Labour market

Tasks of physical and mental labour. The macroeconomics of labour markets. Types of unemployment. Definition, value and consumption of labour power. Association of workers in a particular trade, industry, or plant. The use of collective bargaining.

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1. Labour is a human effort - physical and mental - which is directed to the production of goods and services. But labour is not only a factor of production; it is also the reason why economic activity takes place. The people who take part in production are also consumers, the sum of whose individual demands provides the business person with the incentive to undertake production. For this reason when we are considering real-world economic problems it is necessary to treat labour somewhat differently from the other factors. There are social and political problems which have to be taken into account. For example, the question of how many hours per day a mashine should be operated will be judged solely in terms of efficiency, output, and costs. The same question applied to labour would raise additional considerations of individual freedom and human rights.

It must be borne in mind that is the services of labour which are bought and sold, and not labour itself. The firm cannot buy and own labour in the same way that capital and land can be bought and owned.

Study of how workers are allocated among jobs, how their rates of pay are determined, and how their efficiency is affected by various factors. The labour force of a country includes all those who work for gain in any capacity as well as those who are unemployed but seeking work. Many factors influence how workers are utilized and how much they are paid, including qualities of the labour force itself (such as health, level of education, distribution of special training and skills, and degree of mobility), structural characteristics of the economy (e.g., proportions of heavy manufacturing, technology, and service industries), and institutional factors (including the extent and power of labour unions and employers' associations and the presence of minimum-wage laws). Miscellaneous factors such as custom and variations in the business cycle are also considered. Certain general trends are widely accepted by labour economists; for instance, wage levels tend to be higher in jobs that involve high risk, in industries that require higher levels of education or training, in economies that have high proportions of such industries, and in industries that are heavily unionized.

An area of economic exchange in which workers seek jobs and employers seek workers. A “tight” labor market has more jobs than workers. In a “slack” labor market, the reverse is true.

The noun labor market has one meaning:

Meaning #1: the market in which workers compete for jobs and employers compete for workers

Construction workers generally work long hours for their pay

2. Labour economics seeks to understand the functioning of the market for labour.

Labour markets function through the interaction of workers and employers. Labour economics looks at the suppliers of labour services (workers), the demanders of labour services (employers), and attempts to understand the resulting pattern of wages, employment, and income.

It is an important subject because unemployment is a problem that affects the public most directly and severely. Full employment (or reduced unemployment) is a goal of many modern governments.

3. Two ways of analyzing labour markets. There are two sides to labour economics. Labour economics can generally be seen as the application of microeconomic or macroeconomic techniques to the labour market. Microeconomic techniques study the role of individuals in the labour market. Macroeconomic techniques look at the interrelations between the labour market, the goods market, the money market, and the foreign trade market. It looks at how these interactions influence macro variables such as employment levels, participation rates, aggregate income and Gross Domestic Product

The macroeconomics of labour markets

The labour force is defined as the number of people employed plus the number unemployed but seeking work. The participation rate is the number of people in the labour force divided by the size of the adult population (or by the population of working age). The unemployment level is defined as the labour force minus the number of people currently employed. The unemployment rate is defined as the level of unemployment divided by the labour force. The employment rate is defined as the number of people currently employed divided by the adult population (or by the population of working age). In these statistics, self-employed people are counted as employed.

Variables like employment level, unemployment level, labour force, and unfilled vacancies are called stock variables because they measure a quantity at a point in time. They can be contrasted with flow variables which measure a quantity over duration of time. Changes in the labour force are due to flow variables such as natural population growth, net immigration, new entrants, and retirements from the labour force. Changes in unemployment depend on: inflows made up of non-employed people starting to look for jobs and of employed people who lose their jobs and look for new ones; and outflows of people who find new employment and of people who stop looking for employment.

