65. Labor market: labor demand and supply of labor.

The labour market is an example of a factor market

Supply of labour – those people seeking employment (employees)

Demand for labour – from employers

• A ‘Derived Demand’ – not wanted for its own sake but for what it can contribute to production

• Demand for labour related to productivity of labour and the level of demand for the product

• Elasticity of demand for labour related to the elasticity of demand for the product

The Supply of Labour

The amount of people offering their labour at different wage rates.

• Involves an opportunity cost – work v. leisure

• Wage rate must be sufficient to overcome the opportunity costof leisure

The supply and demand for labor is much like the supply and demand for any other service. Consistent with the law of supply and demand (as price rises, quantity demanded falls and quantity supplied rises), the demand curve has a negative slope and the supply curve has a positive slope.

The supply of labor, like the supply for other services, merely indicates how much labor workers are willing to offer at various prices. The supply curve for each worker will be different as each worker has different opportunity costs and preferences.

The demand for labor indicates how much labor a firm desires at different prices. The demand curve for each firm will differ as each firm faces different labor substitutes (differing rates of potential capital substitution, for instance), preferences, demand curves for the products they produce, and alternative employments for their resources.

Wage rates are simply the price of labor and as such, are determined like all other prices on the market. The intersection of the supply and demand curves for labor indicates the equilibrium, or market clearing, wage rate for certain types of labor. (In a free economy, unhampered by government regulation, wage rates for the same type of labor tend to equalize across markets).

66.The Marginal productivity approach to demand for labor.

Marginal revenue product of labour

Marginal revenue productivity of labour (MRPL) is a theory of the demand for labour and market wage determination where workers are assumed to be paid the value of their marginal revenue product to the business

Marginal Revenue Product (MRPL) measures the change in total revenue for a firm from selling the output produced by additional workers employed.

MRPL = Marginal Physical Product x Price of Output per unit

Marginal physical product is the change in output resulting from employing one extra worker

The price of output is determined in the product market – in other words, the price that the firm can get in the market for the output that they have produced

MRP theory suggests that wage differentials result from differences in labour productivity and the value of the output that the labour input produces. The MRP theory outlined below is based on the assumption of a perfectly competitive labour market and rests on a number of key assumptions that realistically are unlikely to exist in the real world. Most of our labour markets are imperfect – this is one of the many reasons for the existence and persistence of large earnings differentials between occupations which we explore a little later on.

The main assumptions of the marginal revenue productivity theory of the demand for labour are:

Workers are homogeneous in terms of their ability and productivity

Firms have no buying power when demanding workers (i.e. they have no monopsony power)

Trade unions have no impact on the available labour supply (the possible impact on unions on wage determination is considered later)

The physical productivity of each worker can be accurately and objectively measured and the market value of the output produced by the labour force can be calculated

The industry supply of labour is assumed to be perfectly elastic. Workers are occupationally and geographically mobile and can be hired at a constant wage rate