How Wages are Determined in a Perfectly Competitive Labour Market

How Wages are Determined in a Perfectly Competitive Labour Market
As in other markets, the supply and demand of labour determines the price (wage rate) and the quantity (number of people employed). The labour market is different from other markets (like the markets for goods) in several ways. The most important of these differences is the function of supply and demand in setting price and quantity. In markets for goods, if the price is high, in the long run more goods will probably be produced until the demand is satisfied. However, with labour, overall supply cannot in fact be fixed because people have a limited amount of time in the day, and people are not manufactured. A rise in overall wages will, in many situations, not result in a higher supply of labour. It may actually result in less supply of labour as workers take more time off to spend their increased wages because they no longer have to work the longer hours to gain the same amount of money, or it may result in no change in supply. Within the overall labour market, particular parts are thought to be subject to more normal rules of supply and demand as workers are likely to change job types in response to inconsistent wage rates. Many economists have thought that, in the absence of laws or organisations such as unions or large multinational corporations, labour markets can be close to perfectly competitive in the economic sense ? because there are many workers and employers both having perfect information about each other.
There are many conditions that determine the wage rate of labour. If there were an increase in demand for labour, this would cause an extension up the supply curve. This would increase the wage rate and the quantity (amount of people hired) of labour. A decrease in demand would cause the opposite. An increase in supply, however, would cause a shift down the demand curve therefore lowering wage rates and quantity of labour. A shift in the supply curve of labour could be caused in many ways. If labour became more or less productive, this would cause the mrp curve to move ? mrp = Marginal revenue product. This is a theory of wages where workers are paid the mrp to the firm. The price of a substitute could also change i.e. if the price of a substitute goes down, say a certain type of capital, then the demand for that labour will fall. The demand for the product could also change. If the demand for the product could also change e.g. if the demand increases, this would mean a higher price. This in turn would give a higher wage rate as wage is determined by mrp which is mpp(marginal physical product X price). The demand for labour is a derived demand. This means it is decided by how another factor changes e.g. if the demand for a product increases, the demand for labour in that field will increase. If demand for a product increases, this means a higher price and a higher quantity will be produced (for profit maximisation). This would cause the mrp curve to shift outwards, which in turn would mean a higher wage rate, or possibly that more workers are taken on. The labour supply curve can be altered. One way it may be altered is if there is a change in the wage rate in another industry that workers in their current industry could move to. This gives firms an incentive to increase wage rates to keep their labour supply. There could also be an increase in non-monetary rewards in an industry that labour could move into. This could be a long-term supply increase, however, because worker training takes time e.g. doctors training is 6 years. Labour mobility could also be a limiting factor here. b) Discuss the extent to which demand and supply analysis explains the differences in earnings between professional football players and hotel workers (30 marks) The demand for labour is derived demand. Firms only demand employees because of the demand for actual goods or services. Demand is derived from the marginal product of labour ? the extra output produced by an additional worker. People are employed because of the value of their output. This depends on the extra output they produce (their marginal product) and the extra revenue this generates when it is sold (the marginal revenue). The mrp is downward sloping because of the law of diminishing returns. This is as additional units of a variable factor (e.g. labour) are added to a fixed factor (e.g. capital) the extra output (marginal product) of the variable factor will eventually diminish. The mrp of a football player is a lot higher than the mrp of a hotel worker. A hotel worker, say, a maid, has a relatively small output and works along with a very large number of employees i.e. they clean say, 50 rooms in one day. A football player, however, has a much larger output. They work in a smaller team of ?employees? and if a match is won, the club gains a lot more than if a maid cleaned one more room in a day. The elasticity of demand for labour depends on a number of things. Firstly, it depends on labour costs as a percentage of the total cost. The higher the percentage, the greater impact of any wage increase and the more likely it is that the quantity demanded of labour will fall, i.e. the more elastic demand for labour will be. Secondly, it depends on the time period. In the short run, a firm may find it difficult to replace labour with other factors e.g. capital equipment, over time it may prove easier and so demand will be more price elastic. Finally, it depends on the price elasticity of the good or service. A wage increase will increase costs and may increase price. If the effect of the price increase of the good is relatively small, the effect on the quantity demanded of labour is also likely to be relatively small, i.e. an inelastic demand for the product is likely to lead to an inelastic demand for the labour. The elasticity of demand for football players is very inelastic. This is because there is not that many people that could do the job, as it is highly skilled, and clubs only hire a certain number of top league players. A rise in wages for football players will have a very small effect on the number of players hired. This means that football players can charge a much higher wage than more demand elastic jobs such as hotel work. Hotel workers have a very elastic demand because they do a job that does not require much skill, and there is a much larger number of people that could do their job than a football player. It is also not a specified job, so generally no qualifications are required making it open to even more applicants. An individual can choose between leisure and work. If he/she decides to work more, than leisure time falls and vice versa. The decision whether to work or not depends on an income and substitution effect e.g. if the wage increases it makes it more expensive to have leisure time, and an employee may feel they need to work less hours because they can gain the same amount of money as before the wage rise ? the income effect. The substitution effect is usually greater than the income effect and people will want to work more hours when there is a wage increase. However, at some wages the income effect outweighs the substitution effect and people will decide to work less hours when wages increase. This causes a backward sloping curve for the supply of labour. Football players will have the opportunity to work fewer hours than hotel workers as they have a hugely high wage, and can therefore let leisure time be more of an option than hotel workers, who have to work longer hours for less money. This means a change in the number of hours a hotel worker works without an increase in wages effects the hotel worker much more than it would affect the football player, so the hotel worker would be much more prepared to supply more of their labour. Trade unions are organisations of workers that seek through collective bargaining with employers to protect and improve the real incomes of their members, provide job security, protect workers against unfair dismissal and provide a range of other work-related services including support for people claiming compensation for injuries sustained in a job. Hotel workers are not heavily unionised. This means that they are on their own, and are more likely to settle for a lower wage than a football player who is protected by the pfa.

How Wages are Determined in a Perfectly Competitive Labour Market 8.9 of 10 on the basis of 1861 Review.