1. Labour markets
2 parts
1. supply, demand and wage determination
2. Labour market failure
2. Work vs Leisure
• An alternative to work is leisure time.
For each hour an individual works there
is an OPPORTUNITY COST
• If an hour of leisure time is chosen, the
WAGE is the OPPORTUNITY foregone
4. Supply of labour
• The total number of hours that labour is willing and able to supply at a
given wage rate.
And
• The number of workers willing and able to work in a given occupation or
industry for a given wage.
wage
Hours/quantity
5. The labour supply curve
• The labour supply curve for any industry or
occupation will be upward sloping because
• as wages rise, other workers enter this industry
attracted by the incentive of higher rewards.
• They may have moved from other industries or
they may not have previously held a job, such as
housewives or the unemployed.
• The extent to which a rise in the wage or salary
in an occupation increases labour supply
depends on the elasticity of labour supply.
6. Backward sloping labour supply curve!
• In the short run the
individual’s supply
curve may be
backward sloping
because of the
income and
substitution effects
7. Income effect
• The income effect of a wage rise is to:
– Reduce the number of hours people work
……because as the wage rate rises, the worker
buys more goods and services including leisure.
They have enough money so if they can earn
the same for doing fewer hours they will.
8. Substitution effect
• The substitution effect of a wage rise is to
Increase the number of hours people work
……because as the wage rate rises, the worker gains
more from working and increases the opportunity
cost of leisure so the worker selects to work more
hours. I.e. As the wage rate rises, more labour is
supplied to earn more money.
9. If the wage rate is low, do you think there will be more of an
income effect or a substitution effect and why?
• At a low wage rate there is more likely to be a
substitution effect as working more hours will
increase a worker’s living standards
• Once the wage rate has reached a certain
level, the income effect may outweigh the
substitution effect and an individual will buy
more leisure
10. Q What is the problem with the income and
substitution effect theory in reality?
• Many workers are unable to alter the number
of hours they work in their main jobs.
• They have a fixed contract
11. Supply in the long run
• In the long run people are able to change their
occupations - the supply of labour is
influenced by the net advantages of the job.
This means the
• Pecuniary (financial) and
• Non pecuniary (non financial) factors
13. Non-pecuniary factors
• Convenience and flexibility of hours
• Status
• Promotion chances
• Location (flexibility)
• Qualifications and skills
• Job security
• Pleasantness of the job
14. Non-pecuniary factors cont
• Holidays
• Perks and fringe benefits
• Quantity and quality of training on offer
• Recent performance of the firm
15. The elasticity of supply of labour
• The extent to which the supply of labour
changes as a result of a change in the wage
rate is measure by PES of labour
% change in Q of labour supplied
% change in wage rate
16. Influences n PES of labour
qualifications and skills required
• Supply of skilled workers is more inelastic than the
supply of unskilled workers e.g. the supply of vets is
more inelastic than the supply of shop assistants
the length of training
• A long period may discourage people from the
occupation. It will take some time for people to
qualify even if the wage rate rises. If it falls, people
who are a long way into their training may not leave
17. Influences on PES of labour
the immobility of labour
• Depends on how easy it is for workers to switch jobs
(occupational mobility) or to move areas
(geographical mobility). Mobility means more elastic
supply.
the time period
• Over a longer period of time, labour supply becomes more
elastic. In the short run, the wage rate can rise but with little
effect on the labour supply
18. How useful are these explanations?
• Doctor
• McDonald’s worker
• Economist
• Solicitor
• Nurse
• Teacher
• Firefighter
19. Summary – supply of labour
• The supply of labour is upward sloping – the
higher the wage, the more labour is supplied
• In the short run it may be backward sloping
owing to income and substitution effects
• In the long run it is determined by the net
advantages of the job (pec and non pec)
• It can be elastic or inelastic depending on
quals and skills required, length of training,
mobility of labour and time.
20. Demand for labour
• In the recession, the UK housing market experienced a
downturn. Housing projects were delayed and scaled down
existing sites.
• What is most likely to have happened to the employment of
plasterers and bricklayers? – (they will experience lower demand
for their services)
• Demand for labour is DERIVED (demand
for one depends on demand for another)
21. Factors influencing demand for labour
• Demand and expected future demand for a product
The expected revenue from increasing/decreasing
production can change demand for labour
• Productivity
The higher the output per worker, the more attractive
labour is as a resource
• Wage rate
If the wage rate rises about productivity, costs rise and
could contract demand for labour
22. Factors influencing demand for labour
• Complementary labour costs
A change in any other costs associated with labour
e.g. National insurance contributions could change
the demand for labour
• The price of other factors of production
When other factors of prod. change demand for
labour can change e.g. If capital becomes cheaper,
workers could be replaced by machines
23. Question
• Why is demand for migrant workers still high
despite the recession?
