Wage Determination (Cambridge (CIE) O Level Economics): Revision Note

Factors That Influence 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/services

    • If demand for goods/services increases then the demand for labour will increase - and vice versa
      

Factors That Influence the Demand for Labour

Factors Influencing the Supply of Labour

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

Factors Influencing the Supply of Labour

Diagrammatic Analysis of the Labour Market

• 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.   

• Labour market equilibrium occurs where the demand for labour (D_L) is equal to the supply of labour (S_L)

  • The D_L is the demand by firms for workers - firms demand more labour as the wage rate decreases which results in a downward sloping demand curve

  • The S_L is the supply of labour by workers - workers supply more labour as the wage rate increases which results in an upward sloping supply curve

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

  • If they offer a lower wage, they will likely struggle to recruit workers

  • If they offer a higher wage there will be a large number of workers applying to work there

Diagram analysis

• The market for graphic designers is in equilibrium where D_L = S_L 

• The equilibrium wage is W and the quantity of labour is Q

• There is no excess supply of labour

• There is no excess demand for labour

Analysing the PED and PES of Labour

  Price inelastic demand and supply

• Consider the labour market for NBA basketball players

• In 2022, LeBron James received a salary of $45m

   Diagram analysis

• D_L is the demand for labour from the basketball clubs

• S_L is the supply of labour by the basketball players

• The demand for highly skilled players is very price inelastic

  • Clubs want the very best players, almost irrespective of what they cost

• The supply of highly skilled players is also very price inelastic 

  • A significant increase in price will have little impact on the quantity of labour supplied in the market as it takes years to develop LeBron James type skills

• The market equilibrium is found at W₁Q₁ - a high price and relatively low quantity  

Price elastic demand and supply   

• Consider the labour market for labourers on a building site
   

Diagram analysis

• D_L is the demand for labour from the building company for labourers

• S_L is the supply of labour by people willing to work on a building site

• The demand for workers is very price elastic

  • If wages dropped a little, then firms would respond quickly by employing more workers

• The supply of workers is also very price elastic 

  • Due to it being an unskilled job, there would quickly be an increase in the supply of labour if wages were to increase

• The market equilibrium is found at W₁Q₁ - a low price and relatively high quantity

Relative Bargaining Power

• Workers have different degrees of bargaining power when it comes to negotiating wage increases with their employers

• The following factors influence their bargaining power

1. Membership of a trade union: trade unions represent the interests of the workers in negotiations with employers and members frequently enjoy higher wages than non-union members 

2. Age and experience: young, inexperienced workers have less bargaining power then older, more experienced workers. As workers grow older their age often begins to count against them and this reduces bargaining power

3. Level of education: education provides higher levels of skill and specialisation to a worker. This increases their bargaining power relative to unskilled workers

4. Current supply conditions: the supply of labour in many industries can change due to socio-political conditions e.g prior to Brexit, workers in the hotel industry had very little bargaining power. Brexit created a shortage of labour willing to work in hotels and so the bargaining power of workers has increased, resulting in higher wages in the industry

Government Policy: Minimum Wages

• Government's often intervene in the labour market by setting a minimum wage

  • They do this in order to improve equity and avoid the exploitation of worker

• A minimum wage is a legally imposed wage level that employers must pay their workers

  • It is set above the market rate

  • The minimum wage/hour often varies based on age
    

Diagram analysis

• The market equilibrium wage and quantity for truck drivers in the UK is seen at W_eQ_e

• The government imposes a national minimum wage (NMW) at W₁

• Incentivised by higher wages, the supply of labour increases from Q_e to Q_s

• Facing higher production costs, the demand for labour by firms decreases from Q_e to Q_d

• This means that at a wage rate of W₁ there is excess supply of labour and the potential for unemployment equal to Q_dQ_s