Micro - Labour Demand, Supply and Wage Determination

Question 1

The Short Run

Answer 1

A period of time in which the quantity of at least one factor of production available to a firm is fixed - this is likely to be land or capital, with labour usually a variable factor.

Question 2

The Long Run

Answer 2

In the long run, all factor inputs are variable.

Question 3

The Very Long Run

Answer 3

In the long run, technology is assumed to be fixed - the very long run is a period of time over which technology is variable, and is assumed to generally improve over this time.

Question 4

Law of Diminishing Marginal Returns

Answer 4

As additional units of a variable factor are applied to fixed amounts of a fixed factor, the additions to output will at first increase before decreasing, and eventually becoming negative.

Question 5

Marginal Physical Product (MPP)

Answer 5

The additions to total product that arise from employing an additional unit of labour.

Question 6

Average Product (AP) =

Answer 6

Number of units of labour

Question 7

Derived Demand

Answer 7

Demand for labour is said to be a derived demand, as it is only demanded for the goods and services it will help to produce. If demand for the goods and services increases, demand for labour will accordingly follow - the opposite is also true.

Question 8

Marginal Revenue Product =

Answer 8

Marginal Revenue (Price) x MPP

Question 9

Employment Rate

Answer 9

The proportion of the population of working age (16-65) who are in work

Question 10

Economically Inactive

Answer 10

People who are neither in or actively seeking employment, and as such are not part of the labour force

Question 11

Part-Time Workers

Answer 11

People who work fewer than 30 hours per week

Question 12

Offshoring

Answer 12

Transferring part of the production process to another country - the process may be outsourced, or the firm could relocate its own production facilities

Question 13

Outsourcing

Answer 13

Subcontracting part of the production process to another firm

Question 14

Aggregate Demand for Labour

Answer 14

Depends on the overall level of economic activity, and on firms’ expectations for future activity

Question 15

Determinants of Demand for Labour

Answer 15

• Demand for output (derived demand), and expected future demand
• Productivity of labour - the more productive, the higher the demand
• The wage rate
• Complementary labour costs (e.g. Nat’l Insurance contributions) - if they rise, demand falls.
• The price/availability of alternative factors of production, which can be used in place of labour

Question 16

Shape of the MRP Curve

Answer 16

Initially slopes upwards, but then decreases, due to the law of Diminishing Marginal Returns - firms employ on the downward-sloping portion of the curve, in order to access the profits available when the curve runs above the wage rate. Hence, this portion of the MRP curve constitutes the demand curve for labour.

Question 17

Determinants of PED for labour

Answer 17

• PED of the product being produced - wage rate increases, costs increase, price increases - if demand for product is inelastic, consumers will continue to demand it, so firms continue to demand a similar amount of labour
• The proportion of the firm’s total costs made up by wage costs - higher proportion = more elastic demand
• The ease with which labour can be substituted for other factors of production - easier = more elastic
• Elasticity of supply of complementary factors of production - if it is easier for the firm to obtain more of the factors used alongside labour without increasing costs, demand for labour will be more elastic
• Time period - demand for labour is more elastic in the long run, when firms are more able to reorganise their productive process

Question 18

Labour Market Flexibility

Answer 18

The ease with which the labour market adjusts to changes in the patterns of demand for and supply of labour

Question 19

The Income Effect

Answer 19

The idea that a wage rise will cause a worker to decrease their hours worked, as they are better able to purchase more leisure, whilst maintaining their current levels of income. Thought to be prevalent at higher income levels, at which workers have less desire to increase their incomes.

Question 20

The Substitution Effect

Answer 20

The idea that a wage rise will cause a worker to increase their hours worked, as the opportunity cost of undertaking leisure activities increases. Thought to be prevalent at lower incomes, at which workers lend to have more desire to increase their incomes.

