THE LABOUR MARKET

The wages or salary you get paid is determined largely by what type of job you take. If you take a post as a
clerk, you are likely to get more pay than if you start at lower post. Equally , if you become a manager in a
bank , you will get paid more than a clerk. So the question is why is it that some workers get paid more than
others?
Why is it that some people with exceptional sporting talent, for example Tiger woods, Lionel Messi,
Dwayne Johnson etc. so highly paid? The answer to these questions, like many such questions in economics is
that it all depends on supply and demand.

Hollywood star Dwayne 'Rock' Johnson leads

the pack, topping the list of the 10 highest-  Lionel Messi agreed to a contract extension with
paid actors, collecting $89.4 million between Barcelona to stay with the club through the 2020–21
June 1, 2018, and June 1, 2019 (Source season. The contract promises an annual salary and
internet) bonus of at least $80 million (source internet)
 THE DEMAND FOR LABOUR

Firms demand for labour is due to its decision to produce certain goods or services. Labour is therefore demanded not for
its own sake but because it is essential for the production of goods or services.
The demand for labour shows how many workers is willing and able to hire at a given wage rate in a given time period.

There is inverse relationship between demand for labour and the wage rate.
1. If the wage rate is high more costly to higher extra employees.
2. When wages are lower, labour becomes relatively cheaper than capital. A fall in the wage rate might create a
substitution effect and lead to an expansion in labour demand.
 THE MARGINAL REVENUE PRODUCT OF LABOUR

Profit-maximizing firm is concerned with how much worth is that product which is produced by labour. Employment of a
labour by a firm can be understand with the following schedule and example.
Number of workers Output of Clothing Marginal product Average product
0 0 0 0
1 100 100 100
2 180 80 90
3 240 60 80
4 280 40 70
5 295 15 59
6 306 11 51

Suppose wage rate for employing a labour is $ 600 per month and lets assume that a unit of clothing sells for $ 10. When the
firm hires the first worker, this worker generates $ 1000 of revenue for the firm, this is turn represent $ 400 profit i.e. ( Sale =
100 x 10 = 1000 and less cost of labour 600 = $ 400 profit. The amount of revenue generated by an additional worker is
generated by an additional worker is referred to as marginal revenue product of labour. Adding a further worker generates $
800 and $ 200 profit. i.e. ( 80 x 10 = $ 800 less cost of another worker $ 600 = $ 200). There comes a point wen, after the third
worker has been employed, a further worker adds more to cost than to revenue( it’s cost $ 600 to employ the worker but only $
400 worth of clothing is produce. So above this level of employment the value of marginal product that is being produced is less
than the wage.
Following points will be consider by a firm when there will be hiring of labour:

1. A firm should continue to hire labour as long as the additional worker adds more to revenue than he or she
adds to the firm’s costs
2. The market wage is determined by the marginal revenue product of labour.
3. The marginal revenue product curve for labour is the firm’s demand curve for labour.
4. If the wage rate rises or falls, then fewer or more workers will be employed.

It follows for this analysis that the wages paid to workers are a direct reflection of their marginal
revenue product. So a street cleaner has a lower marginal revenue product than a clerk, who in turn has a
lower marginal revenue product than a teacher and so on. It also follows that it is actually possible to measure
marginal revenue productivity.
 SUPPLY OF LABOUR
The labour supply or supply of labour refers to the total number of hours that labour is able and willing to supply at a
particular wage rate. It is useful to consider labour supply at three levels: that of the individual worker, that of a firm or
industry and that of the economy as a whole.
Different factor affects supply depends upon which of these levels we are dealing with.
THE INDIVIDUAL LABOUR SUPPLY

Wages are important factors for decision of any individual worker to enter into the labour market. If the wage is too low,
someone may determine that it is not worth the effort of going to work and decide to stay at home. Not many people are in
this position- most of us need to work to live. Economics theory assumes that there is a positive relationship between
labour supply and the wage rate. So as the wage rate increases, more people are willing to offer their services to employers.
Beyond a certain point, though, individuals will take the view that they prefer leisure to work. This point is indicated by the
backward-sloping curve .
 FACTORS THAT CAN AFFECT AN INDIVIDUAL SUPPLY OF LABOUR

