Wage Determination (CIE IGCSE Economics)

• The labour market is composed of sellers of labour (households) & buyers of labour (firms)
  • Workers supply their labour & 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

The price of the product being produced	The demand for the final product
If the selling price of the product increases, then the firm will be incentivised to supply more & the firm's demand for labour will increase	As demand for labour is a derived demand, when an economy is booming then demand for most goods/services will be high - & the demand for labour will be high Conversely, when an economy is in a recession demand for most goods/services will be lower - & the demand for labour will be lower
The ability to substitute capital (machinery) for labour	The productivity of labour
Firms will constantly evaluate if it will be possible & more cost effective to switch production from using labour to capital (machinery) If it is more cost effective, then demand for labour will fall	If the productivity of labour increases (possibly through training) this will lower average costs & firms will likely demand more labour

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

Factors Influencing The Supply Of Labour

Training period	Wages in other occupations	Changes in migration policy
Long training periods (& their cost) act as a barrier to entry & exclude many households from offering labour in certain markets	Comparative wage rates in substitute labour markets strongly influence the supply of labour e.g. it is getting harder to recruit economics teachers as the private sector offers higher wages for their skills	Policies that increase the net migration rate  increase the supply of labour to certain industries e.g. in 2022, 36% of Singapore's labour force were migrants
Income tax levels	Working conditions	Trade union power
At 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	The working conditions & non-wage benefits can act as strong incentive in certain industries e.g. tech companies are well known for their laid-back work environment & wide range of benefits e.g. on-site childcare & restaurants	Trade unions can increase the supply of labour to certain industries as workers consider the benefits of belonging to the union e.g higher wages & a safer working environment
Level of welfare benefits	Social trends
The higher the level of welfare benefits, the lower the incentive for low-skilled labour to offer their labour - and vice versa	Social trends include any major changes within society & can influence the supply of labour to certain industries e.g. work from home during Covid resulted in significant changes to the labour market & not all workers returned to work when economies opened up again

   

• 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 & supply
  • They are affected by the price elasticity of demand & 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
    
    

In the labour market for graphic designers, the equilibrium wage rate is W and the equilibrium quantity is Q. At this point the D_L = S_L

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
  
  

  Price Inelastic Demand & Supply

• Consider the labour market for NBA basketball players
• In 2022, LeBron James received a salary of $45m
  
  

Wage determination in highly skilled markets is price inelastic in both supply & demand

   
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 & relatively low quantity

  

Price Elastic Demand & Supply
  

• Consider the labour market for labourers on a building site
   

Wage determination in unskilled markets is price elastic in both supply & demand

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 & relatively high quantity

• 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 & members frequently enjoy higher wages than non-union members
    
2. Age & 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 & this reduces bargaining power
   
   
3. Level of education: education provides higher levels of skill & 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 & so the bargaining power of workers has increased, resulting in higher wages in the industry

• Government's often intervene in the labour market by setting a minimum wage
  • They do this in order to improve equity & 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
      

A national minimum wage (NMW₁₎ is imposed above the market wage rate (W_e) at W₁

Diagram Analysis

• The market equilibrium wage & 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 & the potential for unemployment equal to Q_dQ_s