid more on average)
More women work part time
Gap narrowing
MRP of women is much lower (average)
Historically men better qualified
MRP lower as women disproportionately employed in
low paid jobs that generate low marginal revenue
Women leave the labour market to have children and
lose out on promotional chances
Discrimination
Skilled vs Unskilled
Skilled (paid more)
Demand is higher and supply is lower
MRP higher as output is higher
Higher level of human capital
Higher education and training = productivity
Difficult to substitute with machines

Part time vs Full time
Part time (lower paid)
Supply high relative to demand
Productivity lower as they receive less training
Higher proportion are women
Only a small number in a trade union

Ethnic minorities
Ethnic minorities (lower paid on average)
Discrimination
High proportion of Asians working in catering
which is low paid
Qualifications are lower particularly in women
Economic Rent and Transfer Earnings
A person stays in a job depending on the
economic rent and transfer earnings
Transfer earnings = the minimum payment
needed to keep a worker in work (min
payment needed to keep a factor of
production in its present use)
Economic rent = the payment to the factor
(worker) over and above its transfer earnings
in the long run
diagram
Transfer earnings is the minimum wage you
would require for doing a job.
Economic rent is the different between what you
get paid and what you would do the job for.

The amount of transfer
earnings and economic
rent depends on the
elasticity of supply
Summary wage determination
Wages are determined in a competitive market
through:
Supply and demand (note the elasticity can be
important)
MRP of labour
Because of pay differentials
Because of economic rent and transfer earnings
Part 2
Labour market failure
Labour Market Failure
Is caused by:
1. Monopsony power
2. Trade Union power
3. Imperfect information
4. Skill shortages
5. Economic inactivity
6. Unemployment
7. Discrimination
8. Segmented labour markets
9. Geographical and occupational immobility of labour
1.Monopsony
A monopsony producer has significant buying power in the labour market when
seeking to employ extra workers. A monopsony employer may use their buying-
power to drive down wage rates. The market fails if this is the case
The marginal cost of employing one more worker
will be higher than the average cost because to
employ one extra worker the firm has to pay more
and increase the wages of all workers.
To maximise the level of profit the firm
employs Q2 of workers where MC = MRP

The firm only has to
pay a wage of W2. This
is less than the
competitive wage
2. Trade Unions
Trade unions are organisations that represent
people at work.
They can put pressure on firms for improved pay
and conditions and higher pay. They can:
Restrict the supply of labour
Strike/stop/disrupt production

This causes labour market failure (see page 18 of
revision booklet for an evaluation of their use)
How do they work?
They push up wages to W2 which is
above the equilibrium and could
cause unemployment between Q2
and Q3
HOWEVER if the employer is a monopsony they
could actually increase employment as at the higher
wage, more people would be willing to supply their
labour

The wage is at W2 but the union could bargain for
W1 or W3. At W3 more people could be employed
but at W3 no extra workers would want to work but
unemployment would not be made worse
Other causes of labour market failure
3. Imperfect information
Workers may not have the information they
need to get a job or a better job - Employers
may not be able to afford to advertise to all
potential employees so dont get the best
employees solution job centres, national
databases of jobs

Other causes of labour market failure
4. Skill shortages
Occur when firms struggle to recruit people
with the right skills may have to bid up
wages = increased costs. Short-termist
attitude towards training? Solutions
education and training, immigration

Other causes of labour market failure
5. Economic inactivity
People who are not in the workforce (actively
seeking or in a job). Some economically
inactive e.g. students will provide a long term
benefit. Others could work and represent a
waste of resources. Solutions cut benefits,
provide training, minimum wage as an
incentive to work

Other causes of labour market failure
6. Unemployment
Unemployment means some labour markets
are not clearing
Those willing and able to work cannot find a
job
Causes- cyclical (lack of aggregate demand)
Voluntary, frictional and structural
7. Discrimination
Could be caused by several factors including:
Personal prejudice
Imperfect information employers do not
know how productive a worker may be so may
avoid employing for e.g. over 50s as they may
wrongly believe they will be less productive
than younger workers
Solutions education, training, information,
laws


8. Segmented labour markets

There are barriers that prevent workers
moving freely between occupations
Some barriers are good e.g. taxi drivers
requiring a driving licence and Surgeons
requiring skills and qualifications
Others are unnecessary and have been
introduced to push up wages and to keep
groups out

9. Geographical and occupational
immobility of labour
Mobility = the ability to move from one sector of
employment to another

