labour markets

Question 1

Relationship between wage rate and labour demand

Answer 1

• There is an inverse relationship between demand for labour and the wage rate.
• If the wage rate is high - more cost to hire extra employees.
• When wages are lower, labour becomes relatively cheaper than capital. A fall in the wage rate might create a substitution effect and lead to an expansion in labour demand.

Question 2

Elasticity of labour demand

Answer 2

• When labour demand is elastic, employment is sensitive to changing wages and vice versa when inelastic.
• Elasticity of labour demand measures the responsiveness of demand when there is a change in the wage rate. It depends on:

Labour costs as a % of total costs - when labour expenses are a high % of total costs, then labour demand is more elastic.

Ease and costs of factor substitution - Labour demand is more elastic when a firm can substitute easily between labour and capital inputs.

Question 3

Factors affecting labour demand

Answer 3

• A rise in consumer demand which means that a business needs to take on more workers
• An increase in the productivity of labour which makes labour more cost effective than capital.
• A government employment subsidy which allows a business to employ more workers.
• Level of government regulation of the labour market
• Increase in wages reduces labour demand
• The labour demand curve would shift inwards during a recession as businesses shed labour.

Question 4

Labour supply

Answer 4

• The number of hours people are willing and able to supply at a given wage rate.
• The labour supply curve for any industry or occupation will be upward sloping
• As wages rise, other workers enter this industry attracted by the incentive of higher rewards.
• The extent to which a rise in the prevailing wage or salary in an occupation leads to an expansion in the supply of labour depends on the elasticity of labour supply.

Question 5

Labour supply diagram

Answer 5

• The supply of labour curve starts from a certain point on the y axis, which is the minimum pay rate people are willing to work in an occupation.

Question 6

Key factors affecting labour supply

Answer 6

• Real wage rate on offer in the industry itself
• Extra pay e.g. overtime payments and productivity pay
• Wages in substitute occupations e.g. increase in plumbers or electricians earnings may cause people to switch jobs.
• Barriers to entry e.g. minimum entry requirements can restrict supply and increase wages.
• Improvements in the occupational mobility of labour
• Fringe benefits (non monetary characteristics) e.g. risk, job security, working conditions, promotion opportunities.
• Net migration of labour, net inward migration boosts the available labour supply.

Question 7

Elasticity of labour supply

Answer 7

• Elasticity of labour supply measures the extent to which labour supply responds to a change in the wage rate in a given time period

draw diagram

Question 8

Equilibrium market wage rate

Answer 8

• The equilibrium market wage rate is at the intersection of the supply and demand for labour. Employees are hired up to the point where the extra cost of hiring an employee is equal to the extra sales revenue from selling their output.

Question 9

Reasons for pay differentials in the labour market

Answer 9

Compensating wage differentials - reward for risk, working in poor conditions etc.

Reward for human capital - differentials compensate workers for costs of human capital acquisition.

Different skill levels - demand for skilled labour grows more quickly than for semi-skilled workers.

Differences in labour productivity and revenue creation - higher pay for more efficient workers who generate more revenue.

Trade unions - use power to achieve increased wages

Other artificial barriers to labour supply - e.g. profess. exams

Employer discrimination - a factor that cannot be ignored

Question 10

Trade unions in the labour market

Answer 10

• Use collective bargaining power with employers to protect their members.

Question 11

Key roles for trade unions

Answer 11

1. Protecting and improving the real living standards of their members.
2. Protecting workers against unfair dismissal.
3. Promoting improvements in working conditions and health and safety issues.
4. Workplace training and education.
5. Protection of union member’s pension rights.

Question 12

Key causes of labour market failure

Answer 12

• Markets fail when they fail to reach a socially efficient/equitable outcome.

Labour immobility - occupational and geographical immobility.

Disincentives to find/take work - Unemployment trap where there’s poor incentives to take a job, and poverty trap where there’s disincentives to earn extra incomes

Discrimination by employers - Gender pay gap between men and women, affected group’s wages are badly affected.

Monopsony power of employers - They can use their ‘buying power’ in labour market to drive down wages.

Question 13

Government policies to address labour market failure

Answer 13

• Policies seek to improve incentives, skills and labour flexibility, such as:
• Targeted employment subsidies
• Reforms to the housing market to improve affordability.
• Lower income tax
• Increase national minimum wage
• Tougher laws on equality
• Laws on unfair dismissal
• Encourage business start ups

Question 14

Aim of competition policy

Answer 14

• To ensure that any action that ‘prevents, restricts or distorts competition’ is blocked and that fair trading is enforced.

Question 15

Government intervention to control mergers

Answer 15

• If a merger leads to a ‘substantial lessening of competition’, it is likely to be blocked.
• The competition and markets authority determines whether a merger will impact adversely on competition.

