How Wages are Determined in a Perfectly Competitive Labour Market
As in other markets, the supply and demand of labour determines the
price (wage rate) and the quantity (number of people employed). The
labour market is different from other markets (like the markets for
goods) in several ways. 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, in the long run more goods
will probably be produced until the demand is satisfied. However, with
labour, overall supply cannot in fact be fixed 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 a higher
supply of labour. It may actually result in less supply of labour as
workers take more time off to spend their increased wages because they
no longer have to work the longer hours to gain the same amount of
money, or it may result in no change in supply. Within the overall
labour market, particular parts are thought to be subject to more
normal rules of supply and demand as workers are likely to change job
types in response to inconsistent 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 - because there are many workers and employers both having
perfect information about each other.
Text Box: Wage rate
There are many conditions that determine the wage rate of labour.
If there were an increase in demand for labour, this would cause an
extension up the supply curve. This would increase the wage rate and
the quantity (amount of people hired) of labour. A decrease in demand
would cause the opposite. An increase in supply, however, would cause
a shift down the demand curve therefore lowering wage rates and
quantity of labour.
A shift in the supply curve of labour could be caused in many ways. If
labour became more or less productive, this would cause the MRP curve
to move - MRP = Marginal revenue product. This is a theory of wages
where workers are paid the MRP to the firm. The price of a substitute
could also change i.e. if the price of a substitute goes down, say a
certain type of capital, then the demand for that labour will fall.
The demand for the product could also change. If the demand for the
product could also change e.g. if the demand increases, this would
mean a higher price. This in turn would give a higher wage rate as
wage is determined by MRP which is MPP(marginal physical product X
The demand for labour is a derived demand. This means it is decided by
how another factor changes e.g. if the demand for a product...