Influences of the demand for labour and the supply of labour on wage determination

Micro‑economic Decision‑Makers – Workers

Learning objective

Explain how the demand for labour and the supply of labour determine wages in a competitive market, and describe the factors that influence an individual’s choice of occupation, the reasons for wage differences, the role of government and trade‑unions, and the importance of labour mobility and division of labour.

1. Factors that influence an individual’s choice of occupation

When deciding which job to take, people weigh wage‑related and non‑wage considerations. These factors shift the labour‑supply curve.

  • Wage‑related factors

    • Level of pay (hourly, weekly or salary)

    • Prospects for future pay rises

    • Job security and contract type (permanent, temporary, zero‑hours)

    • Opportunities for promotion and career progression

  • Non‑wage factors

    • Working conditions (hours, health & safety, flexibility, shift patterns)

    • Status and prestige of the occupation

    • Location of the job (proximity to home, urban vs. rural, overseas)

    • Age, gender and cultural expectations (explicitly listed in the Cambridge syllabus)

    • Family responsibilities (child‑care, caring for elderly relatives)

    • Job satisfaction, personal interest and values

2. Labour‑mobility

Mobility determines how easily workers can respond to changes in wages and employment opportunities.

  • Occupational mobility – the ability to move from one occupation to another, usually by acquiring new skills or qualifications. Example: a bank clerk retrains to become a computer programmer.

  • Geographic mobility – the willingness and ability to move to a different location for work. Example: nurses relocating from a rural area to a city where there is a shortage of staff.

Higher mobility makes the labour market more flexible and helps the market reach equilibrium more quickly.

3. Division of labour

Division of labour is the process of breaking down production into a series of specialised tasks.

  • Advantages

    • Increases productivity – workers become faster and more skilled at a narrow task.

    • Encourages the use of specialised equipment and techniques.

  • Disadvantages

    • Monotony can reduce worker motivation and increase turnover.

    • Production becomes dependent on the smooth coordination of many specialised workers; a breakdown in one task can halt the whole process.

4. The demand for labour

Labour demand is a derived demand: firms hire workers only if the extra output they produce adds more to revenue than the cost of the wage.

Profit‑maximising rule for a competitive firm

\$\text{MRP}_L \;=\; w\$

where MRPL is the marginal revenue product of labour (the extra revenue from one more worker) and w is the wage rate. If MRPL > w the firm hires more workers; if MRPL < w it reduces employment.

Key determinants of labour demand

DeterminantHow it affects demand
Product demandHigher demand for the firm’s output raises the marginal revenue product of labour → demand for labour shifts right.
Productivity of labour (MPL)Better training, new technology or improved methods increase the marginal product of labour → demand shifts right.
Price of the productWhen the product price rises, each unit of output generates more revenue → MRPL rises → demand shifts right.
Price of other inputs (e.g., capital)A fall in the price of capital makes substitution possible, reducing the quantity of labour demanded → demand shifts left.
TechnologyAutomation can (a) raise the productivity of existing workers → demand shifts right, or (b) replace workers entirely → demand shifts left.
Number of firms in the marketEntry of new firms raises total labour demand; exit lowers it.

5. The supply of labour

The labour‑supply curve shows the quantity of work that individuals are willing and able to offer at each wage rate.

Key determinants of labour supply

DeterminantEffect on supply
Population size and demographicsMore working‑age people → supply shifts right; ageing population → supply shifts left.
Wage ratesHigher wages make work relatively more attractive than leisure → upward‑sloping supply curve.
Alternative employment opportunitiesPart‑time, seasonal or self‑employment options can increase the effective supply of labour.
Education and trainingHigher skill levels increase the supply of qualified workers for particular occupations.
Immigration and emigrationImmigration raises, emigration lowers the domestic labour pool.
Social and cultural factorsAttitudes to work, gender roles, family responsibilities affect willingness to work.
Occupational‑choice factors (Section 1)Changes in wage‑related or non‑wage considerations shift the supply curve for a specific occupation.

6. Wage determination in a competitive labour market

In a perfectly competitive (i.e. “competitive”) labour market the equilibrium wage w* is where the quantity of labour demanded equals the quantity supplied.

