All Economics Terms A-Z

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Economics Terms A-Z

Labour market


In a labour market, employees sell their labour (the item in the market) to employers for a wage (the price at which labour is exchanged in the market). Insofar as labour is a factor of production, a labour market is classified as a factor market. As with the market for any normal good or service, demand for labour tends to increase as the wage (price of labour) falls, while the supply of labour tends to increase as the wage rises and it becomes more attractive for people to work. However, beyond a certain hourly wage level the labour supply will reduce as employees become satisfied with their total income and begin to substitute leisure for work time. In this case the labour supply curve is “backward-bending”.

The graph shows a typical labour market with downward-sloping employer demand for labour D and upward-sloping employee supply of labour S. The market is in equilibrium at an hourly wage of w* for h* hours of labour per week. The supply of labour is backward-bending beyond a wage level of w'. That is, if demand for labour 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 labour), employees in the market would not supply hours of labour beyond h' per week: they would prefer to have more leisure time instead. The labour market would then be said to be “tight” and/or a “sellers’ market”. Employees sell their labour to employers; the employees would have more power than employers in such a situation.
Labour Market
Labour markets can be studied at different levels of the economy. 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 and occupation. In some sectors, free bargaining over wages takes place between employers and employees, while in most industries in developed economies, trade unions exist and function to negotiate wages with employers on behalf of employees. In the public sector, wages may be subject to strict regulation such that its labour market is not really in free-market equilibrium.  Furthermore, governments often set minimum wages for the economy as a whole (see the article on ceteris paribus for an example of how this can affect employment in an economy).

Labour markets differ from the markets for other items in that the labour being exchanged is inherently human; labour is not a simple commodity. Indeed, the conceptualisation 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 labour 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 labour supply and demand in more complex labour markets: people’s valuation of a job in excess of the visible wage can be estimated by observing their working behaviour over time. Labour 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 labour 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 Labour Economics. For the more theoretically-minded reader, Chung-cheng Lin provides a plausible alternative explanation for backward-bending labour 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. While the pros and cons of such set-ups 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 labour 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.