Question 21

Backward-Bending Labour Supply Curve

Answer 21

The combined effect of the Income and Substitution effects is to produce a backward bending supply curve - initially, as wages increase, supply of labour increases in kind, as the Substitution effect is dominant. However, as incomes rise to higher levels, the increase in supply first becomes less pronounced, then begins to fall, as the Income effect takes over. This curve is only relevant in the short run.

Question 22

Long-Run SoL - Pecuniary (Financial) Factors

Answer 22

• The wage rate
• Opportunity for overtime work
• Bonuses

Question 23

Long-Run SoL - Non-Pecuniary Factors

Answer 23

• Convenience/flexibility of working hours
• Status/prestige, e.g. Doctor/Nurse
• Opportunity for promotions - this may attract people to work for initially low wages, e.g. in the media
• Flexibility of location/opportunity to work from home
• Qualifications/skills required - more skills = less supply
• Job security
• Pleasantness of the job (this is often outweighed by other factors)
• Holidays
• Perks/fringe benefits, e.g. company car, paid trips abroad, pension scheme, etc
• Opportunity for training/new skills
• Convenience of location
• Recent performance of the firm/occupation

Question 24

Determinants of Elasticity of Supply of Labour

Answer 24

• Qualifications/skills required - supply more elastic for unskilled than skilled workers
• Length of training required - workers may be put off by a long training period, and it will take a while for more workers to be trained to fill positions if the wage rate rises. Conversely, even if the wage rate falls, workers who have invested large amounts of time in training for the profession may be reluctant to leave it.
• Time period - similarly to demand, supply will tend to be more elastic in the long run, especially for professions with long training periods.

Question 25

Conditions for High Wages

Answer 25

Low and inelastic supply, high (high MRP) and inelastic demand. E.g. Brain Surgeons

Question 26

Conditions for Low Wages

Answer 26

High and elastic supply, low (low MRP) and elastic demand. E.g. waiters/waitresses.

Question 27

Outside influences on Wage Determination

Answer 27

• Relative bargaining power of workers/employers - wage rate will be higher when workers have relatively strong bargaining power, which can be achieved by the existence of large, well-run trade unions
• Government policy - both directly (gov’t is a major employer) and indirectly, via legislation - e.g. controlling union power, introduction of NMW

Question 28

Wage Differential

Answer 28

A difference in average wages between contrasting groups - groups can be divided by gender, race, occupation, level in the profession, etc

Question 29

Reasons for Wage Differentials - Skilled/Unskilled

Answer 29

Demand for skilled workers tends to be higher, due to their higher MRPs, and their supply tends to be lower, due to the requirement for high levels of education/training. Also, skilled labour is more difficult to substitute for capital, and fewer unemployed workers possess the necessary skills to fill the relevant occupations.

Question 30

Reasons for Wage Differentials - Male/Female

Answer 30

Women’s MRPs tend to be lower, due to concentration in low-paid industries, e.g. cleaning, waitressing, care work. Many women lose out on promotion opportunities as maternity leave often takes a large chunk out of women’s careers at a time when many workers look to advance their prospects, i.e. in their late 20s/early 30s. Discrimination still exists.

Question 31

Reasons for Wage Differentials - Part-Time/Full-Time

Answer 31

Part-time workers receive lower average hourly rates - the supply of people willing to work part-time is high, relative to the demand for such workers - workers are attracted by the flexibility of part-time work, whilst employers tend to prefer the stability/reliability of full-time workers. Part-time workers are less likely to receive training from their employers, as it is not as profitable for the employer to do so, so they will tend to have lower MRPs. A smaller proportion belongs to a trade union.

Question 32

Transfer Earnings

Answer 32

The amount that must be paid to current workers in order to keep them from transferring to another occupation - the amount that the worker could earn in the next-best-paid occupation. Can be shown as the area under the Supply of Labour curve, up to the quantity employed. A greater proportion of wages are transfer earnings in occupations with elastic supply.

Question 33

Economic Rent

Answer 33

The amount paid to workers over and above their transfer earnings. Can be shown as the area bounded by the SL curve and the wage rate. A greater proportion of wages is economic rent in occupations with inelastic supply.