Wage Determination (Cambridge (CIE) IGCSE Economics): Revision Note

Influences on the demand for labour

• The labour market is composed of sellers of labour (households) and buyers of labour (firms)

  • Workers supply their labour and firms demand labour

• The demand for labour is a derived demand

  • This means that it depends on the demand for goods and services

    • If demand for goods and services increases, then the demand for labour will increase – and vice versa

Factors that influence the demand for labour

1. The price of the product being produced

• If the selling price of the product increases, then the firm will be incentivised to supply more, and the firm's demand for labour will increase

2. The demand for the final product

• As demand for labour is a derived demand, when an economy is booming, then demand for most goods and services will be high – and the demand for labour will be high

• Conversely, when an economy is in a recession demand for most goods and services will be lower - and the demand for labour will be lower

3. The ability to substitute capital (machinery) for labour

• Firms will constantly evaluate if it will be possible and more cost-effective to switch production from using labour to capital (machinery)

• If it is more cost-effective, then demand for labour will fall

4. The productivity of labour

• If the productivity of labour increases (possibly through training), this will lower average costs, and firms will likely demand more labour

Influences on the supply of labour

• Households supply labour in a market economy

• There are numerous factors that influence the amount of labour supplied to a particular industry

Training period

• Long training periods (and their cost) act as a barrier to entry and exclude many households from offering labour in certain markets

Wages in other occupations

• Comparative wage rates in substitute labour markets strongly influence the supply of labour

  • For example, it is getting harder to recruit economics teachers as businesses in the private sector offers higher wages for their skills

Changes in migration policy

• Policies that increase the net migration rate  increase the supply of labour to certain industries

  • For example, in 2022, 36% of Singapore's labour force were migrants

Income tax levels

• Beyond a certain level, income taxes become a disincentive to households offering their labour

• The assumption is that as income tax increases, labour supply decreases - and vice versa

Working conditions

• The working conditions and non-wage benefits can act as strong incentive in certain industries

  • For example, tech companies are well known for their laid-back work environment and wide range of benefits. e.g. on-site childcare and restaurants

Trade union power

• Trade unions can increase the supply of labour to certain industries as workers consider the benefits of belonging to the union,

  • For example, higher wages and a safer working environment

Level of welfare benefit

• The higher the level of welfare benefits, the lower the incentive for low-skilled labour to offer their labour – and vice versa

Social trends

• Social trends include any major changes within society and can influence the supply of labour to certain industries

  • For example. working from home during Covid resulted in significant changes to the labour market and not all workers returned to work when economies opened up again

Trade unions and their relative bargaining power

• A trade union is an organisation formed by workers to protect and promote their common interests, particularly regarding pay, working conditions, and employment rights

• Trade unions negotiate with employers on behalf of all of their members (collective bargaining) on wages, working hours, and benefits

• Their bargaining power can influence wage levels above what might be set by market forces alone

Factors affecting a trade union’s bargaining power

• Membership size (employee participation)

  • Large, well-organised unions can exert more influence

• Wage levels as proportion of total costs

  • The lower the percentage of total costs that a firms's wages represent, the higher the bargaining power

• Swapping labour for capital

  • The nearer the replacement cost of capital for labour to meeting the increased costs demanded by the union, the weaker the bargaining power

• Legal framework

  • Labour laws may support or restrict union activities (e.g., right to strike, limits on picketing)

• Firm's profits

  • Firms making higher profits may be more able (and willing) to agree to wage increases

• State of the economy

  • In a strong economy with low unemployment, unions have more leverage; in a recession, less

• Skill level of members

  • Unions that represent highly skilled, specialised workers tend to have more bargaining power because their labour is harder to replace.