What determines wages and employment in a labour market?
The demand for and supply of labour, wage determination in competitive labour markets, the marginal revenue product of labour, monopsony and trade unions, and wage differentials.
An answer to AQA A-Level Economics 4.1.6, covering the demand for and supply of labour, wage determination in competitive markets, the marginal revenue product of labour, monopsony and trade unions, and the causes of wage differentials.
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What this dot point is asking
AQA wants you to explain the demand for and supply of labour, wage determination in a competitive market, the marginal revenue product theory of labour demand, the effect of monopsony and trade unions, and the causes of wage differentials. The minimum wage in a monopsony is a favourite evaluation point.
Demand for and supply of labour
The supply of labour to an occupation rises with the wage and also depends on the size of the population, skills and qualifications, migration, and non-monetary factors such as working conditions, status and job satisfaction. A profit-maximising firm hires up to the point where the wage equals MRP, because beyond that an extra worker adds more to cost than to revenue.
Wage determination in a competitive market
In a perfectly competitive labour market, with many small firms and workers and perfect information, the equilibrium wage is set where market labour demand equals labour supply. Each individual firm is a wage taker, facing a horizontal supply of labour at that wage, and hires where the wage equals MRP. A shift in either curve, for example rising productivity (demand) or immigration (supply), changes the equilibrium wage and employment.
Monopsony and trade unions
Wage differentials
Wages differ between and within occupations because of differences in marginal revenue product (skills, training and productivity), the elasticity of labour supply (how easily workers can be replaced, so surgeons earn more than cleaners), qualifications and barriers to entry, non-monetary factors (compensating differentials for dangerous or unpleasant work), and bargaining power (including trade unions and discrimination).
Exam-style practice questions
Practice questions written in the style of AQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
AQA 20194 marksA worker produces 6 extra units of output per hour, each selling for 5 pounds. Calculate the worker's marginal revenue product and explain the maximum hourly wage a profit-maximising firm would pay.Show worked answer →
A 4 mark calculation rewards the MRP formula and the hiring rule.
Marginal revenue product. pounds per hour.
Maximum wage. A profit-maximising firm hires labour up to the point where the wage equals MRP, so it would pay up to 30 pounds per hour for this worker. Paying more would add more to cost than to revenue.
Markers reward the correct MRP of 30 pounds and the rule that the wage equals MRP at the profit-maximising level of employment.
AQA 20219 marksUsing a diagram, analyse how the introduction of a national minimum wage could raise both wages and employment in a monopsony labour market.Show worked answer →
A 9 mark analysis question rewards the monopsony diagram and the chain.
- Monopsony
- A single dominant buyer of labour faces the upward-sloping supply curve, so its marginal cost of labour lies above the supply curve. It employs where , paying a wage read off the supply curve, below the competitive wage, with employment below the competitive level.
- Minimum wage
- A minimum wage set between the monopsony wage and the competitive wage makes the wage (and so the marginal cost of labour) constant up to that point, removing the gap.
- Outcome
- The firm now employs more workers at a higher wage, raising both pay and employment towards the competitive outcome. Markers reward the MCL above supply logic and the dual gain.
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Sources & how we know this
- AQA A-level Economics (7136) specification — AQA (2015)