• Demand for firm’s products means labour still
needed?
• Skills shortages in the UK?
• Migrant workers more productive?
• Cheaper?
• More flexible about hours, working conditions etc?
24. Marginal revenue product of labour –
a theory about demand for labour and about the price
of labour
• MRP theory states that demand for labour depends
upon 2 things
– Productivity of labour
– the demand for the good they produce (which
determines price)
25. MRP Calculation
• MPP (marginal physical product)
• Marginal revenue (this is the price of the
product in perfect competition)
• MRP of labour = MPP x Price
26. Marginal Revenue Product Theory:
MRP is important in determining wages.
• Workers with higher productivity will tend to get higher wages. Also,
workers who help produce profitable goods will get higher salaries. For
example, lawyers and professional footballers get high salaries
because the marginal revenue of their goods are high
27. Criticisms of MRP theory
• it can be difficult to determine the MRP of workers, for
example, many in the service sector do not produce a
tangible output e.g. nurses and teachers
• It assumes that workers are homogenous – they are
not, they have differing abilities and productivities
• It ignores that fact that some businesses have
monopsony power and can dictate a lower wage rate
than MRP suggests
• It assumes that workers are geog and occ mobile and
that the supply of labour is perfectly elastic - in reality
it is not
28. Elasticity of demand for labour
% change in quantity of labour demanded
% change in the wage rate
elastic
inelastic
29. Factors affecting elasticity of demand for labour
1. The proportion of labour costs in the total costs of a business:
When a businesses’ labour expenses are a high proportion of total costs, labour
demand can be expected to be more elastic than a business or industry where
fixed costs of capital are the dominant business expense
2. The ease and cost of factor substitution:
The demand for labour tends to be more elastic when labour and capital are easily
substitutable.
This depends on the nature of the production process, the added “human” value
that the labour input provides (particularly in service industries) and the flexibility
of the labour market (for example the ease and cost of hiring & firing labour is
influenced by existing employment laws). When labour is considered a necessity in
the production process, the demand will be inelastic in responsive to wage
changes. Think about the difference between a car manufacturer and a hotel
30. Factors affecting elasticity of demand for labour - cont
3. The price elasticity of demand for the final output produced by a
business:
If a firm is operating in a highly competitive market where final
demand for the product is price elastic, they may have little power
to pass on higher wage costs to consumers through a higher price,
the demand for labour may therefore be more elastic as a
consequence
4. The time period under consideration:
In the short run, at least one factor of production is assumed to be
fixed so the demand for labour as an input will be more inelastic
compared to the long run when a business has a much greater
opportunity to vary the factor mix between labour and capital
31. Summary – demand for labour
• Demand for labour is DERIVED
• Factors that affect it are: demand for the product,
productivity, wage rate, complementary labour
costs
• MRP is a theory of demand for labour that
depends on productivity – the more productive a
worker, the greater the MRP
• Elasticity of demand for labour depends on: Ease
of factor substitution, Time, PED for the product
(final output) and the proportion of labour costs
to total costs
32. Wage determination
• Supply and demand interact to determine the
wage rate
Demand and supply
Demand and supply
could be inelastic
could be elastic e.g.
e.g. brain surgeons,
cleaners, fast food
barristers (higher
worker (lower wage
wage rate)
rate)
33. Wage determination 2
• MRP(L) also explains the wage rate
• A worker is paid according to his/her MRP. A
barrister would have a higher MRP than a
cleaner therefore would be paid a higher
wage.