When looking at the overall macro economy, several types of unemployment have been identified, including:

· Frictional unemployment -- This reflects the fact that it takes time for people to find and settle into new jobs. If 12 individuals each take one month before they start a new job, the aggregate unemployment statistics will record this as a single unemployed worker. Technological change often reduces frictional unemployment, for example: the internet made job searches cheaper and more comprehensive.

· Structural unemployment -- This reflects a mismatch between the skills and other attributes of the labour force and those demanded by employers. If 4 workers each take six months off to re-train before they start a new job, the aggregate unemployment statistics will record this as two unemployed workers. Technological change often increases structural unemployment, for example: technological change might require workers to re-train.

· Natural rate of unemployment -- This is the summation of frictional and structural unemployment. It is the lowest rate of unemployment that a stable economy can expect to achieve, seeing as some frictional and structural unemployment is inevitable. Economists do not agree on the natural rate, with estimates ranging from 1% to 5%, or on its meaning -- some associate it with "non-accelerating inflation". The estimated rate varies from country to country and from time to time.

· Demand deficient unemployment -- In Keynesian economics, any level of unemployment beyond the natural rate is most likely due to insufficient demand in the overall economy. During a recession, aggregate expenditure is deficient causing the underutilization of inputs (including labour). Aggregate expenditure (AE) can be increased, according to Keynes, by increasing consumption spending (C), increasing investment spending (I), increasing government spending (G), or increasing the net of exports minus imports (X?M).

{AE = C + I + G + (X?M)}

The classical microeconomics of labour markets

Economists see the labour market as similar to any other market in that the forces of supply and demand jointly determine price (in this case the wage rate) and quantity (in this case the number of people employed).

However, the labour market differs from other markets (like the markets for goods or the money market) in several ways. Perhaps 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 there is a tendency in the long run for more goods to be produced until the demand is satisfied. With labour, overall supply cannot effectively be manufactured 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 more supply of labour: it may result in less supply of labour as workers take more time off to spend their increased wages, or it may result in no change in supply. Within the overall labour market, particular segments are thought to be subject to more normal rules of supply and demand as workers are likely to change job types in response to differing wage rates.

Many economists have thought that, in the absence of laws or organizations such as unions or large multinational corporations, labour markets can be close to perfectly competitive in the economic sense -- that is, there are many workers and employers both having perfect information about each other and there are no transaction costs. The competitive assumption leads to clear conclusions -- workers earn their marginal product of labour.

Other economists focus on deviations from perfectly competitive labour markets. These include job search, training and gaining-of-experience costs to switch between job types, efficiency wage models and oligopsony / monopsonistic competition.

Types of Unemployment

· Cyclical (Demand deficient Unemployment) unemployment: When there is not enough aggregate demand for the labor.

· Frictional: When moving from one job to another, the unemployment temporarily experienced when looking for a new job.

· Structural: Experienced when the structure of an industry or skill demands changes in mainly:

o switching from a declining industry to a rapidly growing one.

o Pace of change in the tastes of people.

o Regional Structure of industry.

· Technological: Caused by the replacement of workers by machines or other advanced technology.

· Classical (Real-wage): When real wage for a job are set above the market-clearing level, commonly government (as with the minimum wage) or unions, although some (such as Murray Rothbard, America's Great Depression p. 45) suggest that even social taboos can prevent wages from falling to the market clearing level.

· Marxian: when unemployment is needed to motivate workers to work hard and to keep wages down, to preserve profitability.

· Seasonal: When an industry only is in demand certain times. For example, ski slopes, agriculture, Shopping Mall Santas.

Cardinal and ordinal utility

Economists distinguish between cardinal utility and ordinal utility. When cardinal utility is used, the magnitude of utility differences is a meaningful quantity. On the other hand, ordinal utility captures only ranking and not strength of preferences.

Utility functions of both sorts assign real numbers (utils) to members of a choice set. For example, suppose a cup of coffee has utility of 120 utils, a cup of tea has a utility of 80 utils, and a cup of water has a utility of 40 utils. When speaking of cardinal utility, it could be concluded that the cup of coffee is exactly the same amount better as a cup of tea as the cup of tea is better than the cup of water.

