In a competitive labour market, the wage rate is determined by the interaction of demand and supply. The demand of labour is undertaken by firms, which require workers to help produce goods and services. The supply of labour comes from the general population and, in particular, the workforce of an economy.
In practice there are many different types of labour market: for example: shop assistants, kitchen chefs and lawyers. Labour markets also include public sector workers where the government is a major employer of labour: for example, teachers, nurses and police officers.
The demand for labour
The demand for labour is a derived demand. It is derived from the demand from the goods and services it makes. For example, the demand for building workers is derived from the demand for new housing.
The figure below shows how an increase in demand for new housing will cause an increase in demand for building workers, such as brick;ayers and carpenters. The effect is to increase the wage rate from We to W1, and the quantity employed from Ne to N1.
[diagram on page 35]
There are several ey determinants of the demand for labour:
- Demand for the final product. An increase in demand for a good or service is likely to cause an increase in demand for the labour involved in making it. Firms have a profit incentive, if demand and prices increase, to supply more of the good or service.
- The wage rate. A fall in the wage rate means that labour becomes more affordable, and so firms are likely to hire more workers.
- Other labour costs. For example, a fall in National Insurance contributions of behalf of staff is likely to raise the quantity demanded.
- Price of other factor inputs. An increase in the price of capital might encourage firms to employ more labour and cut back on the use of machinery and equipment where possible. This is because labour and capital may be substitutes in the production process.
- Productivity of labour. An increase in output per worker may lead to higher revenue and profits, encouraging forms to employ more people.
- Government employee regulations. The fewer the number of regulations, the greater the demand for labour is likely to be. For example, if it becomes easy to hire and fire staff or to change working conditions, then the increased labour flexibility may encourage firms to employ more people. However, a national minimum wage set above the free-market wage may cause a decrease in the quantity of labour demanded.
The supply of labour
This refers to the quantity and quality of labour hours offerred for work over a given time period. There are various factors which determine the supply of labour, namely:
- The wage rate. An increase in the wage rate will encourage more people to offer their services to work. A higher wage means the opportunity cost for leisure time increases, encouraging people to work longer hours.
- Other net advantages of work. Improvements in working conditions will also tend to increase the supply of labour: for example, a good pension, paid holidays, job security and promotion prospects.
- Net migration. Over recent years the UK has experienced a significant increase in immigration from central and eastern Europe, helping boost the economy.
- Income tax. A reduction in income tax will increase disposable incomes and therefore offer a greater incentive or people to work. Many people will substitute work for leisure time, increasing the supply for work.
- Benefit reform. A reduction in benefits (e.g incapacity benefit, housing benefit and the jobseekers allowance) may provide a greater incentive to look for work and so increase the supply of labour.
- Trade unions. Trade unions act to artificially increase the wage rate and improve employee conditions by collective bargaining with employers on behalf of workers.. This may encourage an increase in the supply of labour.
- Government regulations. An increase in employment protection or the introduction of a national minimum wage will tend to improve working conditions and so increase the supply of labour. However, it is also possible that government regulations decrease the supply of labour. For example, the EU Work Time directive limits the maximum hours of work per week to 48 for most employees.
- Social trends. There has been a significant increase in the number of women in the the workforce over the past 40 years. The reflects an improvement in equal opportunities, childcare facilities and social attitudes.