Changing occupation (occupational)
Moving to work in another area (geographical)

A lack of labour mobility is the cause of
structural unemployment (mismatches)
Mobility of labour
Occupational immobility is a result of a skills
shortage
Effects
Low skills = low wages
Firms limited to lower profits/cannot achieve
their objectives
Mobility of labour
Inflation and unemployment (because of skills
mismatch )
- there is always a small amount of unemployment
even if the market is in equilibrium.
To solve this AD could be increases but this would lead to
inflation (higher costs = higher prices). The lowest level of
unemployment that keeps inflation stable is called the non
accelerating inflation rate of unemployment (NAIRU)
Limitation on competitiveness
Inequality


Geographical immobility

Lack of information
House prices and structure of housing (renting
vs buying)
Family and social ties

Question
4 (a) With the use of examples, explain what
is meant by labour market failure. [15]

(b) Government attempts to correct market
failure by intervening in the labour market
are likely to cause more problems than they
solve. Discuss this view. *20+
June 2009
Labour market flexibility (solves
market failure)
What is it (different types of)
Where the supply of labour is responsive to
changes in the demand for labour.
Labour mobility (occ and geog)
Flexible working patterns (part time, variable
hours, shift work, temp contracts, home working)
Wage flexibility - wages should move both
upwards and downwards in response to changes
in supply demand
Labour market flexibility
Methods to achieve it
training and education
Cut income tax and UE benefits
Link UE benefit to search for employment
Remove employment protection legislation
(Thatcher did this in the 80s but Labour Govt
signed up to the EU social charter in 1997 so
had to re-introduce more protection)

Implications of it

UK more flexible as govt has removed restrictions
on hiring and firing. USA has lower protection
but other EU has more
Widened participation (i.e. more women in the
workforce as a result of more part time
opportunities
Less job security more frictional unemployment
but greater employment overall.
Greater competitiveness
Evaluation
Look at the figures in your hand out is it
better or worse for the UK economy to have a
flexible workforce.

Why and how does the government intervene
in the labour market?

Employment
Information provision
Regional policy
Training and education
NMW legislation
Discrimination legislation
TU legislation

PENSIONS
Explain why there is a Pensions Crisis.
The Pensions Crisis has come about for various reasons
increasing life expectancy,
early retirement schemes draining pension funds,
poor performance of certain funds,
employers and employees not paying sufficient
contributions.
The crisis is that many funds, particular private sector
ones, will not be in a position to pay out what is
expected in the near future


Discuss the extent to which this Pensions Crisis might impact
on the UK labour market and the economy as a whole.

The most likely impact on the labour market is that the normal
retirement age for male and female workers will increase.
A tightening up on early retirements and similar concessions that
are currently given by pension funds. Consequently, the typical age
of workers will increase some may be rather disillusioned.
The impact on the economy is that government intervention may
be needed in the short term to bale out pension funds.
There are also implications for the funding of the State Pension and
other public services.
Longer term, the economy may become more productive due to
often well qualified people remaining in the labour market.
Unqualified labour may find it more difficult to obtain work and
impact on the rates of direct taxation for those in work.

Immigration
Advantages
An expansion of the labour supply
Reduced pressure on wage inflation
Aggregate demand effects- economic
migrants are likely to earn more than they
spend contributing to the growth of the local
or regional economy

Immigration
The costs of migration
Depressing the real wages of domestic workers
Doubts about productivity effect: Many immigrants,
especially those from poorer countries, have a low
educational level and are more likely to be unemployed
or economically inactive than the domestic population.
Increased pressure on the welfare state (benefits,
education, housing and health)
Unemployment concerns
Increased pressure on scarce resources: (e.g. housing)

EU Directives
EU directives (laws) have to be made into UK law
within a set time period e.g. 2 years

The UK has the least protection for workers in
Europe whereas EU directives tend to help
protect workers e.g. the NMW and maximum
working week came from EU directives. Recently
the parental leave directive was made UK law
evaluate the effects on the labour market
(flexibility in particular)
Poverty and inequality
Represents about market failure as this shouldnt
happen if the market works efficiently the wage
would be at a level that is enough to live on and
everyone would be in a job (this doesnt happen in
reality)
Absolute poverty - The inability to purchase the basic
necessities of life e.g. food, shelter, clothing
Relative poverty (UK) - A measure of households in one
country where income is behind the average
The widely accepted definition of poverty is having an
income which is less than 60% of the national average