It is tempting when dealing with cardinal utility to aggregate utilities across persons. This should be avoided: interpersonal comparisons of utility are suspect because there is no good way to interpret how different people value consumption bundles.

When ordinal utilities are used, differences in utils are not meaningful. The utility values assigned encode an full ordering between members of a choice set, but nothing about strength of preferences. In the above example, it would only be possible to say that coffee is preferred to tea to water, but no more.

Neoclassical economics has largely retreated from using utility functions as the basic objects of economic analysis, in favour of considering agent preferences over choice sets. As will be seen in subsequent sections, however, preference relations can often be rationalized as utility functions satisfying a variety of useful properties.

Utility functions are not unique. Ordinal utility functions are equivalent up to monotone transformations, while cardinal utilities are equivalent up to positive linear transformations.

Labour power

Labor power (in German: Arbeitskraft, or labor force) is a crucial concept used by Karl Marx in his critique of political economy. He regarded labour power as the most important of the productive forces.

However, he argues in capitalism the "productive powers of labour" appear as the creative power of capital. Work becomes just work, workers become an abstract labour force, and the control over work becomes mainly a management prerogative. Unsurprisingly in that case, labor economics survives only as a minor branch of economic science.


Marx introduces the concept in chapter 6 of the first volume of Das Kapital, as follows:

"By labour-power or capacity for labour is to be understood the aggregate of those mental and physical capabilities existing in a human being, which he exercises whenever he produces a use-value of any description." [1]

He adds furtheron that:

"Labour-power, however, becomes a reality only by its exercise; it sets itself in action only by working. But thereby a definite quantity of human muscle, nerve. brain, &c., is wasted, and these require to be restored." [2]

A much shorter, to-the-point explanation of labor-power can be found in the introduction and second chapter of Marx's Wage Labour and Capital: [3]

Labor-power versus labour

According to Marx, there is a clear distinction between labor and labor-power'. "Labor" refers to the actual activity or effort of producing goods or services (or what Marx calls use-values). Neoclassical economists sometimes refer to this as "labor services." On the other hand, "labor-power" (or "laboring power") refers to a person's ability to work, his or her muscle-power, dexterity and brain-power. Marx took over this distinction from Hegels' Philosophy of Right and gave it a new significance.

In some ways, this concept is similar to that of "human capital." However most likely Marx himself would have considered the concept of human capital a reification, the purpose of which was to convince the worker that he was really a capitalist.

Labor power as commodity

Under capitalism, according to Marx, labor-power becomes a commodity - it is sold and bought on the market. A worker tries to sell his or her labor-power to an employer, in exchange for a wage or salary. If successful (the only alternative being unemployment), this exchange involves submitting to the authority of the capitalist for a specific period of time.

During that time, the worker does actual labor, producing goods and services. The capitalist can then sell these and realize a profit - what Marx called surplus value - since the wages paid to the workers are lower than the value of the goods or services they produce for the capitalist.

Value of labour-power

Labour power is a peculiar commodity, because it is an attribute of living persons, who own it themselves. Because they own it, they cannot permanently sell it to someone else; in that case, they would be a slave, and a slave does not own himself.

Labour power can become a marketable object, sold for a specific period, only if the owners are constituted in law as legal subjects who are free to sell it, and can enter into labor contracts. Once actualised and consumed through working, the capacity to work is exhausted, and must be replenished and restored.

In general, Marx argues that the value of labor power is equal to its normal or average reproduction cost, i.e. the established human needs which must be satisfied in order for the worker to turn up for work each day, fit to work. This involves goods and services representing a quantity of labor equal to necessary labour or the necessary product.