• As the MRP of a worker increases, they can be
paid a higher wage
34. Wage differentials
• Why are there differences between the wages earned
in alternative occupations
• This occurs because of
• Skill levels
• Length of time to train
• Demand for labour (PED, substitutes)
• Public opinion
• Government policy
• Relative bargaining strength (trade union)
• MRP
• OTHER FACTORS FOLLOW IN THE NEXT SLIDES
35. Male vs Female
Male (paid more on average)
• More women work part time
• Gap narrowing
• MRP of women is much lower (average)
• Historically men better qualified
• MRP lower as women disproportionately employed in
low paid jobs that generate low marginal revenue
• Women leave the labour market to have children and
lose out on promotional chances
• Discrimination
36. Skilled vs Unskilled
Skilled (paid more)
• Demand is higher and supply is lower
• MRP higher as output is higher
• Higher level of human capital
• Higher education and training = productivity
• Difficult to substitute with machines
37. Part time vs Full time
Part time (lower paid)
• Supply high relative to demand
• Productivity lower as they receive less training
• Higher proportion are women
• Only a small number in a trade union
38. Ethnic minorities
Ethnic minorities (lower paid on average)
• Discrimination
• High proportion of Asians working in catering
which is low paid
• Qualifications are lower particularly in women
39. Economic Rent and Transfer Earnings
• A person stays in a job depending on the
economic rent and transfer earnings
• Transfer earnings = the minimum payment
needed to keep a worker in work (min
payment needed to keep a factor of
production in its present use)
• Economic rent = the payment to the factor
(worker) over and above its transfer earnings
in the long run
40. diagram
• Transfer earnings is the minimum wage you
would require for doing a job.
Economic rent is the different between what you
get paid and what you would do the job for.
The amount of transfer
earnings and economic
rent depends on the
elasticity of supply
41. Summary wage determination
Wages are determined in a competitive market
through:
– Supply and demand (note the elasticity can be
important)
– MRP of labour
– Because of pay differentials
– Because of economic rent and transfer earnings
43. Labour Market Failure
Is caused by:
1. Monopsony power
2. Trade Union power
3. Imperfect information
4. Skill shortages
5. Economic inactivity
6. Unemployment
7. Discrimination
8. Segmented labour markets
9. Geographical and occupational immobility of labour
44. 1.Monopsony
• A monopsony producer has significant buying power in the labour market when
seeking to employ extra workers. A monopsony employer may use their buying-
power to drive down wage rates. The market fails if this is the case
The marginal cost of employing one more worker
will be higher than the average cost because to
The firm only has to
pay a wage of W2. This
employ one extra worker the firm has to pay more
and increase the wages of all workers.
is less than the
competitive wage
To maximise the level of profit the firm
employs Q2 of workers where MC = MRP
45. 2. Trade Unions
• Trade unions are organisations that represent
people at work.
• They can put pressure on firms for improved pay
and conditions and higher pay. They can:
– Restrict the supply of labour
– Strike/stop/disrupt production
• This causes labour market failure (see page 18 of
revision booklet for an evaluation of their use)
46. How do they work?
They push up wages to W2 which is
above the equilibrium and could
cause unemployment between Q2
and Q3
HOWEVER – if the employer is a monopsony they
could actually increase employment as at the higher
wage, more people would be willing to supply their
labour
The wage is at W2 but the union could bargain for
W1 or W3. At W3 more people could be employed
but at W3 no extra workers would want to work but
unemployment would not be made worse
47. Other causes of labour market failure
3. Imperfect information
Workers may not have the information they
need to get a job or a better job - Employers
may not be able to afford to advertise to all
potential employees so don’t get the best
employees – solution – job centres, national
databases of jobs
48. Other causes of labour market failure
4. Skill shortages
Occur when firms struggle to recruit people
with the right skills – may have to bid up
wages = increased costs. Short-termist
attitude towards training? Solutions –
education and training, immigration
49. Other causes of labour market failure
5. Economic inactivity
• People who are not in the workforce (actively
seeking or in a job). Some economically
inactive e.g. students will provide a long term
benefit. Others could work and represent a
waste of resources. Solutions – cut benefits,
provide training, minimum wage as an
incentive to work
50. Other causes of labour market failure
6. Unemployment
Unemployment means some labour markets
are not clearing
Those willing and able to work cannot find a
job
Causes- cyclical (lack of aggregate demand)
Voluntary, frictional and structural
51. 7. Discrimination
Could be caused by several factors including:
Personal prejudice
Imperfect information – employers do not
know how productive a worker may be so may
avoid employing for e.g. over 50s as they may
wrongly believe they will be less productive
than younger workers
Solutions – education, training, information,
laws
52. 8. Segmented labour markets
• There are barriers that prevent workers
moving freely between occupations
• Some barriers are good e.g. taxi drivers
requiring a driving licence and Surgeons
requiring skills and qualifications
• Others are unnecessary and have been
introduced to push up wages and to keep
groups out
53. 9. Geographical and occupational
immobility of labour
Mobility = the ability to move from one sector of
employment to another
Changing occupation (occupational)
Moving to work in another area (geographical)
A lack of labour mobility is the cause of
structural unemployment (mismatches)
54. Mobility of labour
• Occupational immobility is a result of a skills
shortage
Effects
• Low skills = low wages
• Firms limited to lower profits/cannot achieve
their objectives
55. Mobility of labour
• Inflation and unemployment (because of skills
mismatch )
• - there is always a small amount of unemployment
even if the market is in equilibrium.
