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Topic 2.7
Labour Markets
In this topic, you will learn about labour markets and how they work, including the demand and supply for labour. You will also learn about trade unions, and how they can influence these markets. By the end of this topic, you should also be able to explain the difference between gross and net pay.
Labour Markets
Labour markets are where workers sell their labour and employers buy the labour: consisting of a household's supply for labour and a firm's demand for labour. The interaction between these two determine the price for labour, usually called wages/salaries, which is a cost to firms but the main source of income to households. Governments and trade unions also have a bit of influence over wages. Labour markets interact for different: geographical locations, skills and qualifications.
What do labour markets depend on?
Labour markets depend on the exchange of information between employers and potential workers about:
wage rates
conditions of employment
location
level of competition
The labour market is also affected by a few key factors which can be memorised using the acronym SAWTHEM
S
Size
A
Age
W
Working age of population
T
Training
H
Health
E
Education and
M
Migration
Labour Market Fundamentals
trade unions
An organisation of workers that is active on behalf of its members and their rights. They will negotiate with employers to advocate for increased wages; improved working conditions etc. This is known as collective bargaining.
salaries vs wages
A salary is typically yearly and given to higher skilled workers, who have more inelastic demand but inelastic supply. A wage is for lower skilled workers and is hourly/daily/weekly - with elastic demand and supply.
mobility in labour markets
The labour market lacks mobility (people can't move freely from job to job) because:
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people are unwilling to relocate/language barriers
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personal factors/family ties
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information failure - lack of job info
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lack of skills/qualifications
Factors Affecting Demand of Labour
The state of the economy - if the economy is growing then more labour is demanded as existing firms expand and more firms enter the market
Increased demand for a product - derived demand; it leads to increased demand for labour (and vice versa)
Wage rates - When the wage is lower demand increases because firms will be able to reduce costs
Real wages - A fall in real wage (wage adjusted for inflation) encourages employers to employ labour rather than use capital
Productivity of labour - Higher productivity -> more cost-efficient labour rather than capital - more demand
Profitability of firms - The more profit the firm makes, the bigger they grow leading to higher demand
Factors Affecting Supply of Labour
The supply of labour is the total number of people who are willing and eligible to supply their labour, including the unemployed.
Wage rates - When wages are higher supply will increase as they will be more willing to work at that job
Size of Working Population and SAWTHEM
Other money payments - if opportunities to boost earnings (e.g. overtime, productivity related pay schemes) are high then supply will increase
Non-monetary factors - Working conditions, opportunities for promotion, job security
Barriers to entry - The less barriers (e.g. qualification requirements) to entry there are the more supply there is
Education and training - More education will increase supply as there will be more skilled workers available to do that job
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The active labour supply consists of employed and unemployed people, but only those who are actively seeking a job (they are available for work).
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The inactive labour supply is anyone who is not willing/able to work, such as retired people, students, discouraged workers, or those looking after family.
Labour Market Diagrams
Diagrams can also be drawn of labour markets:
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You can plot the demand and supply of labour
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Instead of P for price on the y-axis, W for wages is used
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There is an equilibrium wage and quantity, which is where the demand and supply of labour meet with no excess demand or supply
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The price mechanisms work the same way in labour markets (only that they are called wage mechanisms)
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Excess supply and demand for labour can exist, although excess supply (which is the same as unemployment) is more common
The imposition of a minimum wage
The government can intervene in the labour market and set a minimum wage. This will always be above the equilibrium wage (minimum wage is labelled as Wm on the diagram on the right)
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This will always lead to an expansion of supply, as people will be more willing to work as they will earn more money. However, the demand will contract as hiring more people will be more of a cost to firms. This creates excess supply of labour, which leaves some people unemployed, typically in low-skilled jobs that have very elastic demand.
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This sounds a bit wrong - why would the government do this if they know it causes unemployment?
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They do it to ensure that workers earn enough money to survive and to try and reduce income inequality, without minimum wage people could be given unsustainably low salaries and they can't do anything about it.
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Gross and Net Pay
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Gross pay is the amount of money that an employee earns before deductions are made, which includes wage, overtime pay, bonuses and allowances
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Net pay, or 'take home pay' is the total amount of money an employee is left with after all deductions are made.
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Net pay = Gross pay - deductions
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Deductions typically consist of pension contributions, income tax, national insurance and loan repayments.
Income Tax
Income tax is a tax on personal earnings. The amount you pay depends on how much you earn, with different income bands taxed at different rates
National Insurance
NI is a contribution paid by workers and their employees towards the cost of state benefits. Again, there are bands like with income tax
Pension Contributions
Payments made to a pension fund
Analysing the effect of competition on wages
Competition forces firms to become more economically efficient, which means that a firm will have to become more productive (efficient in the uses of the factors of production), including trying to increase output to gain economies of scale and decrease average costs. This is because they need to keep revenue above costs (and maintain profit), which will require higher-skilled workers. This means that the human capital of each worker has increase since they are each more productive and produce more output. This means that the demand for the service of their labour will shift to the right, which will lead to an increase in wages paid from W1 to W2.
Competition will also force firms to try and innovate and adopt new technologies. This will also require increased education and training of both higher skilled and lower skilled workers. This also contributes to the shift in demand for labour right. This also leads to an increase in wages.
Competition in this sense could be interpreted as more competition for the job position. This could be represented as a shift right of the supply of labour, as more people and willing and able to work in that position. This would lead to a decrease in wages, because employers have more options and do not need to raise wages to attract high-skilled workers. This effect would be limited if PES was elastic however.
When supply and demand are more elastic, wages are more sensitive to competition because workers and firms can switch more easily in response to small wage changes. In a market with elastic labour supply, employers may need to raise wages to attract or keep workers, while elastic labour demand means firms are more likely to reduce hiring or push back on wage increases when labour becomes more expensive.