(Redirected from Labor market)
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.
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Labour force is defined as the sum of all people employed and all those unemployed but seeking work. The participation rate is the number of people in the labour force divided by the size of the adult population. 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 times 100.
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 a 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.
When looking at the overall macroeconomy, several types of unemployment have been identified, including:
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 organisations 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.
Let w denote hourly wage. Let k denote total waking hours. Let L denote working hours. Let π 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 + π, A) s.t. 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 labeled 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.
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:
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 leisure time increases from XA to XC (employment time decreases by the same amount; XA to XC).
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. 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 employment activities). The intuition behind this latter case is that the worker has reach 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.
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.
Other variables that affect this decision include taxation, welfare, and work environment.
This article has examined the labour supply curve which illustrates at every wage rate the maximum quantity of hours a worker will be willing to supply to the economy per period of time. Economists also need to know the maximum quantity of hours an employer will demand at every wage rate. To understand the quantity of hours demanded per period of time it is necessary to look at product production. That is, labour demand is a derived demand: it is derived from the output levels in the goods market.
A firm's labour demand is based on its marginal physical product of labour (MPP). This is defined as the additional output (or physical product) that results from an increase of one unit of labour (or from an infinitecimally small increase in labour). If you are not familiar with these concepts, you might want to look at production theory basics before continuing with this article.
In competitive industries, the VMPPL is in identity with the marginal revenue product of labour (MRPL). This is because in competitive markets price is equal to marginal revenue, and marginal revenue product is defined as the marginal physical product times the marginal revenue from the output (MRP = MPP * MR).
The marginal revenue product of labour can be used as the demand for labour curve for this firm in the short run. In competitive markets, a firm faces a perfectly elastic supply of labour which corresponds with the wage rate and the marginal resource cost of labour (W = SL = MFCL). In imperfect markets, the diagram would have to be adjusted because MFCL would then be equal to the wage rate divided by marginal costs. Because optimum resource allocation requires that marginal factor costs equal marginal revenue product, this firm would demand L units of labour as shown in the diagram.
The demand for labour of this firm can be summed with the demand for labour of all other firms in the economy to obtain the aggregate demand for labour. Likewise, the supply curves of all the individual workers (mentioned above) can be summed to obtain the aggregate supply of labour. These supply and demand curves can be analysed in the same way as any other industry demand and supply curves to determine equilibrium wage and employment levels.
More generally sociologists and political economists claim that labour economics tends to lose sight of the complexity of individual employment decisions. These decisions, particularly on the supply side, are often loaded with considerable emotional baggage and a purely numerical analysis can miss important dimensions of the process.
Also missing from most labour market analysis is the role of unpaid labour. Even though this type of labour is unpaid it can never-the-less play an important part in society. The most dramatic example is child raising. Unpaid work is typically ignored because it is difficult to measure and there is no agreed upon method of incorporating it into standard analysis. When the unpaid labour variable is ignored, the model’s conclusions might be biased.
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