1. Income tax– In all countries this tend to be progressive. Low-wage workers pay little or no tax. As
wages rise, more of the increase is pain in tax to the government.
2. Demographic changes and immigration – Some jobs, such as fruit picking are unpopular with native-
born workers and rely on immigrant labour. If immigration slows down, there can be vacancies in these
particulars jobs.
3. The non-wages benefits of a job – Un peasant jobs will have fewer people willing to do them therefore
supply will be relatively lower. Although many unpleasant jobs, such as cleaning are relatively low
skilled so may still be low paid.
 LABOUR SUPPLY TO A FIRM OR INDUSTRY

This supply curve consists of the sum of the individual supply curves of all workers employed in a firm or
industry. It is usually upward sloping throughout . As happens with an individual worker, the number of
workers wanting to supply their labour increases with the wage rate that is offered. The slope of this supply
curve is measured by the elasticity of supply of labour .
In general the more skills required the more inelastic will be the supply of labour.
WAGE DETERMINATION UNDER FREEE MARKET FORCES

Important features of the workings of the labour market are :

1. The wage paid to labour equals the value of the marginal product of labour.
2. The willingness of labour to supply their services to the labour market is dependent upon the wage rate that is being
offered.

Each firm purchases labour until the value of the wage paid in the market must equal the value of the marginal product
of labour once it is has brought demand and supply into equilibrium. The market therefore clears at the equilibrium
wage.
Any change in the demand or the supply of labour will change the equilibrium wage. The value of the marginal product of
labour will also change by the same amount, as by definition it must always equal the wage rate.

Go back to the same example of clothing if income of the consumers in developed economies will increase there will be
large demand for cloths so demand curve for clothing will shift to the right, indicating that more will be demanded at any
price. In turn, this affects the demand for labour producing the clothing, by the shift to the right of the labour demand
curve.
The role of trade unions and government in wage determination
Trade Unions are organisations that seek to represent labour in their place of work. They were set up and continue to exist
because individuals (labour) have very little power to influence conditions of employment, including wages. Through
collective bargaining with employers, they act on behalf of their member to:

•Increase the wages of their members

•Improve working conditions
•Maintain pay differential between skilled and unskilled workers
•Fight job losses
•Provide a safe working environment
•Secure additional working benefits
•Prevent unfair dismissals.
Traditonally trade unions have been strong in manufacturing and less important in the service sector, transport excepted.
It is important in a competitive labour market, a powerful trade union is able to secure wage for its members above the
equilibrium wage rate.
 At the equilibrium wage , the quantity of labour
employed is L. If a strong trade union can force up wages
to say Wu which is above the equilibrium, the number of
workers who are offered jobs by employers falls to Lu. At
this wage though the number of people who would like to
work is higher. This is shown by Le. Consequently , there
is a shortfall between those who want to work and those
who can actually work, due to the influence of the trade
union. Shown as the difference between Le an Lu.

In practice it is really quite difficult to prove whether or not this theory actually applies in labour markets. A much quoted
example is that of actors and actress in various countries like in Uk and USA where there are very strong unions which
restrict the numbers able to work in films, television and theatres. The wages of their members are supposedly supported
in this way.
 FORMS OF MARKET
Perfect Competition – It refers to a market situation where there are large numbers of buyers and sellers dealing in a
homogeneous product at a price fixed by the market. That is the product which are offered in the market are identical in
each aspect.

FEATURES -
Homogeneous product - This is one of the basic feature of perfect competition, the product that is offered for sale in the
market in homogeneous in nature(identical in every aspect)
Free entry and exit - There is free entry and exit for the firm under perfect competition. So the firms in the perfect
competition could make normal profit only.
As whenever the existing firms start making abnormal profit then new firms will come forward to minimize the excess
profit and vice versa.
Due to homogeneous nature of the product, the price of product is also same in perfect competition.
Perfect knowledge - Due to single product the buyer and sellers were completely aware about the price, quality and
quantity of product.
Firm is price taker - Under perfect competition the firm is only a small unit of the whole market. Hence it plays no role in
determination of price. And hence the firm is only price – taker (takes the price decided by industry) whereas the industry
is a price maker.
Demand Curve - Under perfect competition, the price of the commodity remains unchanged. So the demand curve slopes
horizontal straight line.
It means that a small change in price leads to a greater change in its quantity demanded.
 