– To solve this AD could be increases but this would lead to
inflation (higher costs = higher prices). The lowest level of
unemployment that keeps inflation stable is called the non
accelerating inflation rate of unemployment (NAIRU)
• Limitation on competitiveness
• Inequality
56. Geographical immobility
• Lack of information
• House prices and structure of housing (renting
vs buying)
• Family and social ties
57. Question
• 4 (a) With the use of examples, explain what
is meant by labour market failure. [15]
• (b) “Government attempts to correct market
failure by intervening in the labour market
are likely to cause more problems than they
solve.” Discuss this view. *20+
• June 2009
58. Labour market flexibility – (solves
market failure)
What is it (different types of)
• Where the supply of labour is responsive to
changes in the demand for labour.
• Labour mobility (occ and geog)
• Flexible working patterns (part time, variable
hours, shift work, temp contracts, home working)
• Wage flexibility - wages should move both
upwards and downwards in response to changes
in supply demand
59. Labour market flexibility
• Methods to achieve it
• training and education
• Cut income tax and UE benefits
• Link UE benefit to search for employment
• Remove employment protection legislation
• (Thatcher did this in the 80s but Labour Govt
signed up to the EU social charter in 1997 so
had to re-introduce more protection)
60. Implications of it –
• UK more flexible as govt has removed restrictions
on hiring and firing. USA has lower protection
but other EU has more
• Widened participation (i.e. more women in the
workforce as a result of more part time
opportunities
• Less job security – more frictional unemployment
but greater employment overall.
• Greater competitiveness
61. Evaluation
• Look at the figures in your hand out – is it
better or worse for the UK economy to have a
flexible workforce.
62. Why and how does the government intervene
in the labour market?
• Employment
• Information provision
• Regional policy
• Training and education
• NMW legislation
• Discrimination legislation
• TU legislation
63. PENSIONS
Explain why there is a ‘Pensions Crisis’.
The Pensions Crisis has come about for various reasons
• increasing life expectancy,
• early retirement schemes draining pension funds,
• poor performance of certain funds,
• employers and employees not paying sufficient
contributions.
• The crisis is that many funds, particular private sector
ones, will not be in a position to pay out what is
expected in the near future
64. Discuss the extent to which this Pensions Crisis might impact
on the UK labour market and the economy as a whole.
• The most likely impact on the labour market is that the normal
retirement age for male and female workers will increase.
• A tightening up on early retirements and similar concessions that
are currently given by pension funds. Consequently, the typical age
of workers will increase – some may be rather disillusioned.
• The impact on the economy is that government intervention may
be needed in the short term to bale out pension funds.
• There are also implications for the funding of the State Pension and
other public services.
• Longer term, the economy may become more productive due to
often well qualified people remaining in the labour market.
• Unqualified labour may find it more difficult to obtain work and
impact on the rates of direct taxation for those in work.
65. Immigration
Advantages
• An expansion of the labour supply
• Reduced pressure on wage inflation
• Aggregate demand effects- economic
migrants are likely to earn more than they
spend contributing to the growth of the local
or regional economy
66. Immigration
The costs of migration
• Depressing the real wages of domestic workers
• Doubts about productivity effect: Many immigrants,
especially those from poorer countries, have a low
educational level and are more likely to be unemployed
or economically inactive than the domestic population.
• Increased pressure on the welfare state (benefits,
education, housing and health)
• Unemployment concerns
• Increased pressure on scarce resources: (e.g. housing)
67. EU Directives
• EU directives (laws) have to be made into UK law
within a set time period e.g. 2 years
• The UK has the least protection for workers in
Europe whereas EU directives tend to help
protect workers – e.g. the NMW and maximum
working week came from EU directives. Recently
the parental leave directive was made UK law –
evaluate the effects on the labour market
(flexibility in particular)
68. Poverty and inequality
• Represents about market failure as this shouldn’t
happen if the market works efficiently – the wage
would be at a level that is enough to live on and
everyone would be in a job (this doesn’t happen in
reality)
