The Labour Market

The Labour Market: Wage Determination & Trade Unions

The labour market determines wages and employment levels. Unlike product markets, the labour market involves the derived demand for workers and the supply of labour by individuals.

Demand for Labour

The demand for labour is a derived demand — firms hire workers not for their own sake but because of the demand for the goods/services they produce.

Marginal Revenue Product (MRP) Theory

The MRP of a worker is the additional revenue generated by employing one more worker:

MRP = MPP × MR

Where:

• MPP (Marginal Physical Product) = additional output from one more worker
• MR (Marginal Revenue) = additional revenue from selling one more unit

A profit-maximising firm employs workers up to the point where MRP = wage (MC of labour).

• If MRP > wage: firm should hire more workers (additional revenue exceeds cost)
• If MRP < wage: firm should reduce workforce (cost exceeds additional revenue)
• The MRP curve is the firm's demand curve for labour

Shifts in Labour Demand

• Changes in demand for the final product (higher demand → higher MRP)
• Changes in productivity (training, technology → higher MPP → higher MRP)
• Changes in the price of capital (substitute or complement to labour)
• Changes in wage rates of other workers

Elasticity of Demand for Labour

Factors making demand more elastic:

• Labour is a large proportion of total costs
• The final product has elastic demand
• Labour is easily substitutable with capital
• Longer time period (firms can adjust production methods)

Marshall's Rules of Derived Demand formalise these factors.

Supply of Labour

Individual Labour Supply

The backward-bending supply curve for an individual worker:

• At low wages: substitution effect dominates — higher wages make leisure more expensive relative to work → worker supplies more hours
• At high wages: income effect dominates — worker is wealthy enough to "buy" more leisure → hours supplied decrease

Industry/Occupation Labour Supply

Factors affecting supply to a particular occupation:

• Wage rate offered (movement along the curve)
• Qualifications and training required (barriers to entry)
• Non-monetary benefits (job satisfaction, flexibility, prestige)
• Net migration and labour mobility
• Population size and participation rates
• Transfer earnings (wages in the next best alternative occupation)

Elasticity of Labour Supply

More elastic when:

• Skills are non-specialised (easy to switch occupations)
• Short training period required
• High unemployment (large pool of available workers)
• Longer time period (workers can retrain)

Wage Determination in Competitive Labour Markets

In a perfectly competitive labour market:

• Many employers, many workers
• Homogeneous labour
• Perfect information
• Free entry and exit
• Workers and firms are wage takers

The equilibrium wage is determined where the industry supply of labour equals the industry demand for labour (aggregate MRP).

Wage Differentials

Wages differ between occupations due to:

• Compensating differentials: dangerous or unpleasant jobs pay more (oil rigs, night shifts)
• Human capital: education, training, experience increase productivity and MRP
• Barriers to entry: professional qualifications (medicine, law) restrict supply
• Discrimination: gender pay gap, ethnic pay gap (Becker's taste for discrimination)
• Trade union power: unions may negotiate wages above equilibrium
• Geographical differences: cost of living (London weighting)
• Monopsony power: single employer can suppress wages

Monopsony in the Labour Market

A monopsony is a market with a single buyer of labour (or one dominant employer).

Characteristics

• The firm faces the entire market supply curve for labour (upward-sloping)
• To hire an extra worker, it must raise the wage for all workers
• Therefore MC of labour > Average Cost of labour (= wage)
• The MC of labour curve is steeper than the supply (AC) curve

Monopsony Equilibrium

• The monopsonist hires where MRP = MC of labour
• But pays a wage below MRP (reads wage from the supply curve)
• This results in fewer workers employed at a lower wage than in a competitive market
• Workers are exploited: paid less than their MRP

Real-World Examples

• NHS as a dominant employer of nurses
• Supermarkets in small towns
• Professional sports leagues (historically, before free agency)
• Amazon in warehouse labour markets

Trade Unions

A trade union is an organisation of workers that collectively bargains with employers over pay and conditions.

Types of Union Action

• Collective bargaining: negotiating wages, hours, pensions, safety
• Industrial action: strikes, work-to-rule, overtime bans
• Political lobbying: influencing government policy (minimum wage, workers' rights)

Economic Effects of Trade Unions

In a competitive labour market:

• Unions push wages above the equilibrium
• This creates excess supply of labour (unemployment)
• Higher wages for members come at the cost of fewer jobs
• Classical/neoclassical view: unions create labour market inflexibility

In a monopsony:

• A union can act as a countervailing power (Galbraith)
• Bilateral monopoly: union (monopoly seller of labour) vs monopsony buyer
• The union may be able to raise wages without reducing employment (or even increasing it)
• Outcome depends on the relative bargaining power of each side

Evaluation of Trade Unions

Arguments FOR:

• Correct monopsony exploitation (push wages towards MRP)
• Improve working conditions and safety
• Reduce income inequality
• Give workers a collective voice (Freeman & Medoff, 1984) — may reduce staff turnover and increase productivity
• Ensure fair distribution of profits between capital and labour

Arguments AGAINST:

• May cause wage-push inflation if wages rise above productivity
• Create insider-outsider problem (protect members at expense of non-members/unemployed)
• Reduce labour market flexibility (harder to adjust workforce)
• May resist technological change (Luddite behaviour)
• Can lead to industrial disputes that damage output and consumer welfare

The National Minimum Wage (NMW) / National Living Wage (NLW)

The UK introduced the NMW in 1999, replaced for workers aged 23+ by the NLW.

Arguments FOR:

• Reduces exploitation (especially in monopsonistic markets)
• Reduces in-work poverty and inequality
• Increases incentive to work (reduces the replacement ratio)
• May increase productivity (efficiency wage theory — Yellen)

Arguments AGAINST:

• If set above equilibrium in competitive markets, causes unemployment (classical view)
• May lead to cost-push inflation if firms pass on higher costs
• Could encourage substitution of labour with capital (automation)
• Small firms disproportionately affected

Empirical evidence: Card & Krueger (1994) found no significant employment effects from minimum wage increases in US fast-food — consistent with monopsony model. UK evidence from the Low Pay Commission also suggests limited negative employment effects.

Exam Technique

• Draw two diagrams: competitive labour market (standard S/D) and monopsony (MC of labour above supply, MRP = MC intersection, wage read from supply)
• Use MRP theory to explain wage determination, then evaluate its limitations (assumes measurable productivity, ignores discrimination, institutional factors)
• Apply bilateral monopoly to discuss union-monopsony interaction
• Use the NMW/NLW debate to show the contrast between competitive and monopsony models
• Real-world examples are essential — NHS, Amazon, Premier League