Question 16

Government intervention to control monopolies

Answer 16

• Monopoly power is not necessarily undesirable, but the competition authorities aim to stop a firm abusing it’s dominant position.
• Any action such as collusion, acting as a cartel or deliberately preventing new entry of firms is targeted when oligopolies try to increase their profits at the expense of customs or other non-colluding firms.
• Regulation is used when market forces are judged to be inadequate as a means of protecting consumer interests.
• Unlike in competition policy, the government tries to act as a surrogate for competition by making firms cut prices, or takes legal action.

Question 17

Price regulation

Answer 17

• Price capping is used to regulate several privatised utilities in the U.K.
• The price cap is an upper limit set on the increase that the firms can add to their retail prices.
• It takes into account inflation measured by the retail price index and takes account of possible efficiency gains or investment.

RPI - X - Takes the RPI and subtracts the efficiency gains that the regulator has determined can reasonably be achieved by the firm in question (X).

RPI + K - Takes the RPI and adds the additional capital spending a firm has agreed with the regulator is necessary.

Question 18

Advantages of price capping

Answer 18

• Allows a firm to keep any profits it makes through bringing about greater efficiency gains than the regulator calculated are reasonable.
• Firms are able to plan ahead as the X and K factors are in place for a reasonable period. This means firm will not be unduly penalised for making further efficiency gains.

Question 19

Disadvantages of price capping

Answer 19

• If regulators underestimate efficiency gains, firms can produce what appear as excessive profits, which are used to invest in areas outside the regulator’s remit and generate greater profits in the future.
• Regulatory capture can occur, when the regulator and regulated industry build a close relationship, resulting in a regulator being less strict on the firms.

Question 20

Profit regulation

Answer 20

• This method allows a firm to make a certain level of profit based off it’s capital stock before the remainder of the profit is taxed at 100%.
• This reduces incentive to make efficiency gains that increase profits.
• Firms are penalised for success and are encouraged to make a limited profit.
• Any excess profit is spent on additional capital to increase the level of capital stock and therefore allowable profit while increasing efficiency levels.

Question 21

Performance standards and quality standards

Answer 21

• The regulator can also set performance targets that it will then monitor.
• This may be supported by a system of fines, should the firm fail to meet the targets, or rewards should the firm meet them.

Question 22

Other regulation

Answer 22

Controls in response to the credit crisis - The banking industry is now subject to heavy regulation in terms of the amounts it can lend and the risks it can take.

Controls from outside the UK - Direct controls from the EU take precedence over U.K. rules e.g. carbon emission limits.

Question 23

Government intervention to promote contestability

Answer 23

• Governments seek to promote contestability to give consumers the benefit of greater choice, innovation and competition.
• Governments can do this through reductions in barriers to entry and reductions in restrictive practices.
• If incumbent firms try to ensure the market does not become contestable, regulators can intervene to open up markets.
• Governments can promote start-up businesses.

Question 24

Privatisation, competitive tendering and deregulation

Answer 24

• Once a state-owned enterprise is privatised, now with shareholders to satisfy, the newly privatised firm will seek to maximise profits and therefore to make significant increases in sales and efficiencies, thus reducing costs.

Question 25

Derived demand

Answer 25

• When demand for firms’ products increases, more labour is needed to produce their goods and services.
• If demand for their products falls, they will demand less labour.

Question 26

Government intervention

Answer 26

1. Minimum wages - a legally required minimum amount of pay employers must pay their employees.
2. Maximum wages - Upper limit set on the amount of income an individual/group can earn. E.g Switzerland 1:12

Question 27

Pros of minimum wage

Answer 27

Pros:
- Can reduce levels of poverty

• Allows for more spending on goods and services
• Leads to economic growth
• Reduces income inequality
• More productive workforce, reducing costs over time
• More people enter workforce, less transfer payments

Question 28

Cons of minimum wage

Answer 28

• Less demand for labour, causing unemployment
• Higher costs and lower profits for firms
• Inflationary pressure (both DP and CP)
• Can lead to shut down if AVC>P
• Backward bending labour supply curve
• SRAS and LRAS shift inwards

Question 29

Minimum wage evaluation points

Answer 29

It depends on:
- Proportion of labour cost of total costs
.
- Counter monopsony abuse

• Size of country and size of increase
• More demand can offset the increase in costs
• If economy has spare capacity
• PED/PES of labour

Question 30

Minimum wage diagram

Answer 30

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Question 31

Current labour market issues

Answer 31

• Massive increase in people being absent for long term sickness
• Almost 1/4 of the labour supply are not working
• Skills shortages in engineering, IT and healthcare