Labour‑market diagram: demand (D) and supply (S) intersect at equilibrium wage w* and employment L*.

Shifts in demand or supply

ShiftTypical cause(s)Effect on equilibrium
Demand rightwardIncrease in product demand, higher productivity, rise in product priceHigher wage, higher employment
Demand leftwardTechnological substitution, fall in product price, reduced output demandLower wage, lower employment
Supply rightwardPopulation growth, immigration, more women entering the workforce, higher enrolment in education (temporary)Lower wage, higher employment (if demand unchanged)
Supply leftwardAging population, restrictive immigration policies, large numbers leaving education for workHigher wage, lower employment (if demand unchanged)

7. Government and trade‑union intervention

National Minimum Wage (NMW) – a price floor

  • The government may set a statutory minimum wage wmin. If wmin > w* the market experiences a surplus of labour (unemployment).

  • If wmin ≤ w* the floor is non‑binding and has no effect.

Diagram showing a minimum‑wage floor above the equilibrium wage. The horizontal line at wmin intersects the demand curve at a lower quantity of labour than the supply curve, creating excess supply (unemployment).

Trade‑union bargaining – a wage‑setting curve (WS)

  • Unions negotiate a wage that they can obtain for a given level of employment. This can be represented by a WS curve that lies above the competitive equilibrium wage.

  • The actual wage and employment are found where the WS curve meets the labour‑demand curve. If the negotiated wage is above the competitive level, firms hire fewer workers, creating unemployment.

Comparison of the two interventions

InterventionType of market mechanismTypical effect on wage & employment
National Minimum WageGovernment‑imposed price floorWage ↑; if set above equilibrium, employment ↓ (unemployment).
Trade‑union bargainingCollective wage‑setting (WS curve)Wage ↑; firms may hire fewer workers, also leading to unemployment if the negotiated wage exceeds the competitive level.

8. Reasons for differences in wages (six syllabus explanations)

  1. Differences in demand for different occupations – occupations that are in high demand (e.g., IT specialists) command higher wages.

  2. Differences in the supply of qualified workers – scarce skills (e.g., surgeons, pilots) lead to higher pay.

  3. Bargaining power of workers or employers – strong unions or monopsony employers can push wages up or down.

  4. Discrimination – unequal pay for men vs. women or for ethnic groups even when productivity is similar.

  5. Sector of the economy – public‑sector jobs often have different (sometimes lower) pay structures than private‑sector jobs.

  6. Skill level and education – higher qualifications and specialised training usually attract higher wages.

9. Real‑world considerations (brief recap)

  • Minimum‑wage legislation can create unemployment if set above the market‑determined wage.

  • Collective bargaining may raise wages above the competitive level, also potentially creating unemployment.

  • Labour‑market imperfections – information asymmetry, geographic immobility, discrimination and other frictions – mean the market does not always reach the theoretical equilibrium.

10. Summary checklist

  • Labour demand is derived from product demand and the marginal productivity of workers.

  • Key demand‑shifters: product price, technology, input prices, number of firms, and changes in product demand.

  • Labour supply depends on population, wages, alternative opportunities, education, immigration, social & cultural factors, and occupational‑choice considerations.

  • Occupational and geographic mobility allow workers to respond to wage differentials.

  • Division of labour increases productivity but can cause monotony and inter‑dependence.

  • Equilibrium wage is where labour demand equals labour supply; shifts produce predictable changes in wages and employment.

  • National minimum wage = price floor; trade‑union bargaining = wage‑setting curve – both can move the market away from the simple competitive equilibrium.

  • Wage differences arise from demand differences, supply differences, bargaining power, discrimination, sector, and skill/education level.

11. Practice questions

  1. Explain how a rise in the price of a firm’s output affects the demand for labour and the equilibrium wage.

  2. Using a diagram, illustrate the impact on the labour market of a large influx of immigrant workers.

  3. Discuss two ways in which technological change can have opposite effects on the demand for labour.

  4. Explain how a national minimum wage set above the equilibrium wage creates unemployment. Include a diagram.

  5. Identify and explain three reasons why two workers with the same job title might earn different wages.

  6. Define occupational mobility and geographic mobility and give one real‑world example of each.

  7. Briefly describe the division of labour, giving one advantage and one disadvantage.