 
Monopoly Competition - It is derived from 2 Greek words, ‘ Monos’ which means single and ‘Polos’ means a seller. It is type
of market in which there is only one seller selling his product with no close substitute and strong barriers to entry.
Example – Railways services
 
 
Features -
One seller and large number of buyer – The main root of monopoly is that under it there is only one seller and large number
of buyers in the market.
No close substitute of the product – As there exist only one seller for the product. SO it is very difficult to get an alternative
product under monopoly.
Restriction in entry – There exist strong barriers for entry of new firms and exit of existing firms. So monopoly firms can earn
abnormal profit in long run.
These barriers could be due to legal restrictions like licensing, patent right etc.
Price discrimination – A monopolist firm can charge different prices for his product from different sets of consumer at the
same time (just because of sole seller in the market)
Price maker – In case of monopoly firm and industry are one and same so the firm has complete control over the price and
hence it is price maker.
Demand Curve – In monopoly competition there is a single seller who fixes its own prices output policy (Monopolist). If the
monopolist tries to increase its quantity of selling then it can reduce its price.
Monopolistic competition - It can be treated as the mixture of perfect competition and monopoly. The monopolistic competition was
developed by C’ T Chamberlin’
This is the type of market in which there are large number of buyers and selling producing similar but differentiated product which
are close substitute of each other.

Features –
Large number of buyers and sellers – Under monopolistic competition there exist large number of buyer and seller dealing in
differentiated products.
Price differentiation - In this competition the products are produced by the seller are differentiated in nature. That is –
REAL PRODUCT DIFFERENTIATION – On the basis of quality, quantity , technology etc.
FANCY PRICE DIFFERENTIATION – On the basis of packing, binding, free gifts etc.
 
Selling cost – It is a important feature of monopolistic competition. The producer has to spend a lot of money on advertisement just
to popularize their quality, quantity and technology of the product.
 
Note – Selling cost = All expenses including marketing, sales promotion and advertisement
 
Free entry and exist – In monopoly competition , firms are free to enter and exit at any time they wish. It means there is neither
abnormal profit nor loss to a firm in long run.
Lack of knowledge – Due to large number of similar but differentiated products it becomes difficult for a consumer to evaluate all the
products available in the market.
Non – price competition – The firms under this competition can compete with each other without changing their price. It refers to
competing with other firms by offering any deals like free gifts, making favorable credit terms etc.
Demand curve – In this competition the demand curve is highly elastic just because of the close substitute of the product and price
controlling power of the seller.
 
`Oligopoly market – This is a situation where only few firms exist and selling homogeneous or differentiated products.
Transfer earnings and economic rent in the labour market
TRANSFER EARNINGS - This is the minimum payment necessary to keep labour in its payment use.

ECONOMIC RENRT – Any payment to labour which is over and above transfer earnings.
 Theory of the firm

The firm is simply the economic organization that transforms factor inputs into goods and
services for the market.
An accountant’s view of a firm’s cost is that they are incurred when the firm makes a
recognised expenditure. There are production expenses paid out at a particular time and
price. Profits are what is left when the expenses are deducted from the firm’s income or
sales revenue.
The economist’s view of costs is wider than this. The accounting view does not fully
recognize the private cost of economic activity. As well as money paid out to factors, there
must be an allowance for anything owned by the entrepreneur and used in the production
process. This factor cost must be estimated and included with the other costs.
NORMAL PROFIT – Entrepreneur may used his capital anywhere instead of business at no risk and can earn an income. The
entrepreneur will expect a minimum level of profit, reflecting what his or her capital and labour would have earned
elsewhere. This is the concept of normal profit.
 
Abnormal profit – Profit for economist is Total revenue (price X Unit sold) MINUS total cost (including normal profit). If this
is positive, then it is ABNORMAL PROFIT. The prospect of making abnormal profit motivates the entrepreneur to take the
business risks in supplying goods and services to the market.
 
In case of perfect competition firms – Firms will only make different amounts of profit from each other if they have
different cost structures. Their behaviour is strictly limited and the only way to boost profit would be to increase
productivity and lower average total cost.
Abnormal profit will only be a feature of perfect competition in the short run. This is because its existence will act
as an economic incentive for entry of new firms. The effect of this on the existing firms is that the market price will fall and
the abnormal profit will diminish. When abnormal profit goes, the entry of new firms dries up, and the existing ones will
simply be covering costs.
 
