Chapter 12:
The factor markets:
the labour market
CHAPTER OUTLINE
LEARNING OUTCOMES
12.1 INTRODUCTION
12.2 THE LABOUR MARKET VERSUS THE GOODS MARKET
12.3 A PERFECTLY COMPETITIVE LABOUR MARKET
12.4 IMPERFECT LABOUR MARKETS
12.5 WAGE DIFFERENTIALS
FACTOR MARKETS
IMPORTANT CONCEPTS
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LEARNING OUTCOMES
Once you have studied this chapter you should be able to
• identify the main differences between the labour market and the goods
market
• explain the main determinants of the supply of labour
• explain how the demand for labour is derived
•
•
•
•
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explain how a perfectly competitive labour market functions
analyse various labour market imperfections
discuss the desirability of minimum wages
explain why wages differ
ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
12.1 INTRODUCTION
Figure 12-1 The interaction between
households and firms in the labour market
(Textbook page 208)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
INTRODUCTION
• Labour is an important factor of production.
• The cost of labour is the largest cost factor in the economy.
• Changes in the cost of labour therefore have a significant impact on cost and
price trends in the economy.
• The cost of labour depends on the wages and salaries paid to workers and
on the productivity of labour.
• Productivity (or quality) of labour is an important determinant of the cost of
labour.
• Wages and salaries do not only represent costs. They are also an important
demand factor as they are the main source of household income and they
therefore influence the demand for goods and services.
• Creation of jobs arguably the most important objective of economic policy.
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: identify the main differences between the labour market and the goods market
12.2 THE LABOUR MARKET VERSUS THE
GOODS MARKET
See Box 12-1 Some basic concepts relating to the remuneration of labour (Textbook page 209)
Differences between labour market and goods market
• Non-monetary factors important
• Labour services are not transferable
• Labour is rented not sold
• Non-economic considerations
• Trade unions, employees’ associations, collective bargaining and
government intervention
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: identify the main differences between the labour
market and the goods market
THE LABOUR MARKET VERSUS THE GOODS MARKET
• Long-term contracts
• Heterogeneous
• Variety of labour markets, segmented market
• Non-wage benefits
• Remuneration is affected by a number of factors which are not directly
related to labour market conditions
See Box 12-1 SOME BASIC CONCEPTS RELATING TO THE REMUNERATION OF LABOUR
(Textbook page 209)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: explain how a perfectly competitive labour market functions
12.3 A PERFECTLY COMPETITIVE LABOUR
MARKET
Requirements for perfect competition
• Large number of buyers and sellers
• Homogeneous labour
• Completely mobile
• No government intervention
• Perfect knowledge
• Perfect competition in the goods market
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
Equilibrium in the labour market
• Quantity demanded = quantity supplied
Figure 12-2 Equilibrium in a perfectly
competitive labour market
(Textbook page 210)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: explain how a perfectly competitive
labour market functions
LO: explain how a perfectly competitive labour market functions
LO: explain the main determinants of the supply of labour
A PERFECTLY COMPETITIVE LABOUR MARKET
Quantity of labour
supplied eventually
decreases as wage
rate increases
The individual supply of labour
Backward-bending supply curve
Maximum
quantity of
labour supplied
Figure 12-3 The individual supply of labour
(Textbook page 211)
Wage rate
1
2
3
4
5
RESET
Quantity of
labour supplied
increases as
wage rates
increase
30
Eric’s work hours
Eric’s supply schedule
Eric’s wage rate
(Rands per hour)
Quantity of labour
(hours per week)
Weekly wage
C
R70
40
R2 800
B
R50
45
R2 250
R30
32
R960
R10
0
R0
A
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
32
At wage rates higher than R50 an hour, Eric
Eric
Baloyi
has of
tohours,
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At
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time
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work
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an
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45
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a
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a
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higher
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perand
week.
A PERFECTLY COMPETITIVE LABOUR MARKET
The individual supply of labour
LO: explain how a perfectly competitive labour market functions
LO: explain the main determinants of the supply of labour
The backward-bending supply
curve can be ascribed to two
forces:
• Substitution effect – as wage
rate increases, workers tend to
work more hours
• Income effect – as a worker
spends more on goods and
services, his or her marginal
utility of consumption
decreases, and his or her
demand for leisure increases
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
Income
effect
Substitution
effect
A PERFECTLY COMPETITIVE LABOUR MARKET
LO: explain how a perfectly competitive labour market functions
LO: explain the main determinants of the supply of labour
The market supply of labour
Figure 12-4 The market supply of labour (Textbook page 212)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
The market supply of labour
LO: explain how a perfectly competitive labour market functions
LO: explain the main determinants of the supply of labour
Market supply will change if, for example:
• new workers enter the market
• the number of workers decreases as a result of the impact of HIV/Aids
• the wages that can be earned in other occupations change
• the non-monetary aspects of the occupation change
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
LO: explain how a perfectly competitive labour market functions
LO: explain how the demand for labour is derived
An individual firm’s demand for labour
• Derived demand
• Compare marginal benefit to marginal cost
• Wage taker
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
An individual firm’s demand for labour
LO: explain how a perfectly competitive labour market functions
LO: explain how the demand for labour is derived
Figure 12-5 A perfectly competitive labour market (Textbook page 213)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
LO: explain how a perfectly competitive labour market functions
LO: explain how the demand for labour is derived
An individual firm’s demand for labour
• How much labour will the firm employ at the given wage rate?
