determinants

Employment and Unemployment – Determinants (Cambridge AS & A‑Level 9708)

Understanding why employment levels rise and fall is essential for analysing labour‑market outcomes. The sections below follow the Cambridge syllabus, covering the demand and supply of labour, wage‑setting in different market structures, institutional and macro‑economic influences, and the measurement of unemployment.

1. Labour‑Market Demand

• Derived demand – Firms demand labour because it is needed to produce a final good or service. The demand for labour therefore derives from the demand for output.
• Marginal Revenue Product (MRP) – The value of the additional output produced by one more worker.
  $$\text{MRP}= \text{MP}\times P$$ where MP = marginal product of labour and P = price of the output.
• Marginal Factor Cost (MFC) – The additional cost to the firm of employing one more unit of labour.
  In a perfectly competitive labour market, MFC = W.
  In a monopsony, the upward‑sloping supply of labour makes MFC > W and the monopsonist hires where MFC = MRP.
• Wage‑elasticity of labour demand – Measures the responsiveness of the quantity of labour demanded to a change in the wage.
  Elastic demand (|ε| > 1) → large change in employment for a small wage change.
  Inelastic demand (|ε| < 1) → employment changes little.

Factors that shift the labour‑demand curve (D)

2. Labour‑Market Supply

• Labour‑force participation – Decision of working‑age individuals to offer their labour.
  Participation rate = (Labour force ÷ Working‑age population) × 100 %.
• Wage expectations – Workers compare the expected real wage (nominal wage adjusted for expected inflation) with alternative sources of income.
• Non‑wage determinants of labour supply
  • Leisure / working‑time preferences.
  • Health status and disability.
  • Child‑care costs and family responsibilities.
  • Geographic mobility and commuting costs.
  • Availability of part‑time, self‑employment or informal work.
• Typical shape of the labour‑supply curve – Upward‑sloping; flatter at low wages because workers need to meet subsistence needs, steeper at higher wages as the substitution effect dominates.

Factors that shift the labour‑supply curve (S)

3. Wage Determination in Different Market Structures

Minimum‑Wage Example

If a statutory minimum wage (W_min) is set above the competitive equilibrium wage, the labour‑demand curve intersects the supply curve at a lower quantity of labour. The difference between the quantity supplied and the quantity demanded represents involuntary unemployment.

4. Institutional Determinants & Government Failure

• Minimum‑wage legislation – Sets a wage floor. If W_min > equilibrium, creates excess supply (policy‑induced unemployment).
• Trade unions & collective bargaining – Negotiated wages above market‑clearing level; can raise structural unemployment.
• Employment‑protection legislation (EPL) – Strict dismissal rules increase the cost of firing workers, discouraging firms from hiring.
• Unemployment benefits – Generous benefits reduce the urgency of job‑search, shifting the effective labour‑supply curve leftward (lower labour‑force participation).
• Payroll taxes & subsidies for training – Payroll tax raises firms’ labour costs (shifts D left); training subsidies raise productivity and shift D right.
• Government‑failure (policy‑induced unemployment) – When well‑intentioned policies (e.g., high minimum wages, excessive EPL) raise the natural rate of unemployment, the economy experiences “policy‑induced” or “institutional” unemployment.

5. Macro‑Economic Determinants

• Fiscal policy – Government spending raises aggregate demand, shifting labour demand right; higher taxes can reduce disposable income and labour‑force participation.
• Monetary policy – Lower interest rates stimulate investment, increasing labour demand; higher rates have the opposite effect.
• Inflation expectations – If workers expect higher inflation they demand higher nominal wages; if productivity does not rise, real wages increase, potentially reducing employment.
• Phillips‑curve link – In the short run, lower unemployment is associated with higher inflation. The expectations‑augmented Phillips curve shows that once inflation expectations adjust, the trade‑off can disappear.

6. Measuring Unemployment

• Unemployment rate (U)
  $$U = \frac{U_t}{L}\times 100\%$$ where U_t = number of unemployed, L = total labour force.
• Labour‑force participation rate (P_LF)
  $$P_{LF}= \frac{L}{\text{Working‑age population}}\times 100\%$$
• Under‑employment – Workers employed below their skill level or working fewer hours than they would like.
• Types of unemployment
  • Structural – mismatch of skills or location.
  • Cyclical – caused by fluctuations in aggregate demand.
  • Frictional – short‑term job‑search unemployment.
  • Seasonal – due to regular seasonal variations in demand.

7. Summary Table of Determinants

8. Suggested Diagrams

• Labour‑market diagram showing demand (D) and supply (S) curves:
  • Rightward shift of D (e.g., higher productivity) → lower unemployment.
  • Rightward shift of S (e.g., population growth) → higher unemployment if D is unchanged.
  • Binding minimum wage – horizontal line above equilibrium wage creating excess supply (unemployment).
• Monopsony diagram illustrating where MFC = MRP and the resulting wage W < MRP.
• Efficiency‑wage diagram (optional) showing wage set above the competitive level and the associated unemployment gap.

9. Key Points to Remember

1. Labour demand is derived and equals the marginal revenue product of labour (MRP = MP × P).
2. Anything that raises MRP – higher productivity, higher output price, or training subsidies – shifts the demand curve right.
3. Labour supply depends on participation decisions; the participation rate measures the proportion of the working‑age population in the labour force.
4. Non‑wage factors (leisure preference, health, childcare costs, mobility) also affect the supply of labour.
5. Wage‑setting varies with market structure:
   • Perfect competition: W = MRP.
   • Monopsony: firm hires where MFC = MRP, paying a lower wage.
   • Unionised or efficiency‑wage settings can push wages above the market‑clearing level, creating unemployment.
6. Institutional factors (minimum wage, trade unions, EPL, unemployment benefits, payroll taxes) can create wage rigidities and lead to policy‑induced unemployment.
7. Macroeconomic policies influence labour demand indirectly: fiscal expansion and monetary easing raise AD and investment, reducing cyclical unemployment; inflation expectations affect real‑wage adjustments.
8. Distinguish between cyclical (demand‑driven) and structural (skill‑mismatch or institutional) unemployment when evaluating policy effectiveness.