Understand how the demand for labour and the supply of labour influence the determination of wages in a competitive market.
1. The Demand for Labour
The demand for labour is a derived demand – firms will only hire workers if the contribution of the worker to output adds more to revenue than it costs in wages.
Key determinants of labour demand
Product demand: Higher demand for the firm’s product raises the marginal revenue product of labour (MRPL).
Productivity of labour: Improvements (e.g., better training, technology) increase the marginal product of labour (MPL).
Price of the product: When the product price rises, each unit of output contributes more revenue, raising MRPL.
Price of other inputs: If the price of capital falls, firms may substitute capital for labour, reducing labour demand.
Technology: Automation can either increase the productivity of existing workers (shifting demand right) or replace workers (shifting demand left).
Number of firms in the market: Entry of new firms raises overall labour demand.
The profit‑maximising condition for a competitive firm is:
\$\text{MRP}_L = w\$
where \$w\$ is the wage rate. If MRPL exceeds \$w\$, the firm will hire additional workers; if it is lower, the firm will reduce its workforce.
2. The Supply of Labour
The supply of labour represents the quantity of work that individuals are willing and able to offer at different wage rates.
Key determinants of labour supply
Population size and demographics: Larger working‑age population expands the labour pool.
Wage rates: Higher wages make work more attractive relative to leisure, increasing the quantity supplied (upward‑sloping supply curve).
Alternative employment opportunities: Availability of part‑time, seasonal or self‑employment can affect the willingness to work for a given wage.
Education and training: Higher skill levels can increase the supply of qualified labour for specific occupations.
Immigration and emigration: Inflows raise, outflows reduce the domestic labour supply.
Social and cultural factors: Attitudes towards work, gender roles, and family responsibilities influence labour‑force participation.
3. Wage Determination in a Competitive Labour Market
In a perfectly competitive market, the equilibrium wage (\$w^*\$) is set where the quantity of labour demanded equals the quantity supplied.
Suggested diagram: Labour market showing demand (D) and supply (S) curves intersecting at equilibrium wage \$w^*\$ and employment \$L^*\$.
Effects of shifts in demand or supply
Shift
Cause
Resulting change in equilibrium
Demand rightward
Increase in product demand, higher productivity, rise in product price
Higher wage, higher employment
Demand leftward
Technological substitution, fall in product price, reduced output demand
Lower wage, lower employment
Supply rightward
Population growth, immigration, more women entering workforce
Minimum wage legislation: Sets a legal floor above the market‑determined equilibrium wage, potentially creating unemployment if set above the equilibrium.
Collective bargaining: Trade unions can negotiate wages above the market level, influencing both demand (through higher labour costs) and supply (by attracting workers).
Labour market imperfections: Information asymmetry, mobility constraints, and discrimination can prevent the market from reaching the theoretical equilibrium.
5. Summary Checklist
Labour demand is derived from product demand and the marginal productivity of workers.
Key factors shifting labour demand: product price, technology, input prices, number of firms.
Labour supply depends on population, wages, alternative opportunities, education, and social factors.
Equilibrium wage is where labour demand equals labour supply; shifts cause predictable changes in wages and employment.
Government policies and unions can alter the simple market outcome.
6. Practice Questions
Explain how a rise in the price of a firm’s output affects the demand for labour and the equilibrium wage.
Using a diagram, illustrate the impact on the labour market of a large influx of immigrant workers.
Discuss two ways in which technological change can have opposite effects on the demand for labour.