Included is both a physical component (the minimum physical requirements for a healthy worker) and a moral-historical component (the satisfaction of needs beyond the physical minimum which have become an established part of the lifestyle of the average worker). The value of labor power is thus an historical norm, which is the outcome of a combination of factors: productivity; the assertion of human needs; the costs of acquiring skills; state laws stipulating minimum or maximum wages, etc.

Buying labour power usually becomes a commercially interesting proposition only if it can yield more value than it costs to buy, i.e. employing it yields a net positive return on capital invested. However, in Marx's theory, the value-creating function of labour power is not its only function; it also importantly conserves and transfers capital value.

Consumption of labor power

When labor power has been purchased and an employment contract signed, normally it is not yet paid for. First, labor power must be put to work in the production process. The employment contract is only a condition for uniting labor power with the means of production. From that point on, Marx argues, labour power at work is transformed into capital, specifically variable capital which accomplishes the valorisation process.

Functioning as variable capital, living labour creates both use values and new value, conserves the value of constant capital assets, and transfers part of the value of materials and equipment used to the new products. The result aimed for is the valorisation of invested capital, i.e. other things being equal, the value of capital has increased through the activity of living labour.

At the end of the working day, labour power has been more or less consumed, and must be restored through rest, eating & drinking, and recreation.

· Note : medical estimates of the average holiday time necessary for workers to fully recuperate in a physiological and psychological sense from work stress during the year differ from country to country; but as an approximate gauge, three weeks continuous holiday is physiologically optimal for the average worker. ILO statistics show a wide range of average hours worked and average holidays for different countries; for example, Korean workers work far more hours per year, and Americans have fewer formal holidays than West Europeans. Several researchers have questioned however to what extent additional hours worked really increase the marginal productivity of labour; particularly in services, the work that gets done in five days could often also be done in four. The most difficult aspect to measure is the intensity of work, though some argue the incidence of work accidents are a reliable yardstick.

Labour union

Association of workers in a particular trade, industry, or plant, formed to obtain improvements in pay, benefits, and working conditions through collective action. The first fraternal and self-help associations of labourers appeared in Britain in the 18th century, and the era of modern labour unions began in Britain, Europe, and the U.S. in the 19th century. The movement met with hostility from employers and governments, and union organizers were regularly prosecuted. British unionism received its legal foundation in the Trade-Union Act of 1871. In the U.S. the same effect was achieved more slowly through a series of court decisions that whittled away at the use of injunctions and conspiracy laws against unions. The founding of the American Federation of Labor (AFL) in 1886 marked the beginning of a successful, large-scale labour movement in the U.S. The unions brought together in the AFL were craft unions, which represented workers skilled in a particular craft or trade. Only a few early labour organizers argued in favour of industrial unions, which would represent all workers, skilled or unskilled, in a single industry. The Congress of Industrial Organizations (CIO) was founded by unions expelled from the AFL for attempting to organize unskilled workers, and by 1941 it had assured the success of industrial unionism by organizing the steel and automotive industries (see AFL-CIO). The use of collective bargaining to settle wages, working conditions, and disputes is standard in all noncommunist industrial countries, though union organization varies from country to country. In Britain, labour unions displayed a strong inclination to political activity that culminated in the formation of the Labour Party in 1906. In France, too, the major unions became highly politicized; the Confйdйration Gйnйrale du Travail (formed in 1895) was allied with the Communist Party for many years, while the Confйdйration Franзaise Dйmocratique du Travail is more moderate politically. Japan developed a form of union organization known as enterprise unionism, which represents workers in a single plant or multiplant enterprise rather than within a craft or industry.

Labor power and wages

Marx regards money-wages and salaries as the price of labour power (though workers can also be paid "in kind"). That price may contingently be higher or lower than the value of labour power, depending on market forces of supply and demand, on skill monopolies, legal rules, etc. Normally, unless government action prevents it, high unemployment will lower wages, and full employment will raise wages, in accordance with the laws of supply and demand. But wages can also be reduced through high price inflation and consumer taxes. Therefore a distinction must always be drawn between nominal gross wages' and real wages adjusted for tax and price inflation. The labour-costs of an employer are not the same as the real buying power a worker acquires through working.

