Determining Wage Rates: Competitive Labour Markets (AQA A Level Economics)

• In a perfectly competitive labour market, relative wage rates are determined at the point where D_L = S_L 
• There is an assumption in perfect competition that all workers possess identical skills and receive the same wage rate
  • In reality, workers have diverse skill sets and different motivational factors drive them
    
    

• An excess demand of labour leads to a shortage of workers in a particular occupation, causing wages tend to increase
  • This causes a rise in wages and is an incentive to workers to enter the labour market for that occupation
    • This increases the supply of labor (S_L)

 

• An excess supply of labour leads to a surplus of workers in a particular industry, which causes wages to decrease 
  • This fall in wages cause some workers exit the labour market for that occupation 

 

• The equilibrium for labour adjusts where
  • There is no excess supply of labour
  • There is no excess demand for labour

• Perfectly competitively firms are price takers in the labour market, as they have to accept the wage rate that workers are being paid in the industry

 

• The labour market is a type of factor market
  • Factor markets follow exactly the same rules as product markets
  • They are affected by changes to price, demand and supply
  • They are affected by the price elasticity of demand and supply

Diagram: Wage Determination in a Perfectly Competitive Labour Market

In the labour market for perfectly competitive firms, the wage rate is set by the industry wage rate

Diagram analysis

Market

• Labour market equilibrium occurs in the industry where demand for labour (D_L) = supply of labour (S_L)
• The equilibrium wage is W₁

Individual firm

• The supply of labour for the individual firm is considered to be perfectly elastic, as workers have to accept the market wage (W₁)
  • If the firm offers a lower wage, it will struggle to recruit workers
  • If the firm offers a higher wage, it will paying above the market rate and a large number of workers will apply to work there
  • The S_L is also the average cost of labour (AC_L) or the marginal cost of labour (MC_L)
     
• Labour market equilibrium for individual firms in perfect competition occurs when demand for labour (D_L) or MRP_L is equal to the supply of labour (S_L) 
  • The equilibrium wage is W₁ and the quantity of labour is Q₁