Economics Terms A-Z - The most important terms in economics.

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Economics Terms A-Z

Labor Market

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Employment is a major topic within macroeconomics, so much that labor economics is a massive field of research on its own. The market for employment, while unique, can be thought of just like the market for a physical good or service. So, what is the labor market?

In the labor market, employees sell their labor (the service being sold) to employers for a wage (the price at which employers can purchase the service we call labor).

Since labor is a very important factor of production, the labor market is classified as a factor market. As with the market for any normal good or service, demand for labor tends to increase as the wage (or, the price of labor) falls, while the supply of labor tends to increase as the wage rises and it becomes more attractive for people to work.

This is the same general relationship that can be observed in most product markets. However, the market for labor has a few unique characteristics that other markets don’t have. For example, as wages increase beyond a certain hourly wage level, the labor supply will start to decrease. This happens because when wages become high enough, employees become satisfied with their total income and begin to want more leisure rather than more income. 

This causes them to substitute work time for leisure. Due to this desire for work-life balance, the labor supply curve is “backward-bending”, unlike most product or service markets. In other words, an increasingly high wage will eventually incentivize people to work less, since they can afford to take a large amount of time off and still enjoy a high income.

Figure 1 shows a typical labor market with downward-sloping employer demand for labor D and upward-sloping employee supply of labor S. The market is in equilibrium at an hourly wage of w* for h* hours of labor per week. The supply of labor is backward-bending beyond a "high enough" wage level of w', where further increases in wages will only incentivize workers to take more time off. 

That is, if quantity demanded for labor in this market increased such that employers were willing to pay more than w' per hour (for example due to a surge in demand for a product that requires specialist skilled labor), employees in the market would not supply hours of labor beyond h' per week as they would prefer to have more leisure time instead. 

The labor market would then be said to be “tight” and/or a “sellers’ market”. Since employees sell their labor to employers, the employees would have more power than employers in this situation.

Figure 1: Labor supply as hours and wages increase

Labor Economics

Labor economics is the sub-field of economics that studies the labor market and the labor force. Labor markets, job markets, the movement of workers, labor force participation rates, and more can be studied at different levels of the economy. And, these can all be studied for different types of employment, from the perspective of different types of workers, by gender, by level of education, across borders, and much more. No wonder labor economics is one of the largest subfields of economics!

It is common to sort employment in an economy by region, industry, occupation and the educational qualifications of employees. In practice, the process by which wages are determined also varies according to industry, education level, and occupation – and sometimes, even by factors such as ethnicity or gender (even though determining wages based on these factors can constitute illegal discrimination in many cases). 

In some sectors, free bargaining over wages takes place between employers and employees. This bargaining is heavily affected by the relative market power that employers and laborers hold. In situations where employers have more power (i.e., labor supply exceeds demand), negotiations will be tilted in favor of the employers, and vice versa.

Another common type of wage determination involves trade unions, which negotiate wages with employers on behalf of employees. In these cases, individuals don’t negotiate for their wages; representatives for the employees do. Negotiating failures in these circumstances can often lead to widely-publicized strikes, where employees refuse to work until employers make concessions in wage negotiations.

Meanwhile, in the public sector, wages may be subject to strict regulation such that its labor market is not really in free-market equilibrium. Furthermore, governments often set minimum wages for the economy as a whole (which function as a price floor in the market for labor).

Labor markets differ from the markets for other items in that the labor being exchanged is inherently human; labor is not a simple commodity. Indeed, the conceptualization of the market for employment as hours worked in direct exchange for a wage is overly simplistic.

The notion that people only go to work for the money is misplaced. There are many other motivations for seeking employment such as the desire to make a contribution to society, as well as one’s personal and social esteem associated with a job. 

There are benefits to holding a job in addition to the direct monetary compensation, typically including access to health and other social insurance, accommodation during the working day and opportunities to access wider professional and social networks. The fact that people volunteer their labor for no wage at all in some sectors of the economy is evidence of these other motivations.

Nevertheless, the basic tools of microeconomics can still be used to quantify labor supply and demand in more complex labor markets: people’s valuation of a job in excess of the visible wage can be estimated by observing their working behavior over time. Labor Economics is a very rich and interesting area of study for economists precisely because of its more human aspects.

Further reading

The US Bureau of Labor Statistics offers a vast range of information and statistics on the American labor market on its website, and it is an excellent starting place to gain an overview of important and current topics for the sub-discipline of Labor Economics. For the more theoretically-minded reader, Chung-cheng Lin provides a plausible alternative explanation for backward-bending labor supply curves in his article, “A backward-bending labor supply curve without an income effect” (Oxford Economic Papers, 2003).

Good to know

In recent years, much has been made of the emergence of a “gig economy” in which firms hire workers on a short-term basis via contracts that offer little or no job security (just as musicians and other artists have traditionally been hired for gigs). People then no longer work as employees for an employer but rather as contractors paid by the hour or, more commonly, based on some specified output as gig workers (such as number of rides given for an Uber driver). 

While the pros and cons of such set-ups like gig work are certainly debatable, it is very possible that the future world of work will be more gig-like. In fact, when the labels of “employee” and “employer” are dropped for participants in the market, a gig economy comes closer to a "pure" labor market and it is thus easier for economists to study, understand and predict than employment markets that are regulated with high degrees of social protection for employees.

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