8.3 Labour market forces and government intervention

A firm’s demand for labour depends on the marginal revenue product of labour: the extra revenue generated by one more worker, which combines marginal physical product with the value of output.

Demand tends to rise when product demand or price increases, worker productivity improves, or complementary capital becomes more effective. It falls when the wage exceeds the value of the worker’s marginal contribution.

If an extra worker produces 10 units and each sells for $5, marginal revenue product is$50 before considering other changes. A wage below that may make hiring worthwhile; a wage above it may not.

Labour demand is not determined by workers’ preferences alone; it is a derived demand linked to demand for the product and the productivity of labour.

A firm’s demand for labour is derived from the demand for its product. It tends to rise with a higher product price, stronger product demand, higher worker productivity or more productive complementary capital.

The wage is one determinant, but it moves along the labour-demand curve rather than shifting it in the simplest model. Technology can substitute for labour or complement it, so “technology raises demand” is not a universal rule.

A rise in demand for restaurant meals raises the value of extra servers; a labour-saving ordering system may reduce demand for routine tasks but increase demand for technicians.

Do not treat a higher wage as a shift in labour demand, and do not assume all workers are affected equally by a technology change.

A movement along the labour-demand curve follows a change in the wage, holding other conditions constant. A shift changes demand at every wage because product demand, productivity, output price or complementary inputs change.

State the changed variable before drawing. A wage rise usually reduces quantity of labour demanded; higher product demand can shift the whole curve right even if the wage is unchanged.

A café hiring fewer workers after the hourly wage rises is a movement. A festival that increases demand for meals shifts the café’s labour demand right.

A new employment equilibrium does not by itself prove a labour-demand shift; compare the determinant, not just the observed quantity.

Marginal revenue product (MRP) is the additional revenue created by one more worker: MRP = marginal physical product × marginal revenue. A firm hires labour up to the point where MRP equals the wage in a competitive labour market.

Because marginal physical product often falls as more labour uses fixed inputs, MRP can slope downward. The relevant revenue may be product price for a price-taking firm or marginal revenue for a price-setting firm.

If the next worker adds 6 units and each unit adds $8 of revenue, MRP is$48. Hiring is profitable when the wage is below $48, subject to other costs and constraints.

MRP is not just physical productivity, and the wage is not always equal to MRP if the firm has labour-market power.

Labour supply is the amount of labour workers are willing and able to offer at different wage rates. It depends on the wage, non-wage benefits, working conditions, preferences, skills, migration and the opportunity cost of leisure.

At individual level, a higher wage can encourage work by raising the reward, but at high incomes the income effect may encourage more leisure. Market labour supply also reflects population, participation and occupational mobility.

A flexible schedule may attract workers even at the same wage; a shortage of childcare can reduce the hours supplied despite a higher hourly rate.

Labour supply is not simply the number of people of working age, and willingness to work is not the same as being employed.

A movement along labour supply follows a change in the wage. A shift changes the quantity offered at every wage because population, migration, skills, preferences, taxes, benefits or working conditions change.

Separate an individual’s response from a market-wide change. Better childcare or immigration can shift supply right; a wage rise changes quantity supplied along the existing curve unless it also changes another determinant.

A higher wage may attract more nurses along the curve. A new training programme increases the number qualified and can shift the market supply curve right.

Do not draw a supply shift merely because employment rose; identify whether the wage or the underlying labour pool changed.

In a perfectly competitive labour market, many employers and workers take the market wage as given. Equilibrium employment occurs where labour demand equals labour supply.

The wage reflects the value of the marginal worker to firms and the opportunity cost of that worker’s time. A wage above equilibrium creates excess supply; a wage below it creates excess demand, assuming adjustment is possible.

If the market wage is set above the intersection, more people want jobs than firms want to hire, creating unemployment. A wage below the intersection leaves vacancies or unmet labour demand.

The equilibrium wage is not necessarily fair or a living wage, and the competitive model does not describe monopsony or strong bargaining power.

In an imperfect labour market, one or more employers or worker groups have bargaining power, information advantages or barriers to movement, so the wage is not set by a simple market-clearing intersection.

A monopsony faces an upward-sloping labour supply and may hire where marginal labour cost equals marginal revenue product, paying a wage below the competitive level. Trade unions can raise wages or improve conditions, but effects depend on bargaining power and demand elasticity.

A dominant local hospital may face little competition for nurses; a union can counterbalance that power, though a large wage rise may reduce employment if labour demand is elastic.

Imperfect competition does not always mean lower wages: collective bargaining or professional scarcity can raise them.

A wage differential is a difference in pay between workers or occupations. It can reflect marginal productivity, education and training, scarcity, risk, working conditions, discrimination, bargaining power and institutional rules.

Compare jobs on the same basis: a higher wage may compensate for unpleasant risk, require scarce qualifications or reflect a union. Observed pay can also diverge from productivity because information and discrimination distort the market.

A hazardous offshore job may pay more partly as a compensating differential; a shortage of specialist engineers can raise pay through scarcity even when working conditions are attractive.

A high wage is not proof that a job creates more social value, and a low wage is not proof of low productivity.

Transfer earnings are the minimum payment needed to keep a factor in its present use. Economic rent is any payment above transfer earnings. Total earnings equal transfer earnings plus economic rent.

The split depends on the elasticity of supply to that use. A factor with few alternatives has high economic rent; a factor that can move easily has a larger transfer-earnings component.

If a singer would accept $30,000 to stay in a show but is paid$80,000, transfer earnings are $30,000 and economic rent is$50,000.

Economic rent is not the same as profit, and a high payment can contain little rent if the factor has an attractive alternative.