• Marginal benefit of employing additional units of labour
•
•
•
•
Physical productivity of labour (MPP)
Marginal revenue product (MRP)
Firm’s marginal revenue equals price of product
The law of diminishing returns implies that the marginal product of labour
has a declining tendency
MRP = MPP × MR (12.1)
MRP = MPP × P (12.2)
See Box 12-2 Imperfect competition in the product market and the demand for labour
(Textbook page 214)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
An individual firm’s demand for labour
LO: explain how a perfectly competitive labour market functions
LO: explain how the demand for labour is derived
MRP > Wage rate (w): employment expansion profitable
MRP < w: results in loss
Equilibrium (maximum profit):
• Marginal benefit = marginal cost
• MRP = w (12.3)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
An individual firm’s demand for labour
LO: explain how a perfectly competitive labour market functions
LO: explain how the demand for labour is derived
Table 12-1 Calculation of the marginal revenue product of labour: an example (Textbook page 214)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
An individual firm’s demand for labour
LO: explain how a perfectly competitive labour market functions
LO: explain how the demand for labour is derived
Figure 12-6 The individual firm’s demand for labour (Textbook page 215)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
LO: explain how a perfectly competitive labour market functions
LO: explain how the demand for labour is derived
An individual firm’s demand for labour
Figure 12-7 The equilibrium position of a firm operating in a perfectly competitive labour market
(Textbook page 215)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
LO: explain how a perfectly competitive labour market functions
LO: explain how the demand for labour is derived
The market demand for labour
The market demand will shift if:
• The number of firms change
• The price of the product changes
•
•
•
•
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MPP (or productivity) changes
A new substitute for labour becomes available
The price of a substitute factor of production changes
The price of a complementary factor of production changes
ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
LO: explain how a perfectly competitive labour market functions
LO: explain how the demand for labour is derived
Changes in labour market equilibrium
Click on the number to reveal
the graph. Click again to hide.
Figure 12-8 Changes in labour market equilibrium (Textbook page 217)
a
The
The initial
initial equilibrium
equilibrium is
is illustrated
illustrated by
by
the
the intersection
intersection of
of the
the demand
demand curve
curve
(D
(D00D
D00)) and
and the
the supply curve (S00SS00).). The
The
equilibrium
equilibrium wage
wage rate
rate is
is w
w00 and
and the
the
equilibrium
equilibrium level
employment N
of employment
level of
N00..
b
c
InIn(b)
(d)
the
supply
labour
decreases,
(c)the
thedemand
supply of
of
labour
increases,
In
for
labour
decreases,
In
(a)
the
demand
for
labour
increases,
illustrated
by
leftward
illustrated
shiftof
ofthe
the
illustratedby
byaaarightward
leftward shift
shift
of
the
supply
curve
to
S14D2.The
wage
rate
supply
curve
toto
Sto3DSD324.The
wage
rate
falls
demand
curve
D
.1The
equilibrium
demand
curve
.The
wage
rate
toemployment
w41 but
toincreases
wrate
the
level
of the
employment
wage
and
fall to
and
the level
level of
of
3 but
employment
increases
falls
totoNto
w2employment
and
N2 respectively.
N
. 4.
3 1N
d
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
A PERFECTLY COMPETITIVE LABOUR MARKET
Changes in labour market equilibrium
LO: explain how a perfectly competitive labour market functions
LO: explain how the demand for labour is derived
In all these cases, the magnitude of the changes in the wage rate and the level of employment
will depend on the elasticities of demand and supply. For example, if the demand for labour
decreases, the impact will depend on the elasticity of the supply of labour. The more inelastic the
supply of labour, the greater the impact on the wage rate and the smaller the impact on the level
of employment will be. Likewise, the impact of a change in the supply of labour will depend on
the elasticity of the demand for labour.
