Business Economics – MAN1071

Semester 2 2018/19

• Week 5 (TUTORIAL SLIDES)

• The Labour market

• Labour demand
• Labour supply
• Labour market equilibrium

Office-hour/drop-in each Tuesday in room 71MS02 from 9am –

10.30/11am.
Summary
• Labour supply and demand – is similar graphically and
algebraically to supply and demand
Summary
• Labour supply and demand – c.f. S&D (wks 2&3)
• MPL and MVPL – c.f. MC and MR (wks 3&4)
What % of UK people aged 16-64 are working?

A. 60 %
B. 65 %
C. 70 %
D. 78 %
E. 80 %
78% of UK population aged 16-64 are employed
The nature of work in the UK is changing

Looking at a longer-term comparison,

between June 1978 (when
comparable data started) and
September 2018:

•The proportion of jobs in

manufacturing, mining and quarrying
sectors fell from 26.4% to 7.9%

•The proportion of jobs in the services

sector increased from 63.2% to
83.1%
Labour market
• The concepts covered in previous weeks apply to the labour market to:
Supply and demand of labour
• ‘Labour economics’ analyses the market for ‘wage labour’ which has two
sides
• The suppliers of labour services: workers
• The demand for labour services: employers, firms
• And also studies the resulting wages, employment and income
• This week: labour market from a microeconomic perspective: we are
interested in the role of individuals and individual firms in the market
• Note: in week 9, we will study the labour market from a macroeconomic
perspective – participation rates, employment levels and how labour and
GDP interact
Industry labour market (S&D) equilibrium
Labour Demand – Short Run – Example
• Consider a competitive firm that produces scarves that can be sold at £20 each. The wage
is £50 per day. Given the production pattern shown in the table, how many labour hours
does the company demand?
MVPL = MPL x Price
Labour demand
• The labour demand represents those demanding labour services; firms
• Labour is one input to firms – and linked to demand and supply
• The demand for labour is a derived demand, it reflects the demand for the firm’s output
• Wages offered must be higher than the opportunity cost; the value of the lost time and
money that could be earnt elsewhere

In the Short Run:

• In the short run, some of the factors of production (inputs) are fixed.
In the Long Run:
• All inputs can be adjusted: labour, capital (machines) and other inputs can be altered as
the firm looks for the least costly technique to produce output
Labour Demand – Short Run
• In the short run, some of the factors of production (inputs) are fixed.
• Here we consider that capital is fixed and that labour is variable
• When deciding how much labour to demand the firm use the marginal principle and will
compare:
Labour demand
• The firm make decisions over labour input and goods output (eg 5 workers, 43 scarves)
• The firm employs as long as the MVPL is greater than the wage of an extra worker
Changes in the Demand for Labour
Capital and Labour mix
• The optimum mix of capital and labour depends on the relative
prices of each input.
• This helps to explain why more labour-intensive means of
production are used in some countries where labour is relatively
abundant
• For example, if wages increase, firms may consider a more
capital intensive production technique is cost effective and
subsequently reduce the quantity of labour demanded
Labour supply
• The labour supply represents those supplying labour services: individuals:
• Labour Force: is everyone in work or seeking a job
• Labour Force Participation: is the fraction (%) of the working age population who is
the labour force
• Once in the labour force, hours do people want to work? Two factors:
• The Real Wage (𝑾/𝑷): the nominal wage divided by the price of goods (the quantity
of goods that can be purchased after investing some hours at work)
• The relative personal value between work and leisure: individuals compare their
personal value of an hour of leisure and the value (in goods that can be purchased) of
an hour at work
• These twin factors combine into two effects:
• Substitution effect: As the real wage 𝑊/𝑃 rises individuals chose to work more: a
higher real wage raises the quantity of goods an extra hour of work will buy
• Income effect: After a certain 𝑊/𝑃 the individuals’ income has increased enough to
make leisure more attractive (leisure is a ‘luxury good’, with income elasticity greater
than one)
Labour supply Income and
Substitution after substitution effect
point A – leisure and
labour
Laffer curve
Labour supply
• The substitute and the income effect work in different directions
• Data shows that in the UK/Western economies both effects almost cancel out: a small
change in the real wage has almost no effect on the amount on the quantity of hours
supplied (this is the case especially for men)
• The more important effect of real wages on the labour supply is on the incentive
to join the labour force
• If the real wage is sufficiently low, individuals may decide not to work
• As the wage increases it reaches a level (reservation wage) where the individual is
indifferent between working or not. To participate in the market the individual must be
offered at least the reservation wage
• The reservation wage and hence labour force participation depends on
• The real wage rate
• Costs in working (uniforms, travel, childcare…)
• Non labour income (benefits, inheritance....)
• Change in preferences and social attitudes
Labour supply
A higher real wage rate 𝑊/𝑃:
• Raises labour supply from those at work (although the effect may not be large)
• Entices individuals into the labour force (this effect is larger)
Industry labour supply
Industry labour market in equilibrium
Minimum wage in an industry
UK National Minimum Wage

The National Minimum Wage in the

United Kingdom is set to increase to
£8.21 per hour on 1 April 1st 2019
from the current GBP 7.83 per hour.
The rates change every April.
 Minimum Wage Statistics
Minimum wage jobs are concentrated in a relatively
small number of occupations in the UK.
Half of all minimum wage jobs are in 3 occupation
groups:
retail, hospitality and cleaning & maintenance.

Although the number of people paid at the NMW in

a particular occupation may be small, this can
represent a large proportion of employees in that
occupation e.g. there were about 26,000 minimum
wage jobs in Hair and Beauty representing over 35%
of people aged 25 + over working in these areas.
occupations.

