3.5.4 Labour market failure and government intervention

Question 1

Imperfect information in the labour market

Answer 1

Imperfect information is a source of labour market failure.

Perfect information would exist if workers knew everything about every job and employers knew everything about every potential worker. However, this doesn’t happy in reality.

Question 2

Consequences of imperfect information in the labour market

Answer 2

• Many workers end up in jobs that aren’t the best fit for them and/or don’t pay enough.
• Employers end up with workers that aren’t as productive as they could be, which increases their costs of production and makes their goods less competitive.
• Imperfect information increases frictional unemployment. When people are between jobs they need to spend time researching to find the right job. If they had the benefit of perfect information their task would be simpler.

Question 3

Unemployment in the labour market

Answer 3

Unemployment exists when labour supply is greater than labour demand.

Unemployed workers are a waste of scarce resources – unemployment means an economy isn’t making use of all its resources effectively. However, in an economy there’s always some level of unemployment.

Unemployment only becomes a serious market failure if it’s at a high level and persists for a long period of time.

Question 4

What issue arises if the level of unemployment benefits are too high?

Answer 4

It can cause voluntary unemployment. This means that people can be better off by choosing not to work and claiming unemployment benefits rather than working for a low wage – this is called the unemployment trap.

Question 5

Geographic immobility

Answer 5

When workers aren’t able to (or are reluctant to) move to different locations to find the best jobs for themselves.

When this happens they end up either unemployed or in jobs that aren’t suited to them – so there is a misallocation of resources and market failure occurs.

Question 6

Main reasons for geographic immobility

Answer 6

• People don’t want to move away from their home, as people make friends and have family there.
• It is expensive to move houses.
• Poor infrastructure

Question 7

Occupational immobility

Answer 7

When workers aren’t able to move from one occupation to another with ease.

Question 8

What are some factors affecting occupational immobility?

Answer 8

• Age: Younger workers are more likely to retrain, but older workers may lack the confidence or motivation to do so.
• Some occupations also require high-level qualifications. And particular personality traits. For example, not everyone is able to cope with the difficult studies required to become a doctor or lawyer.

Question 9

What can occupational immobility cause in the economy?

Answer 9

Unemployment, and may mean skills shortages are harder to fix.

• For example, if the labour of skilled workers in a particular occupation started to be replaced by machines, those workers may not be able to easily transfer their skills to other occupations and many could become unemployed.

Question 10

National Minimum Wage

Answer 10

The NMW sets a legal minimum hourly rate of pay for different age groups.

It was first introduced by Labour PM Tony Blair in 1999 to stop firms setting wages so low that employees couldn’t afford a decent standard of living. It aims to prevent the exploitation of workers due to the payment of unfairly low wages.

By increasing the pay of the poorest workers, a NMW leads to a more equitable distribution of income (improving the Gini Coefficient).

A NMW helps to encourage people to work, and increases the number of people in work – which increases the labour supply.

Question 11

NMW and unemployment

Answer 11

Using supply and demand diagrams it could be argued that increasing the wage rate would lead to a contraction in demand for labour.

Unemployment caused by the introduction of a NMW would be an example of government failure. However, there is evidence to show that having a NMW hasn’t caused a significant negative impact on the level of employment in the UK.

A NMW can be used to help tackle inequality and poverty.

Question 12

Advantages of a NMW

Answer 12

Question 13

Disadvantages of a NMW

Answer 13

Question 14

Maximum wages

Answer 14

A maximum wage limits a worker’s wage rate.

To be effective it must be set below the market equilibrium wage rate, which will reduce wages in that market and increase demand for labour.

Question 15

Benefits of a maximum wage

Answer 15

• Rises in wages above increases in productivity can cause inflation, so setting a maximum wage can limit how much prices can rise and help prevent the wage-price spiral.
• A maximum wage could limit the level of inequality in a country (especially if there’s also a minimum wage).
• A maximum wage could reduce a firm’s labour cost and increase their willingness to hire more workers.

Question 16

Arguments against a maximum wage

Answer 16

• Some believe it’s unfair to not reward greater effort or ability with higher income.
• The possibility of higher pay and pay increases provides motivation to work harder.
• If some countries had a maximum wage, people who could earn higher wages in other countries might move abroad. Similarly, if one industry had a maximum wage and another didn’t, then people might be more likely to train in the industry without a maximum wage.