In case of Monopoly – A monopoly can’t always make abnormal profit – it depends how high its costs are. There may be
situations where the fixed costs are so high relative to the total cost that the market price can just cover the average costs.
In this case the monopolist would only make normal profit.
The monopolist’s profits could be increased in certain
circumstances by a practice known as price
discrimination. The monopolist is making use of the fact
that some consumers would have been prepared to pay
more than the single price. At this price they would be
enjoying some consumer surplus. The monopolist’s aim
is to charge what the consumers will pay and turn the
consumer surplus into producer surplus in the form of
abnormal profit.
The production function
 
Q = F (K, L, T)
Q= Output
K = Capital
L = Labour
T = Technology
 
Production function is the relationship between physical input and physical output.
 
Types of production function
Short run production function - It refers to short period of time in which 2 factors are available such as – (a) Fixed factor
and (b) variable factor.
(a) Fixed factor which remains fixed in short run even when there is change in quantity of output is known as fixed factor.
Example – Land, Building etc
(b) Variable factors which can be changed due to the change in quantity of output is known as variable factor.
Example- Labour, Raw material, fuel etc.
 
 
Long run production function: It refers to long period of time in which only one factor is available (i.e variable factor). All
the available factors are variable in nature under long run because a producer can change all the factors of production
due to availability of time.
Production function is the relationship between physical input and physical output.
 
Types of production function
Short run production function - It refers to short period of time in which 2 factors are available such as – (a) Fixed factor
and (b) variable factor.
(a) Fixed factor which remains fixed in short run even when there is change in quantity of output is known as fixed factor.
Example – Land, Building etc
(b) Variable factors which can be changed due to the change in quantity of output is known as variable factor.
Example- Labour, Raw material, fuel etc.
 
Long run production function: It refers to long period of time in which only one factor is available (i.e variable factor). All
the available factors are variable in nature under long run because a producer can change all the factors of production due
to availability of time.
Types of products:
 
Total products : It is sum of total quantity of output produced by all the units of variable factor along with some units of
fixed factor used in the process of production.
 
2. Average product: It refers to the output per unit of variable factor employed.
 
A.P = Total product
Units of variable factor
 
3. Marginal product – It refers to an additional product which can be derived by employing one more unit of variable
factor.
In other words, it refers to the change in total product with respect to the change in variable inputs. (labour)
 
MP = TPn – Tpn-1
 
TPn = Total product at current unit of production
TPn-1 = Total product at previous unit of production.
 
Mp = change in total product
Change in per unit of variable factor
 
Fixed factor Variable factor Total product Average product Marginal product

1 1 20 20 20
1 2 50 25 30
1 3 90 30 40
1 4 116 29 26
1 5 130 26 14
1 6 130 21.6 0
1 7 125 17.8 -5
LAW OF VARIABLE PROPORTION/LAW OF DIMINISHING RETURN OF THE F

This is an important theory of production. It is related to short- run production function. The theory states that “As we increase the quantity of only
one input (variable) keeping other factor constant(fixed) then the total product initially increases at an increasing rate, then at decreasing rate and
finally at a negative rate.
In other words , As we employ more and more units of variable factor with the given fixed factor. The proportion between variable factor and
output changes in such a way that the resulting output(MP) at first increases, then diminishes and finally becomes 0 and negative.
Assumptions.
This theory is related to short run production function.

Land Labour TP AP MP
1 1 100 100 100
1 2 210 105 110
1 3 330 110 120
1 4 420 105 90
1 5 490 98 70
1 6 490 81.6 0
1 7 488 69.7 -2
 ECONOMIES OF SCALE

Meaning – Economies of scale stand for a situation when expansion of output lelads to a reduction in the unit costs.

Internal economies of scale – Internal economies of scale are the benefits that accrue to a firm as a result of its decision
to produce on a larger scale. They occur because the firm’s output is rising proportionally faster than the inputs, hence
the firms is getting increasing returns to scale. If the increase in output is proportional to the increase in inputs, the firm
will get constant returns to scale and the long run average cost will be horizontal.