There is typically a constant conflict over the level of wages between employers and employees, since employers seek to limit or reduce wage-costs, while workers seek to increase their wages, or at least maintain them. How the level of wages develops depends on the demand for labor, the level of unemployment, and the ability of workers and employers to organise and take action with regard to pay claims.

Marx regarded wages as the "external form" of the value of labour power. The compensation of workers in capitalist society could take all kinds of different forms, but there was always both a paid and unpaid component of labour performed. The "ideal" form of wages for capitalism, he argued, were piece wages because in that case the capitalist paid only for labour which directly created those outputs adding value to his capital. It was the most efficient form of exploitation of labour power.

Neoclassical microeconomic model -- Supply

Households are suppliers of labour. In microeconomics theory, people are assumed rational and seeking to maximize their utility function. In this labour market model, their utility function is determined by the choice between income and leisure. However, they are constrained by the waking hours available to them.

Let w denote hourly wage.

Let k denote total waking hours.

Let L denote working hours.

Let р denote other incomes or benefits.

Let A denote leisure hours.

The utility function and budget constraint can be expressed as following:

max U(w L + р, A) such that L + A ? k.

This can be shown in a diagram (below) that illustrates the trade-off between allocating your time between leisure activities and income generating activities. The linear constraint line indicates that there are only 24 hours in a day, and individuals must choose how much of this time to allocate to leisure activities and how much to working. (If multiple days are being considered the maximum number of hours that could be allocated towards leisure or work is about 16 -- Everyone has to sleep eventually!) This allocation decision is informed by the curved indifference curve labelled IC. The curve indicates the combinations of leisure and work that will give the individual a specific level of utility. The point where the highest indifference curve is just tangent to the constraint line (point A), illustrates the short-run equilibrium for this supplier of labour services.

The Income/Leisure trade-off in the short run

If the preference for consumption is measured by the value of income obtained, rather than work hours, this diagram can be used to show a variety of interesting effects. This is because the slope of the budget constraint becomes the wage rate. The point of optimization (point A) reflects the equivalency between the wage rate and the marginal rate of substitution, leisure for income (the slope of the indifference curve). Because the marginal rate of substitution, leisure for income, is also the ratio of the marginal utility of leisure (MUL) to the marginal utility of income (MUY), one can conclude:

Effects of a wage increase

If wages increase, this individual's constraint line pivots up from X,Y1 to X,Y2. He/she can now purchase more goods and services. His/her utility will increase from point A on IC1 to point B on IC2. To understand what effect this might have on the decision of how many hours to work, you must look at the income effect and substitution effect.

The wage increase shown in the previous diagram can be decompiled into two separate effects. The pure income effect is shown as the movement from point A to point C in the next diagram. Consumption increases from YA to YC and -- assuming leisure is a normal good -- leisure time increases from XA to XC (employment time decreases by the same amount; XA to XC).

The Income and Substitution effects of a wage increase

But that is only part of the picture. As the wage rate rises, the worker will substitute work hours for leisure hours, that is, will work more hours to take advantage of the higher wage rate, or in other words substitute away from leisure because of its higher opportunity cost. This substitution effect is represented by the shift from point C to point B. The net impact of these two effects is shown by the shift from point A to point B. The relative magnitude of the two effects depends on the circumstances. In some cases the substitution effect is greater than the income effect (in which case more time will be allocated to working), but in other cases the income effect will be greater than the substitution effect (in which case less time is allocated to working). The intuition behind this latter case is that the worker has reached the point where his marginal utility of leisure outweighs his marginal utility of income. To put it in less formal (and less accurate) terms: there is no point in earning more money if you don't have the time to spend it.

