Wage Determination (Cambridge (CIE) IGCSE Economics)

Revision Note

Steve Vorster

Written by: Steve Vorster

Reviewed by: Jenna Quinn

Factors That Influence The Demand for Labour

  • The labour market is composed of sellers of labour (households) and buyers of labour (firms)

    • Workers supply their labour and firms demand labour

  • The demand for labour is a derived demand

    • This means that it depends on the demand for goods/services

      • If demand for goods/services increases then the demand for labour will increase - and vice versa

Factors That Influence the Demand for Labour

The price of the product being produced

The demand for the final product

  • If the selling price of the product increases, then the firm will be incentivised to supply more and the firm's demand for labour will increase

  • As demand for labour is a derived demand, when an economy is booming then demand for most goods/services will be high - and the demand for labour will be high

  • Conversely, when an economy is in a recession demand for most goods/services will be lower - and the demand for labour will be lower

The ability to substitute capital (machinery) for labour

The productivity of labour

  • Firms will constantly evaluate if it will be possible and more cost effective to switch production from using labour to capital (machinery)

  • If it is more cost effective, then demand for labour will fall

  • If the productivity of labour increases (possibly through training) this will lower average costs and firms will likely demand more labour

Factors Influencing the Supply of Labour

  • There are numerous factors that influence the amount of labour supplied to a particular industry

Factors Influencing the Supply of Labour

Training period

Wages in other occupations

Changes in migration policy

  • Long training periods (and their cost) act as a barrier to entry and exclude many households from offering labour in certain markets
     

  • Comparative wage rates in substitute labour markets strongly influence the supply of labour e.g. it is getting harder to recruit economics teachers as the private sector offers higher wages for their skills

  • Policies that increase the net migration rate  increase the supply of labour to certain industries e.g. in 2022, 36% of Singapore's labour force were migrants

Income tax levels

Working conditions

Trade union power

  • At a certain level, income taxes become a disincentive to households offering their labour.

  • The assumption is that as income tax increases, labour supply decreases - and vice versa

  • The working conditions and non-wage benefits can act as strong incentive in certain industries e.g. tech companies are well known for their laid-back work environment and wide range of benefits e.g. on-site childcare and restaurants

  • Trade unions can increase the supply of labour to certain industries as workers consider the benefits of belonging to the union e.g. higher wages and a safer working environment

Level of welfare benefits

Social trends

 

  • The higher the level of welfare benefits, the lower the incentive for low-skilled labour to offer their labour - and vice versa

  • Social trends include any major changes within society and can influence the supply of labour to certain industries e.g. work from home during Covid resulted in significant changes to the labour market and not all workers returned to work when economies opened up again

 

Diagrammatic Analysis of the Labour Market

  • 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.   

  • Labour market equilibrium occurs where the demand for labour (DL) is equal to the supply of labour (SL)

    • The DL is the demand by firms for workers - firms demand more labour as the wage rate decreases which results in a downward sloping demand curve

    • The SL is the supply of labour by workers - workers supply more labour as the wage rate increases which results in an upward sloping supply curve

  • Individual firms are price takers in the labour market as they have to accept the wage rate that workers are being paid in the industry

    • If they offer a lower wage, they will likely struggle to recruit workers

    • If they offer a higher wage there will be a large number of workers applying to work there

A supply and demand graph for graphic designers' wages, with the wage rate on the vertical axis and quantity on the horizontal; equilibrium at point (W, Q).
In the labour market for graphic designers, the equilibrium wage rate is W and the equilibrium quantity is Q. At this point the DL = SL

Diagram analysis

  • The market for graphic designers is in equilibrium where DL = S

  • The equilibrium wage is W and the quantity of labour is Q

  • There is no excess supply of labour

  • There is no excess demand for labour

Analysing the PED and PES of Labour

  Price inelastic demand and supply

  • Consider the labour market for NBA basketball players

  • In 2022, LeBron James received a salary of $45m

Wage determination in highly skilled markets is price inelastic in both supply and demand
Wage determination in highly skilled markets is price inelastic in both supply and demand

   Diagram analysis

  • DL is the demand for labour from the basketball clubs

  • SL is the supply of labour by the basketball players

  • The demand for highly skilled players is very price inelastic

    • Clubs want the very best players, almost irrespective of what they cost

  • The supply of highly skilled players is also very price inelastic 

    • A significant increase in price will have little impact on the quantity of labour supplied in the market as it takes years to develop LeBron James type skills

  • The market equilibrium is found at W1Q- a high price and relatively low quantity  

Price elastic demand and supply   

  • Consider the labour market for labourers on a building site
     

3-3-2-wage-determination-elastic

Diagram analysis

  • DL is the demand for labour from the building company for labourers

  • SL is the supply of labour by people willing to work on a building site

  • The demand for workers is very price elastic

    • If wages dropped a little, then firms would respond quickly by employing more workers

  • The supply of workers is also very price elastic 

    • Due to it being an unskilled job, there would quickly be an increase in the supply of labour if wages were to increase

  • The market equilibrium is found at W1Q- a low price and relatively high quantity

Relative Bargaining Power

  • Workers have different degrees of bargaining power when it comes to negotiating wage increases with their employers

  • The following factors influence their bargaining power

  1. Membership of a trade union: trade unions represent the interests of the workers in negotiations with employers and members frequently enjoy higher wages than non-union members 

  2. Age and experience: young, inexperienced workers have less bargaining power then older, more experienced workers. As workers grow older their age often begins to count against them and this reduces bargaining power

  3. Level of education: education provides higher levels of skill and specialisation to a worker. This increases their bargaining power relative to unskilled workers

  4. Current supply conditions: the supply of labour in many industries can change due to socio-political conditions e.g prior to Brexit, workers in the hotel industry had very little bargaining power. Brexit created a shortage of labour willing to work in hotels and so the bargaining power of workers has increased, resulting in higher wages in the industry

Government Policy: Minimum Wages

  • Government's often intervene in the labour market by setting a minimum wage

    • They do this in order to improve equity and avoid the exploitation of worker

  • A minimum wage is a legally imposed wage level that employers must pay their workers

    • It is set above the market rate

    • The minimum wage/hour often varies based on age

A national minimum wage (NMW1) is imposed above the market wage rate (We) at W1
A national minimum wage (NMW1) is imposed above the market wage rate (We) at W1

Diagram analysis

  • The market equilibrium wage and quantity for truck drivers in the UK is seen at WeQe

  • The government imposes a national minimum wage (NMW) at W1

  • Incentivised by higher wages, the supply of labour increases from Qe to Qs

  • Facing higher production costs, the demand for labour by firms decreases from Qe to Qd

  • This means that at a wage rate of W1 there is excess supply of labour and the potential for unemployment equal to QdQs

Examiner Tips and Tricks

When evaluating national minimum wages, do not assume that they will automatically increase unemployment.

Many studies have shown that unemployment does not increase - and in some instances employment increases. This is likely due to the fact that workers are receiving higher wages and choose to consume more. This increases total demand in the economy which in turn increases the demand for labour by firms - thus reducing/eliminating any potential unemployment.

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Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.

Jenna Quinn

Author: Jenna Quinn

Expertise: Head of New Subjects

Jenna studied at Cardiff University before training to become a science teacher at the University of Bath specialising in Biology (although she loves teaching all three sciences at GCSE level!). Teaching is her passion, and with 10 years experience teaching across a wide range of specifications – from GCSE and A Level Biology in the UK to IGCSE and IB Biology internationally – she knows what is required to pass those Biology exams.