• Absolute poverty - The inability to purchase the basic
necessities of life e.g. food, shelter, clothing
• Relative poverty (UK) - A measure of households in one
country where income is behind the average
– The widely accepted definition of poverty is having an
income which is less than 60% of the national average
69. What causes poverty?
• Unemployment
• Low wages
• Sickness and disability
• Old age
• Poverty trap
• Bing a lone parent
• Reluctance to claim benefits
70. What are the effects of poverty?
• Low life expectancy
• Poor health
• Lower education
• Alienation from society
• Burden on government/reduction in
productivity
71. Measuring relative poverty
• (1) The Lorenz Curve – a diagram to illustrate income
distribution
• (2) The Gini-coefficient - a calculation based on the
lorenz curve to compare income inequality. A value
between 0 and 1. The closer to 1 the more unequal
• (3) The percentage of households living below a given
percentage of median incomes (60% in UK)
• Most measures of relative poverty concentrate on
income rather than wealth
72. Causes of income inequality
• Main cause: The disparity in wages and earnings growth in different jobs and industries
– Huge rises in earnings for the better off
– Slower growth of pay for people in low-paid jobs
• Welfare:
– Falling relative incomes for those dependent on state welfare benefits – whose value
rises each year in line with prices rather than incomes
• Structural / long-term unemployment
– E.g. a high level of workless households (the “economically inactive”) where no one in
the household is in paid work
• Low paid jobs:
– A long term shift towards part-time service sector employment – often relatively low
paid work with little or no trade union protection
• Taxation: Less progressive tax system
– Cuts in the higher rates of income tax (40%)
• Inequalities in wealth also create income inequalities
– (e.g. interest from savings, dividends from shares, income from private occupational
pensions)
73. Government interventions
A Tax
• Increasing progressive taxes such as the higher
rate of income tax from 40% to 50% will take
more income from those on high income
levels. This enables cuts in regressive taxes
and increased benefits which help increase
the income of the poor.
74. Government interventions
B. increase benefits to the poor
Advantages of means tested benefits: • Also not everyone entitled to means
• They allow money to be targeted to those tested benefit will collect them
who need it most. e.g family tax credit or because of ignorance or difficulties in
pension credit. applying.
• It is cheaper than universal benefits and
reduces the burden on the tax payer
• The government used to prefer
universal benefits because it avoided
However means tested benefits are the above problem, and people feel if
often unpopular because people are they contribute towards taxes they
stigmatised as being poor. deserve their benefits regardless of
• Also it may create a disincentive to their wealth
earn a higher wage, because if you
do get a higher paid job you will lose
at least some of your benefits and
pay more tax. This is known as “the
benefit trap” or the “poverty trap”
• Some relatively poor may fall just
outside the qualifying limit.
75. Government interventions
C. Minimum Wage
A concern about the NMW is that it
may cause unemployment. An increase
in the NMW to above the equilibrium
will lead to real wage unemployment of
Q3 –Q2.
Since the introduction of the NMW many low paid workers have seen an increase
in the hourly wage as firms are obliged to pay workers the statutory minimum
wage.
To some extent this has helped reduce relative poverty, as the lowest paid
workers have seen a significant increase in their weekly income. This is more
prevalent in the North where wages tended to be lower; fewer jobs in the south
have been affected by the NMW.
76. Evaluation of NMW
• The advantages of a national • The disadvantages of a national
minimum wage: minimum wage:
• Greater equity will be achieved, and • A high minimum wage can cause
the distribution of income between price inflation as firms pass on the
the high paid and the low pay may be higher wages in higher prices.
narrowed. • Falling employment, as demand
• Poverty may be reduced as the low contracts, and rising unemployment
paid gain more income and the as supply extends.
unemployed may be encouraged to • The competitiveness of UK goods
join the labour market. In this case abroad can suffer compared with low
the higher wage is an incentive for wage economies, such as China and
individuals to supply their labour. India.
• Less worker exploitation by labour • Inward investment may be deterred,
market monopsonists, who are single as foreign investors will look to avoid
employers is able to pay below the high wage economies.
market equilibrium. • The labour market may become
inflexible in response to changes in
the rest of the economy.
77. Productivity etc
• Productivity – the output per worker employed
• Unit labour cost – cost of labour/output
• Business owners compare unit labour costs to
measure productivity. If the unit labour cost
decreased over a period of time, productivity
increased.
78. Possible analyse questions
1. Analyse the factors that determine the supply of
labour in the short run and the long run
2. Analyse the factors that determine elasticity of
supply for labour
3. Analyse why premiership footballers earn more
than nurses
4. Analyse 2 causes of labour market failure.
5. Analyse the reasons for differences in economic
rent and transfer earnings
6. Analyse the reasons for pay differentials
