Labour markets: the demand for labour as a derived demand and marginal revenue product, the supply of labour, wage determination in competitive and imperfect labour markets, trade unions and monopsony, and the causes of wage and income inequality.

What this key area is asking

The labour market applies the structures toolkit to a factor market: instead of a good, the thing being bought and sold is labour. You must explain the demand for labour (a derived demand, measured by its marginal revenue product), the supply of labour, how the wage is determined in competitive and imperfect markets, the effects of trade unions and monopsony employers and the minimum wage, and the causes of wage and income inequality. The tools are the familiar demand and supply diagram, now in the labour market.

The demand for labour: a derived demand

The $MRP$ curve slopes down because of diminishing returns (each extra worker eventually adds less output). Anything that raises labour productivity or the output price shifts the demand for labour to the right.

The supply of labour

The supply of labour to an occupation reflects the number of people willing and able to work at each wage. It generally rises with the wage, and depends on:

• The wage relative to other jobs.
• Non-monetary factors: working conditions, hours, status, job satisfaction.
• Qualifications and training required (barriers restrict supply).
• Geographical and occupational mobility of workers.

Wage determination in a competitive labour market

In a competitive labour market, with many small employers and workers, the wage and employment are set where the demand for labour (MRP) equals the supply of labour:

This explains wage differentials: occupations pay more where labour is highly productive (high $MRP$) and scarce (restricted supply through long training or rare talent), and less where $MRP$ is low and supply plentiful. Compensating differentials, bargaining power, immobility and discrimination modify the picture.

Imperfect labour markets: unions and monopsony

Real labour markets are rarely perfectly competitive.

• A trade union uses collective bargaining (or restricts supply) to push the wage above the competitive level. In a competitive market this is a wage floor: the higher wage cuts the quantity of labour demanded, so employment falls and there is excess supply.
• A monopsony is a single dominant buyer of labour (a large local employer). It faces the whole upward-sloping labour supply curve, so to hire one more worker it must raise the wage for all, making the marginal cost of labour exceed the wage. A profit-maximising monopsony therefore hires fewer workers at a lower wage than a competitive market would.
• In a monopsony, a union or a minimum wage can raise both the wage and employment, because it counters the employer's wage-setting power: the monopsony was paying below $MRP$, so a higher imposed wage can increase hiring up to the competitive level.

The national minimum wage

A national minimum wage set above the competitive wage is a wage floor:

• In a competitive market it raises pay for those who keep their jobs but reduces labour demand, risking unemployment; the size depends on the elasticity of labour demand.
• In a monopsony it can raise the wage without cutting (or even raising) employment.
• Wider effects to weigh: reducing in-work poverty and wage inequality, raising business costs, and possible effects on incentives and prices. The empirical evidence on employment effects is mixed, which makes this an ideal evaluation question.

The causes of inequality

Wage and income inequality arise because:

• Skills and productivity differ, so $MRP$ and wages differ.
• Education, training and qualifications restrict supply to high-paid jobs.
• Bargaining power (unions, professional bodies) differs between groups.
• Ownership of capital and wealth adds non-wage income, concentrating income further.
• Discrimination, immobility and inheritance entrench differences.

Inequality is a recurring project theme and links directly to fiscal policy (progressive taxes and transfers) in the macroeconomic area.

Worked example: hiring to the MRP rule

Why this matters

The labour market shows the structures tools working in a factor market and connects directly to the macroeconomic and policy areas: wage determination underlies unemployment and the Phillips curve, while inequality is a central concern of fiscal policy and a popular project topic. Understanding the monopsony case in particular lets you give the nuanced, "it depends on the market" answer the SQA rewards on minimum-wage and trade-union questions.

Try this

Q1. Define the marginal revenue product of labour and state the rule a firm uses to decide how many workers to hire. [3 marks]

• Cue. $MRP$ is the extra revenue from one more worker, marginal physical product times the output price. A firm hires up to where the wage equals $MRP$.

Q2. Explain why a national minimum wage might not reduce employment in a monopsony labour market. [2 marks]

• Cue. A monopsony pays below $MRP$ and restricts hiring; a minimum wage above its low wage removes its power to depress pay, so it can hire more, raising both the wage and employment.