Determining Wage Rates: Competitive Labour Markets (AQA A Level Economics)
Revision Note
Written by: Lorraine
Reviewed by: Steve Vorster
Wage Rates in Perfectively Competitive Labour Markets
In a perfectly competitive labour market, relative wage rates are determined at the point where DL = SL
There is an assumption in perfect competition that all workers possess identical skills and receive the same wage rate
In reality, workers have diverse skill sets and different motivational factors drive them
An excess demand of labour leads to a shortage of workers in a particular occupation, causing wages tend to increase
This causes a rise in wages and is an incentive to workers to enter the labour market for that occupation
This increases the supply of labor (SL)
An excess supply of labour leads to a surplus of workers in a particular industry, which causes wages to decrease
This fall in wages cause some workers exit the labour market for that occupation
The equilibrium for labour adjusts where
There is no excess supply of labour
There is no excess demand for labour
Examiner Tips and Tricks
In the same way that perfectively competitive markets do not actually exist in reality (though some industries get close!), labour markets are never perfectively competitive. One of the reasons for this is the existence of asymmetric information. Workers and employers do not always know if there is a shortage or excess of labour, or they may not fully realise what the precise wage rate should be.
Labour markets are inherently imperfect.
Wage Determination in a Perfectly Competitive Labour Market
Perfectly competitively firms are price takers in the labour market, as they have to accept the wage rate that workers are being paid in the industry
The labour market is a type of factor market
Factor markets follow exactly the same rules as product markets
They are affected by changes to price, demand and supply
They are affected by the price elasticity of demand and supply
Diagram: Wage Determination in a Perfectly Competitive Labour Market
In the labour market for perfectly competitive firms, the wage rate is set by the industry wage rate
Diagram analysis
Market
Labour market equilibrium occurs in the industry where demand for labour (DL) = supply of labour (SL)
The equilibrium wage is W1
Individual firm
The supply of labour for the individual firm is considered to be perfectly elastic, as workers have to accept the market wage (W1)
If the firm offers a lower wage, it will struggle to recruit workers
If the firm offers a higher wage, it will paying above the market rate and a large number of workers will apply to work there
The SL is also the average cost of labour (ACL) or the marginal cost of labour (MCL)
Labour market equilibrium for individual firms in perfect competition occurs when demand for labour (DL) or MRPL is equal to the supply of labour (SL)
The equilibrium wage is W1 and the quantity of labour is Q1
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