The Labour Supply curve

If the substitution effect is greater than the income effect, the supply of labour curve (diagram to the left) will slope upwards to the right, as it does at point E for example. This individual will continue to increase his supply of labour services as the wage rate increases up to point F where he is working HF hours (each period of time). Beyond this point he will start to reduce the amount of labour hours he supplies (for example at point G he has reduced his work hours to HG). Where the supply curve is sloping upwards to the right (positive wage elasticity of labour supply), the substitution effect is greater than the income effect. Where it slopes upwards to the left (negative elasticity), the income effect is greater than the substitution effect. The direction of slope may change more than once for some individuals, and the labour supply curve is likely to be different for different individuals.

Other variables that affect this decision include taxation, welfare, and work environment.

A wage is a compensation which workers receive in exchange for their labor.

Labor and finance fields

In labor and finance settings a wage may be defined more narrowly to include only cash paid for some specified quantity (measured in units of time) of labor. Wages may be contrasted with salaries, with wages being paid at a wage rate (based on units of time worked) while salaries are paid periodically without reference to a specified number of hours worked. Once a job description has been established, wages are often a focus when negotiating an employment contract between employer and employee.

In economics

Economists define wages more broadly than just cash compensation and include any return to labor, such as goods workers might create for themselves, returns in kind (such as sharecroppers receive), or even the enjoyment that some derive from work. For economists, even in a world without others, an individual would still acquire wages from labor: food hunted or gathered would be considered wages and any returns resulting from an investment in tools (such as an axe or a hoe) would be deemed Profits (a return to real capita).

Determinants of wage rates

Depending on the structure and traditions of different economies around the world, wage rates are either the product of market forces (Supply and Demand), as is common in the United States, or wage rates may be influenced by other factors such as tradition, social structure and seniority, as in Japan.

Several countries have enacted a statutory minimum wage rate that fixes the price of certain kinds of labor.

Productive forces, "productive powers" or "forces of production" [in German, Produktivkrдfte] is a central concept in Marxism and historical materialism.

In Karl Marx and Frederick Engels's own critique of political economy, it refers to the combination of the means of labor (tools, machinery, infrastructure and so on) with human labour power. Although this is little known, Marx and Engels in fact derived the concept from Adam Smith's reference to the "productive powers of labour" (see e.g. chapter 8 of The Wealth of Nations).

All those forces which are applied by people in the production process (body & brain, tools & techniques, materials, resources and equipment) are encompassed by this concept, including those management and engineering functions technically indispensable for production (as contrasted with social control functions). Human knowledge can also be a productive force.

Together with the social and technical relations of production, the productive forces constitute an historically specific mode of production.

Productive forces and labour

Karl Marx emphasized that, with few exceptions, means of labor are not a productive force unless they are actually operated, maintained and conserved by living human labour. Without applying living human labour, their physical condition and value would deteriorate, depreciate, or be destroyed (an example would be a ghost town or capital depreciation due to strike action).

Capital itself, being one of the factors of production, comes to be viewed in capitalist society as a productive force in its own right, independent from labour, a subject with "a life of its own". Indeed, Marx sees the essence of what he calls "the capital relation" as being summarised by the circumstance that "capital buys labour", i.e. the power of property ownership to command human energy and labour-time, and thus of inanimate "things" to exert an autonomous power over people. What disappears from view is that the power of capital depends in the last instance on human cooperation.

The productive power of cooperation comes to be viewed as the productive power of capital, because it is capital which forcibly organises people, rather than people organising capital. Marx regarded this as a supreme reification.

Defining the labour supply

The labour supply refers to the total number of hours that labour is willing and able to supply at a given wage rate. It can also be defined as the number of workers willing and able to work in a given occupation or industry for a given wage.

Elasticity of labour supply to an occupation

The elasticity of labour supply measures the extent to which labour supply responds to a change in the wage rate in a given time period. In low-skilled occupations we expect the labour supply to be elastic. This means that a pool of readily available labour is employable at a fairly low market wage rate.

