Labour‑Market Forces and Government Intervention (Cambridge A‑Level Economics 9708 – Topic 8.3)
Learning Objectives
- Explain why the demand for labour is a derived demand.
- Identify and explain the main factors that shift the demand and supply curves for labour.
- Distinguish clearly between a movement along a curve and a shift of the curve.
- Apply the Marginal Revenue Product (MRP) theory of labour demand.
- Define transfer earnings (TE) and economic rent (ER) and use them to evaluate wage‑setting and taxation policies.
1. Derived Demand for Labour
Firms demand labour only because it is needed to produce a good or service that consumers want. Hence the labour‑demand curve is derived from the product‑market demand curve.
- Higher consumer demand for smartphones → higher demand for assembly‑line workers.
- Fall in demand for coal → lower demand for miners.
Diagram tip: Show a product‑market diagram with a downward‑sloping demand curve. The equilibrium price determines marginal revenue (MR); an arrow from MR to the labour‑market diagram indicates that MRP = MR × MPL, which generates the labour‑demand curve. For imperfectly‑competitive firms note that MR falls as output expands, giving a downward‑sloping labour‑demand curve.
2. Factors that Shift the Demand for Labour
| Factor | Direction of Shift | Illustrative Example |
|---|
| Output price (Py) | Higher Py → right‑ward shift | Rising wheat prices increase demand for farm workers. |
| Technology (productivity‑enhancing) | Higher productivity → right‑ward shift | New software that speeds coding raises demand for programmers. |
| Technology (labour‑saving) | Automation → left‑ward shift | Robotic pick‑and‑place arms reduce demand for manual assemblers. |
| Prices of other inputs (capital, raw materials) | Higher non‑labour input costs → left‑ward shift | Higher steel prices cut profits for car makers, reducing demand for production staff. |
| Productivity of labour (MPL) | Higher MPL → right‑ward shift | Training that raises a worker’s output from 10 to 15 units per hour. |
| Subsidies / taxes on production | Subsidy → right‑ward shift; tax → left‑ward shift | Government grant for renewable‑energy plants raises demand for engineers. |
3. Movements vs. Shifts of the Labour‑Demand Curve
- Movement along the curve: Change in the wage rate while all non‑wage determinants remain unchanged.
- Shift of the curve: Change in any non‑wage determinant (e.g., a rise in product price, a new technology) that alters the marginal revenue product at every wage level.
Diagram tip: Plot the original demand curve DL and a new curve D′L after a rise in product price; the wage axis stays the same.
4. Marginal Revenue Product (MRP) Theory of Labour Demand
Firms hire workers up to the point where:
Wage (W) = MRPL
where
MRPL = MR × MPL
- MR – marginal revenue from selling one more unit of output.
- MPL – marginal product of the last worker hired.
Numeric illustration (perfect competition):
- Product price = $5 ⇒ MR = $5.
- MP of the 101st worker = 0.8 units.
MRP = 5 × 0.8 = $4.- If the market wage = $4, the firm is indifferent about hiring the 101st worker; if the wage falls to $3.5, the firm will hire.
5. Factors that Shift the Supply of Labour
| Factor | Direction of Shift | Illustrative Example |
|---|
| Real wage rates | Higher real wages → right‑ward shift | Increase in the minimum wage attracts previously inactive workers. |
| Working conditions & job security | Improved conditions → right‑ward shift | Better health‑and‑safety standards increase supply of construction workers. |
| Education & training | More qualified workers → right‑ward shift (skilled labour) | Expansion of university places in engineering. |
| Demographics (population growth, age structure) | Growth in working‑age population → right‑ward shift | Baby‑boom cohort entering the labour market. |
| Migration policies | More immigration → right‑ward shift for targeted skills | EU freedom of movement increasing supply of nurses. |
| Taxes & subsidies on labour | Higher income tax → left‑ward shift; subsidies → right‑ward shift | Child‑care tax credit encouraging parental labour supply. |
| Non‑wage preferences (leisure, lifestyle) | Greater taste for leisure → left‑ward shift | Rise in remote‑working preferences reducing supply of office‑based workers. |
6. Movements vs. Shifts of the Labour‑Supply Curve
- Movement along the curve: Change in the wage rate with all non‑wage factors unchanged.
