Labour market forces and government intervention

Economics A2 · Government microeconomic intervention. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

The demand for labour is a derived demand: firms want workers only because consumers want the goods the workers make. A firm keeps hiring while an extra worker adds more to revenue than to cost, so its demand curve for labour is the marginal revenue product curve.

The supply of labour to an occupation depends on the wage and on non-wage factors such as working conditions, hours, training needed and job security. In a competitive market the wage is set where demand equals supply.

Real markets are imperfect. Trade unions and a minimum wage can push the wage above equilibrium. A monopsony, a single buyer of labour, pays a lower wage and employs fewer workers than a competitive market would.

Rules to remember

Marginal revenue product (MRP) = marginal product × marginal revenue. In a perfectly competitive product market, MRP = marginal product × price.
A firm hires workers up to the point where MRP = the marginal cost of labour (the wage, in a competitive labour market).
A change in the wage causes a movement along the demand curve. A change in productivity or product price shifts it.
A wage set above a competitive equilibrium raises the supply of labour and cuts the quantity demanded, giving unemployment.
Monopsony: hires where the marginal cost of labour = MRP and pays the wage on the supply curve at that employment. A minimum wage can raise both the wage and employment.
Transfer earnings: the minimum payment needed to keep a factor in its present use. Economic rent: any payment above transfer earnings.
The more inelastic the supply of labour, the larger the share of earnings that is economic rent.

Common mistake

Students take the wage as the cost of an extra worker for a monopsonist. To hire one more worker it must raise the wage for all workers, so the marginal cost of labour is above the wage.

Worked example

A monopsony employer has 5 workers and pays each $60 a day. To attract a sixth worker it must pay all workers $65 a day. The marginal revenue product of the sixth worker is $85. Should it hire the sixth worker?

Wage bill with 5 workers = 5 × 60 = $300.
Wage bill with 6 workers = 6 × 65 = $390.
Marginal cost of the sixth worker = 390 − 300 = $90, which is more than the wage of $65.
The marginal cost of labour ($90) is greater than the MRP ($85).

Answer: No. The sixth worker would add $90 to costs but only $85 to revenue, so the firm stays at 5 workers.

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