What causes poverty?
Unemployment
Low wages
Sickness and disability
Old age
Poverty trap
Bing a lone parent
Reluctance to claim benefits

What are the effects of poverty?
Low life expectancy
Poor health
Lower education
Alienation from society
Burden on government/reduction in
productivity

Measuring relative poverty
(1) The Lorenz Curve a diagram to illustrate income
distribution

(2) The Gini-coefficient - a calculation based on the
lorenz curve to compare income inequality. A value
between 0 and 1. The closer to 1 the more unequal

(3) The percentage of households living below a given
percentage of median incomes (60% in UK)
Most measures of relative poverty concentrate on
income rather than wealth

Causes of income inequality
Main cause: The disparity in wages and earnings growth in different jobs and industries
Huge rises in earnings for the better off
Slower growth of pay for people in low-paid jobs
Welfare:
Falling relative incomes for those dependent on state welfare benefits whose value
rises each year in line with prices rather than incomes
Structural / long-term unemployment
E.g. a high level of workless households (the economically inactive) where no one in
the household is in paid work
Low paid jobs:
A long term shift towards part-time service sector employment often relatively low
paid work with little or no trade union protection
Taxation: Less progressive tax system
Cuts in the higher rates of income tax (40%)
Inequalities in wealth also create income inequalities
(e.g. interest from savings, dividends from shares, income from private occupational
pensions)

Government interventions
A Tax
Increasing progressive taxes such as the higher
rate of income tax from 40% to 50% will take
more income from those on high income
levels. This enables cuts in regressive taxes
and increased benefits which help increase
the income of the poor.




Government interventions
B. increase benefits to the poor

Advantages of means tested benefits:
They allow money to be targeted to those
who need it most. e.g family tax credit or
pension credit.
It is cheaper than universal benefits and
reduces the burden on the tax payer

However means tested benefits are
often unpopular because people are
stigmatised as being poor.
Also it may create a disincentive to
earn a higher wage, because if you
do get a higher paid job you will lose
at least some of your benefits and
pay more tax. This is known as the
benefit trap or the poverty trap
Some relatively poor may fall just
outside the qualifying limit.

Also not everyone entitled to means
tested benefit will collect them
because of ignorance or difficulties in
applying.

The government used to prefer
universal benefits because it avoided
the above problem, and people feel if
they contribute towards taxes they
deserve their benefits regardless of
their wealth

Government interventions
C. Minimum Wage
Since the introduction of the NMW many low paid workers have seen an increase
in the hourly wage as firms are obliged to pay workers the statutory minimum
wage.
To some extent this has helped reduce relative poverty, as the lowest paid
workers have seen a significant increase in their weekly income. This is more
prevalent in the North where wages tended to be lower; fewer jobs in the south
have been affected by the NMW.
A concern about the NMW is that it
may cause unemployment. An increase
in the NMW to above the equilibrium
will lead to real wage unemployment of
Q3 Q2.
Evaluation of NMW
The advantages of a national
minimum wage:
Greater equity will be achieved, and
the distribution of income between
the high paid and the low pay may be
narrowed.
Poverty may be reduced as the low
paid gain more income and the
unemployed may be encouraged to
join the labour market. In this case
the higher wage is an incentive for
individuals to supply their labour.
Less worker exploitation by labour
market monopsonists, who are single
employers is able to pay below the
market equilibrium.

The disadvantages of a national
minimum wage:
A high minimum wage can cause
price inflation as firms pass on the
higher wages in higher prices.
Falling employment, as demand
contracts, and rising unemployment
as supply extends.
The competitiveness of UK goods
abroad can suffer compared with low
wage economies, such as China and
India.
Inward investment may be deterred,
as foreign investors will look to avoid
high wage economies.
The labour market may become
inflexible in response to changes in
the rest of the economy.

Productivity etc
Productivity the output per worker employed
Unit labour cost cost of labour/output

Business owners compare unit labour costs to
measure productivity. If the unit labour cost
decreased over a period of time, productivity
increased.



Possible analyse questions
1. Analyse the factors that determine the supply of
labour in the short run and the long run
2. Analyse the factors that determine elasticity of
supply for labour
3. Analyse why premiership footballers earn more
than nurses
4. Analyse 2 causes of labour market failure.
5. Analyse the reasons for differences in economic
rent and transfer earnings
6. Analyse the reasons for pay differentials