- Shift of the curve: Change in any non‑wage determinant (e.g., a new tax on earnings, a change in immigration policy).
Diagram tip: Show the original supply curve SL and a new curve S′L after a reduction in tuition fees for a particular profession.
7. Wage Determination in a Perfectly Competitive Labour Market
In equilibrium:
W* = MRPL = Transfer Earnings (TE)
- Firms hire workers up to the point where wage equals the marginal revenue product.
- Workers supply labour up to the point where wage equals their marginal willingness to work – i.e., their transfer earnings.
8. Transfer Earnings (TE) and Economic Rent (ER)
8.1 Transfer Earnings
Transfer Earnings (TE) – the minimum income a worker must receive to stay in the current occupation rather than move to the next best alternative use of time (another job, self‑employment, or leisure). In other words, TE is the opportunity cost of supplying labour.
Mathematically:
TE = max { Next‑best wage, Value of leisure }
8.2 Economic Rent
Economic Rent (ER) – any earnings a worker receives above their transfer earnings.
ER = Actual earnings – TE
8.3 Worked Example
- Alex is a qualified software developer earning $80,000 p.a.
- His next‑best alternative is a junior developer role paying $55,000 p.a.; the value he places on a year of leisure is $30,000 p.a.
- Opportunity cost =
max(55,000, 30,000) = 55,000.
- Transfer earnings = $55,000.
- Economic rent = $80,000 – $55,000 = $25,000.
8.4 Why Transfer Earnings Matter
- They set the **floor** for wages in a competitive market.
- Only the surplus above TE (i.e., ER) can be taxed without changing the worker’s decision to stay in the occupation.
- Understanding TE helps evaluate the impact of minimum‑wage legislation, wage subsidies, and other labour‑market policies.
9. Government Intervention and Its Interaction with TE & ER
9.1 Minimum Wage
- If the statutory minimum wage (MW) is **above** TE, workers receive
W = MW > TE. The excess MW – TE is economic rent for those workers.
- Taxing this rent (e.g., a levy on high‑wage earners) does **not** affect the labour‑supply decision because workers still earn at least their TE.
- If MW is **below** TE, the policy has little effect on wages; it may still affect employment if firms adjust hiring.
9.2 Taxation of Economic Rent
Because ER is a surplus above the minimum required earnings, a tax on ER can raise government revenue with minimal distortion to the labour market.
9.3 Wage Subsidies
A subsidy that raises the effective wage received by workers can push the realised wage above TE, creating ER that may be shared between workers and firms depending on the relative elasticities of supply and demand.
10. Suggested Diagrams for Revision
- Derived‑demand diagram: Product‑market demand → MR → MRP → labour‑demand curve.
- Labour‑demand curve: Downward‑sloping; label the shift caused by a change in output price.
- Labour‑supply curve: Upward‑sloping; mark the point where the supply curve meets the wage axis as Transfer Earnings (TE).
- Wage‑determination diagram: Combine demand and supply; indicate equilibrium wage (W*), TE (floor), a minimum‑wage line (MW) above TE, and the wedge representing Economic Rent.
- Shift illustrations: (a) Right‑ward shift of demand due to a rise in product price; (b) Left‑ward shift of supply after an increase in income tax.
11. Key Points to Remember
- Labour demand is derived from product demand; it is driven by the marginal revenue product of labour.
- Non‑wage determinants shift the demand and supply curves; a change in the wage itself causes a movement along the curves.
- In a perfectly competitive market, equilibrium wage = MRP = Transfer Earnings.
- Economic rent is the surplus over transfer earnings; it is the portion of earnings that can be taxed with little impact on labour‑supply decisions.
- When assessing policy (minimum wage, subsidies, taxes) compare the statutory wage floor with TE to predict whether the policy creates rent, causes unemployment, or is ineffective.