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: explain how a perfectly competitive labour market functions
LO: analyse various labour market imperfections
12.4 IMPERFECT LABOUR MARKETS
Reasons for imperfect labour markets
• Trade unions (act as monopolistic suppliers of labour)
• Monopsony
• Labour is heterogeneous
• Labour is not completely mobile
• Labour market is a segmented market
• Government intervention
• Imperfect knowledge
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
IMPERECT LABOUR MARKETS
LO: explain how a perfectly competitive labour market functions
LO: analyse various labour market imperfections
Trade unions
Click on the number to reveal
the graph. Click again to hide.
Figure 12-9 Ways in which a trade union can attempt to increase the wage rate (Textbook page 219)
Trade unions can attempt to raise the wage
rate by (a) restricting supply, (b) enforcing a
higher disequilibrium wage or (c) assisting
firms to raise the demand for the product of
the industry.
a
b
Part (c) illustrates a situation in which the
The
restriction
is illustrated
in
union
succeedsof
(insupply
conjunction
with the
part
a leftward
shift offor
the
supplythe
firms)
inby
raising
theademand
Part(a)
(b)
illustrates
situation
in the
which
curve
S1Sthe
product
of
This
in anto
1. industry.
unionto
succeeds
in raising
theresults
wage rate
increase
in the
derived
demand
for labour
w2, which
is higher
than
the equilibrium
(to
D1D1As
). The
wage
increases (toby
w3a)
wage.
in (a),
thisrate
is accompanied
and the level
of employment
also
decline
in employment
increases.
c
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: explain how a perfectly competitive labour market functions
LO: analyse various labour market imperfections
IMPERECT LABOUR MARKETS
Monopsony
Table 12-2 The cost and marginal revenue product of labour in a monopsonistic labour market
(Textbook page 220)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
IMPERECT LABOUR MARKETS
LO: explain how a perfectly competitive labour market functions
LO: analyse various labour market imperfections
Figure 12-10 Wage and employment determination
in a monopsonistic labour market
(Textbook page 221)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
IMPERECT LABOUR MARKETS
LO: explain how a perfectly competitive labour market functions
LO: analyse various labour market imperfections
Bilateral monopoly
The relative bargaining strength of the two parties is determined, inter alia, by:
• ratio of wage cost to total cost
• Changes in productivity
• The relationship between the wages paid in the industry and the wages paid
elsewhere for similar work
• The nature of the product
• The price elasticity of the demand for the product
• The degree to which the union controls the supply of labour
• The level of unemployment
• The extent to which machinery can readily replace labour
• Increases in the cost of living
• The structure of the goods market
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
IMPERECT LABOUR MARKETS
LO: explain how a perfectly competitive labour market functions
LO: analyse various labour market imperfections
Government intervention in the labour market
Flexible labour market: A perfectly competitive labour market that can
adjust instantaneously and fully to changes in demand and supply (e.g.
adjust the size, compensation and working conditions of its workforce
with speed and at low cost). In practice, most labour markets have some
rigidities.
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
IMPERECT LABOUR MARKETS
LO: explain how a perfectly competitive labour market functions
LO: analyse various labour market imperfections
LO: discuss the desirability of minimum wages
Minimum wages
A Minimum wage in a perfectly
competitive labour market
Figure 12-11 The impact of the imposition
of a minimum wage in a perfectly
competitive labour market
(Textbook page 224)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
IMPERECT LABOUR MARKETS
LO: explain how a perfectly competitive labour market functions
LO: analyse various labour market imperfections
LO: discuss the desirability of minimum wages
A Minimum wage in a
monopsonistic labour market
Figure 12-12 The impact of the imposition of a
minimum wage in a monopsonistic labour
market (Textbook page 224)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
IMPERECT LABOUR MARKETS
LO: explain how a perfectly competitive labour market functions
LO: analyse various labour market imperfections
Labour immobility and imperfect information
• Geographical immobility
• Occupational immobility
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: explain how a perfectly competitive labour market functions
LO: explain why wages differ
12.5 WAGE DIFFERENTIALS
See Box 12-3 Other sources of inequality (Textbook page 226)
•
•
•
•
•
•
•
•
•
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Job-related differences
Compensating wage differential
Worker-related differences
Investment in human capital
Differences related to market structure
Differences as a result of discrimination
Discrimination
Differences in productivity
Productivity
ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
FACTOR MARKETS
Most important = labour
market
Other:
• Land
• Capital and interest
• Entrepreneurship and profit
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
IMPORTANT CONCEPTS
•
•
•
•
•
•
•
•
•
•
•
•
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Wage rate
Earnings
Nominal wage
Real wage
Supply of labour
Backward-bending supply curve
Demand for labour
Derived demand
Marginal physical product
Marginal revenue product
Marginal cost of labour
Trade union
•
•
•
•
•
•
•
•
•
•
•
ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
Monopsony
Collective bargaining
Bilateral monopoly
Flexible labour market
Minimum wages
Mobility of labour
Wage differentials
Compensating wage differential
Investment in human capital
Discrimination
Productivity