The percentage of employee jobs paid at or below

the minimum wage varies across the UK. Coverage is
lowest in London (4%) and the South East (5%) and
highest in Northern Ireland (12%).
Summary
• Labour supply and demand – S&D
• MPL and MVPL –MC and MR
Summary
• The demand for labour is derived from the demand for what it is
used to produce.
• Firms stop hiring workers when the value of what they produce
(MVPL) begins to fall below what it costs to hire them (W).
• For someone already in the labour force, a rise in the hourly real
wage has both a substitution effect tending to increase the supply of
hours worked, and an income effect tending to reduce the supply of
hours worked
• Involuntary unemployment is the difference between desired supply
and desired demand at a disequilibrium wage rate.
• Possible causes of involuntary unemployment are minimum wage
agreements, trade unions, scale economies, insider–outsider
distinctions and efficiency wages.
Labour market
• Many of the concepts we have learnt in previous weeks apply to
the labour market too
• Labour economics analyses the market for ‘wage labour’ which
has two sides
• The suppliers of labour services: workers
• The demand for labour services: employers, firms
• Labour economics studies the resulting wages, employment and
income
Summary
• The demand for labour is derived from the demand for what it is
used to produce.
• Firms stop hiring workers when the value of what they produce
(MVPL) begins to fall below what it costs to hire them (W).
• For someone already in the labour force, a rise in the hourly real
wage has both a substitution effect tending to increase the supply of
hours worked, and an income effect tending to reduce the supply of
hours worked
• Involuntary unemployment is the difference between desired supply
and desired demand at a disequilibrium wage rate.
• Possible causes of involuntary unemployment are minimum wage
agreements, trade unions, scale economies, insider–outsider
distinctions and efficiency wages.
Labour demand
• The labour demand represents those demanding labour
services: firms
• Labour is one input to firms – and linked to demand and supply
• The demand for labour is a derived demand, it reflects the
demand for the firm’s output
• Wages offered must be higher than the opportunity cost – the
value of the lost free time and the money that could be earnt
elsewhere
Labour Demand – Short Run
• In the short run, some of the factors of production (inputs) are fixed. Here we consider
that capital is fixed and that labour is variable
• When deciding how much labour to demand the firm use the marginal principle and will
compare:
Labour demand
• The firm chooses both labour input and goods ouput (in our example: 5 workers and 43
scarves)
• The firm employs as long as the MVPL is greater than the wage of an extra worker
Labour Demand – Short Run – Example
• Consider a competitive firm that produces scarves that can be sold at £20 each. The wage
is £50 per day. Given the production pattern shown in the table, how many labour hours
does the company demand?
MVPL = MPL x Price
PROCESS TO SOLVE
(a)
• 1. Calculate MPL (products each extra
worker produces)
• 2. Calculate MVPL (value of products
each additional worker produces)
• Answer (a)
(b)
• 3. Graph MVPL and w0 on a wage-
employment graph
• Answer (b)
(c)
• 4. Graph w1 on the same graph
• Answer (c)
(d)
• 5. Recalculate the table for £16 for both
w0 = £80 and w1 = £120
• 6. Graph it
• Answer (d)
Minimum Wage in the UK –Current Level
Industry labour market in equilibrium
Minimum wage in an industry
(a)
• Find the inverse Supply curve (in terms of w) – where does the curve cut the axis?
• Find the inverse Demand curve (in terms of w) – where does the curve cut the axis?
• Find the equilibrium point where labour supply equals labour demand
• Draw the labour supply and demand curves on a wage-employment graph
(b)
• Draw wm1 = £4 on graph
• Sentence stating the implication of the minimum wage on involuntary unemployment
(c)
• Draw wm1 = £6 on graph
• Sentence stating the implication of the minimum wage on involuntary unemployment
Labour supply
Substitution after
point A – leisure and
labour
Labour supply
• The labour supply represents those supplying labour services: individuals:
• Labour Force: is everyone in work or seeking a job
• Labour Force Participation: is the fraction (%) of the working age population who is
the labour force
• Once in the labour force, hours do people want to work? Two factors:
• The Real Wage (𝑾/𝑷): the nominal wage divided by the price of goods (the quantity
of goods that can be purchased after investing some hours at work)
• The relative personal value between work and leisure: individuals compare their
personal value of an hour of leisure and the value (in goods that can be purchased) of
an hour at work
• These twin factors combine into two effects:
• Substitution effect: As the real wage 𝑊/𝑃 rises individuals chose to work more: a
higher real wage raises the quantity of goods an extra hour of work will buy
• Income effect: After a certain 𝑊/𝑃 the individuals’ income has increased enough to
make leisure more attractive (leisure is a ‘luxury good’, with income elasticity greater
than one)
Labour supply
• The substitute and the income effect work in different directions
• Data shows that in the UK and most of the Western economies both effects almost
cancel out: a small change in the real wage has almost no effect on the amount on
the quantity of hours supplied (this is the case especially for men)
• The more important effect of real wages on the labour supply is on the
incentive to join the labour force
• If the real wage is sufficiently low, individuals may decide not to work
• As the wage increases it reaches a level (reservation wage) where the individual is
indifferent between working or not. To participate in the market the individual
must be offered at least the reservation wage
• The reservation wage and hence labour force participation depends on
• The real wage rate
• Costs in working (uniforms, travel, childcare…)
• Non labour income (benefits, inheritance....)
• Change in preferences and social attitudes