Where jobs require specific skills and lengthy periods of training, the labour supply will be more inelastic. It is hard to expand the workforce in a short period of time.

In many professional occupations there are barriers to the entry of new workers. examples include Law, Accountancy and Medicine. The need for high level educational qualifications makes the supply of newly qualified entrants to these occupations quite inelastic in the short run and is one reason why these workers may earn higher than average salaries.

The labour supply for the whole economy

The whole economy labour supply measures the total number of people able available and willing to participate in paid employment. This comprises the employed labour force plus those registered as unemployed and actively looking for new work.

In the summer and early Autumn of 2000, the number of people in employment in the Uk reached 28 million for the first time. 1.6 million people were classified as unemployed using the Labour Force Survey and over 17 million people of working age were counted as economically inactive. Labour's economic reforms are seeking to encourage more people back into work from the economically inactive - to boost the available labour supply in the economy as a whole.

The table below shows the labour supply for the United Kingdom



All aged 16 and over

Work-age 16-59/64

In employment



ILO unemployed



Economically active



Economically inactive



The total supply of labour available to produce goods and services is a key factor determining how much output an economy can generate. The government wants to expand the UK's active labour supply through its flagship Welfare to Work policies and also increase the productivity of the work-force to improve international competitiveness. Both objectives are long-term aims.

Supply of Labour to Market

How many people are willing and able to work in different industries and occupations? This question refers to the supply of labour. The labour supply curve. The labour supply curve for any industry or occupation will be upward sloping. This is because, as wages rise, other workers enter this industry attracted by the incentive of higher rewards. They may have moved from other industries or they may not have previously held a job, such as housewives or the unemployed. The extent to which a rise in the prevailing wage or salary in an occupation leads to an expansion in the supply of labour depends on the elasticity of labour supply.

Key factors affecting labour supply

The supply of labour to a particular occupation is influenced by a range of monetary and non-monetary considerations.

The real wage rate on offer in the industry itself - higher wages raise the prospect of increased factor rewards and should boost the number of people willing and able to work

Overtime: Opportunities to boost earnings come through overtime payments, productivity-related pay schemes, and share option schemes and financial discounts for employees in a certain job.

Substitute occupations: The real wage rate on offer in competing jobs is another factor because this affects the wage and earnings differential that exists between two or more occupations. So for example an increase in the relative earnings available to trained plumbers and electricians may cause some people to switch their jobs. In recent times, the British media has been fond of stories of people leaving jobs in academia (including high level university research) and moving in household services because the basic rates of pay and potential earnings are so much greater.

Barriers to entry: Artificial limits to an industry's labour supply (e.g. through the introduction of minimum entry requirements or other legal barriers to entry) can restrict labour supply and force average pay and salary levels higher - this is particularly the case in professions such as legal services and medicine where there are strict “entry criteria” to the professions. Indeed these labour market barriers are partly designed to keep pay levels high as well as being methods of maintaining the quality of people entering these professions

The length of time it takes to qualify as an architect restricts the labour supply and keeps salaries highImprovements in the occupational mobility of labour: For example if more people are trained with the necessary skills required to work in a particular occupation

Non-monetary characteristics of specific jobs - these can be important - they include factors such as the level of risk associated with different jobs, the requirement to work anti-social hours or the non-pecuniary benefits that certain jobs provide including job security, opportunities for promotion and the chance to live and work overseas, employer-provided in-work training, employer-provided or subsidised health and leisure facilities and other in-work benefits including occupational pension schemes

Net migration of labour - the UK is a member of the European Union single market that enshrines free movement of labour as one of its guiding principles. A rising flow of people seeking work in the UK is making labour migration an important factor in determining the supply of labour available to many industries - be it to relieve shortages of skilled labour in the NHS or education, or to meet the seasonal demand for workers in agriculture and the construction industry

Compensating wage (pay) differentials

Wage differentials in part act as a compensation for people who have to work unsocial hours or who are exposed to different degrees of risk at work, both in the short term and long run. Some jobs require a wage-rate that encompasses this risk premium - so workers in the North Sea Oil industry expect a higher return to adjust for the inherent dangers of their work.

