In the labour market, people from households supply labour and businesses demand labour. The demand for labour is known as derived demand — this means that demand for labour is determined by demand for the goods and services that they produce. Businesses will demand more labour if there is a high demand for the goods and services they produce, for example at times of economic boom. Demand for labour also increases if workers are more productive, or if capital becomes more expensive (labour and capital are substitutes).
Supply of labour is determined by a number of factors:
– changes in migration patterns: when many of the newer member states of the EU joined the EU, countries such as the UK saw an increase in immigrants, and therefore an increase in the labour supply.
– income tax: when income tax is high, workers may feel that it is not worth working because they take home too little of their pay, and so labour supply may fall ie the value of their leisure time is more valuable than an hour of work, and so they substitute leisure for work. On the other
hand, workers may feel that they have to work longer hours to compensate for the reduction in pay, and so labour supply may increase.
– benefits: if state benefits (eg for sickness, disability, unemployment etc) are generous, then people are more likely to stay at home rather than work, thus reducing the labour supply
– trade unions: because trade unions act to increase wage rates through a process of collective bargaining, this may increase the labour supply as more people are encouraged to join the
workforce. However, higher wage rates mean reduced demand for labour, so unemployment might result. A similar outcome may occur as a result of a National Minimum Wage.
– social trends: the workforce in the UK had increased female participation compared to a few decades ago, as it has become more acceptable for women to work and childcare has become
easier to access.
The price of labour is known as the wage rate. If wages are too high, then there is more labour supplied than demanded — we have unemployment. If this occurs in a free labour market, then workers will have to accept lower wages or go without a job; thus the wage rate will tend to fall to the market clearing rate. If wages are too low, then demand for labour will be high but supply will be low so there will be a labour shortage, ie workers will not work if they are paid too little (an hour of their leisure time is more valuable than a hour of work). Firms will have to pay workers more as an incentive to work, and so the wage rate will be bid up to the market clearing wage.