The Labour Market

The interaction between households and firms in the labour market

The labour market versus the goods market Differences between labour & other markets due to human beings rather than with inanimate objects. The following are some of the most important differences: Workers usually physically present - non-monetary factors (eg. Location of employment) more important. Labour services not transferable to other people. Goods are fully transferable between purchasers and sellers. Labour is rented rather than sold. Labour market affected by non-economic considerations eg. loyalty, fairness, appreciation and justice.

The labour market versus the goods market (cont…) Labour markets characterised by trade unions, employees’ associations, collective bargaining and government intervention. Labour usually employed by long-term contracts therefore not traded at the best price on a daily basis. Labour is heterogeneous. Remuneration of labour includes non-wage benefits (such as housing, medical, pension, travel and holiday benefits).

A perfectly competitive labour market Perfect competitive labour market used as a benchmark.  Requirements for perfect competition in Labour Market… Large number of buyers (employers) & large number of sellers (employees) in the market. No individual can influence price of labour. All participants price (wage) takers. Labour must be homogeneous – i.e. all workers have identical skills. Workers completely mobile - able to move freely from one employer/market/region to another. Entry and exit completely free.

Requirements for perfect competition in labour market (cont)… No government intervention influencing employers or workers. All participants must have perfect knowledge of market conditions.

Wage rate & equilibrium quantity determined by the interaction of supply and demand. Equilibrium in the labour market

The INDIVIDUAL supply of labour Individuals decide how to divide time between work and leisure. Quantity of labour supplied rises as the wage rate rises, but only up to a certain point… What happens next…

What is happening in the diagram below? Hourly wage rate of R70 per hour - 40 hours (Point C). R70 per hour = additional R550per week + additional five hours of leisure. Gives rise to a backward bending supply curve hourly wage rates > R50 can earn R2250 per week by working fewer hours leaving more time for leisure. Hourly wage rate of R50 per hour = 45 hours per week (Point B) weekly wage of R2250 (45 x R50). Individuals divide time between work and leisure. Hourly wage rate of R10 = no willingness to work at all (Point A) What is happening in the diagram below?

Backward- bending supply curve due to two forces… Substitution effect increases in the price of labour persuade workers to substitute work for leisure. Income effect spending on goods/services increases, marginal utility of consumption decreases. Leisure = normal good, as income increases (along with the wage rate), demand for leisure will thus increase.

direction of substitution effect depends on change in relative prices As price of labour increases, relative to the price of leisure… quantity of labour supplied increases quantity of leisure demanded decreases The income effect works in the opposite direction As income increases more leisure will be demanded and less labour will be supplied.

At R50 per hour income effect > substitution effect Q leisure demanded increases; q labour supplied decreases. point A - B substitution effect > income effect q labour supplied increases; Q leisure demanded decreases

The MARKET supply of labour backward-bending supply curve concerns individuals BUT…unlikely backward bend occurs at same wage rate increase in wage rate also attracts more people to enter labour market Thus market supply of labour as below…

Market Supply changes if non-wage determinants changes (shift of the market supply curve) market supply will change if… new workers enter the market (pop. increase or immigration) number of workers decreases (HIV/AIDS) relative wages change, making an occupation less/more attractive non-monetary aspects change (danger, fringe benefits, job security, status…)

An INDIVIDUAL firm’s demand for labour Demand for labour is derived from the demand for goods and services Decision to employ depends on marginal benefit and marginal cost of employing the worker. marginal benefit > marginal cost - employ additional units. continues until marginal benefit = marginal cost.

determinants of marginal cost of labour (MCL) and marginal benefit of labour thus need to be considered. (Sf) - perfectly elastic supply of labour to the firm. MCL - marginal cost of labour (MCL). We - EQUILIBRIUM WAGE RATE

How much labour will the firm employ at the given wage rate? Depends on marginal benefit to the firm of employing additional units of labour. the physical productivity of labour marginal revenue   in a perfectly competitive product market, MR = P continue to employ labour as long as each additional unit of labour adds more to its total revenue than total cost (i.e. as long mr > mc).

Thus MRP = MPP x MR Thus MRP = MPP x P two components of marginal benefit gained by employing labour - physical productivity of labour and the marginal revenue. law of diminishing returns implies marginal product of labour has a declining tendency. more units of variable factor of production – labour –added to fixed quantities → additional output decreases, therefore marginal product starts to decline. The marginal physical product of labour (MPP) indicates the physical value to the firm of employing an additional unit of labour. increase in total revenue from additional unit of labour = MPP x MR Known as marginal revenue product (MRP). Thus MRP = MPP x MR For a perfectly competitive firm, mr =p Thus MRP = MPP x P

Maximum profit is achieved when… MRP = wage rate > 4 workers MRP (R100) < wage rate (R200/week)  not profitable to employ > 4 workers Maximum profit is achieved when… MRP = wage rate < 4 workers MRP > wage rate  more profitable to employ additional workers At a wage rate (w) of R200 per week firm maximises profits by employing four workers

The firm in our example will employ… MAX The firm in our example will employ… MAX. two workers if wage rate =R400 max. three workers if wage rate is R300...

horizontal supply curve (determined in the labour market) Equilibrium… MRP = w horizontal supply curve (determined in the labour market) firm’s demand for labour = marginal revenue product of labour (MRP) EQUILIBRIUM POSITION OF INDIVIDUAL FIRM OPERATING IN A PERFECTLY COMPETITIVE LABOUR MARKET

The MARKET demand for labour obtained by adding individual firms’ demand curves – downward sloping.  market demand change if non-wage determinants of quantity of labour demanded changes (shift of market demand curve). Caused by changes in… number of firms (employers) price of the product – change MRP  Q labour demanded at each wage rate (MRP = MPP x P  if P changes, MRP will also change, ceteris paribus) MPP (productivity) of labour - also changes MRP, ceteris paribus

new substitutes for labour becomes available – eg new substitutes for labour becomes available – eg. ATM’s replacing bank tellers the price of a substitute factor – eg. price of machinery (capital) decreases; labour replaced the price of a complementary factor of production – eg. price of trucks decreases → quantity of trucks increases → truck drivers demanded will also increase.

Changes in labour market equilibrium and changes in equilibrium Magnitude of the changes in the wage rate and the level of employment will depend on the elasticities of demand and supply.