Elasticity of labour supply

The elasticity of labour supply to an occupation measures the extent to which labour supply responds to a change in the wage rate in a given time period. In low-skilled occupations we expect labour supply to be elastic. This means that a pool of readily available labour is employable at a fairly low market wage rate. Where jobs require specific skills and lengthy periods of training, the labour supply will be more inelastic. It is hard to expand the workforce in a short period of time when demand for workers has increased.

In many professions there are artificial barriers to the entry of workers. Examples include Law, Accountancy and Medicine. The need for high level educational qualifications makes the supply of newly qualified entrants to these occupations quite inelastic in the short run and is one reason why these workers may earn a higher real wage than average salaries.

The work-leisure trade off

Once somebody has entered the labour force how many hours will they choose to work?

For many people, the hours they work are fixed by their employers and they have little or no flexibility in the total number of hours they supply. But the majority of workers have an opportunity at some point to work additional hours, or perhaps switch from a full-time job to a part-time position, a. And the official data probably understates the true number of people who are “moonlighting” and working in a second or third job because of the rapid expansion of the shadow economy which had encouraged the expansion of a shadow labour force.

Often employers adjust the number of hours of work available to meet their employees' preferences. Over seven million people are now in part-time employment and much of this growth in part-time jobs has been sustained because it meets the preferences of people looking for greater flexibility in their working arrangements.

Economic theory would suggest that the real wage is a key determinant of the number of hours. The real wage is the money wage rate adjusted for changes in the price level and it measures the quantity of goods and services that can be bought from each hour worked. An increase in the real wage on offer in a job should lead to someone supplying more hours of work over a given period of time, although there is the possibility that further increases in the going wage rate might have little effect on an individual's labour supply. Indeed, there is the possibility of a backward-bending individual labour supply curve. This is illustrated in the next diagram.

Two distinct individual labour supply curves are shown. In the first curve, higher real wages do lead to an increase in the number of extra hours supplied, although the rate at which the individual is prepared to give up their leisure time and work longer hours diminishes as the real wage rises. But the labour supply curve meets the standard prediction that higher wages attract people to work longer hours. In the second curve, for most of the range of real wages, the same prediction holds true, but when as real wages step upwards, eventually an individual may choose to actually work fewer hours (ceteris paribus) giving us what is sometimes termed a “backward bending” labour supply curve.

Income and substitution effects

To understand why this might happen we consider the income and substitution effects that arise from a change in the real wage being paid to an individual worker. We start with the income effect.

The income effect: Higher real wages increase the income that someone can earn from a job, but they also mean that the time that must be spent at work to earn sufficient to pay for a particular product declines. Put briefly, higher pay levels mean that a target real wage can be achieved with fewer hours of labour supply. So this income effect might persuade people to work less hours and enjoy extended leisure time.

The substitution effect: The substitution effect of a higher wage rate should unambiguously give people an incentive to work extra hours because the financial rewards of working are raised, and the opportunity cost of not working (measured by the wages given up when people opt for leisure instead) has increased.

With the income and substitution effects working in opposite directions, there is no hard and fast prediction about whether people will choose to increase their labour supply as real wages increase. Are the income and substitution effects different for male compared to female workers? What about younger workers entering the labour market for the first time who are looking to save to finance a deposit on a house or to fund other major items of spending? How might people closer to retirement age respond to changes in real wages? What of workers in households where at least someone else is in paid employment compared to a household where there is only one main “breadwinner”?

The available empirical evidence for the UK labour market is mixed, indeed some analysts believe that in aggregate, the income and substitution effects effectively cancel each other out so that real wages have no impact on the individual labour supply!

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