LABOR MARKET

The labor market is a critical component of the economy, involving the supply and demand of labor. It
consists of the labor force (those employed or seeking employment), employment (number of
individuals working), unemployment (those seeking jobs but unable to find them), and job openings
(available positions). Understanding the labor market is essential for policymakers, businesses, and
individuals.
Labor Force:
The labor force is an important measure of economic health, indicating the number of people
available for work. The labor force participation rate reflects the percentage of the population
involved in the labor force.
Employment:
Employment is a key indicator of economic growth and prosperity, demonstrating the number of
individuals currently working. Rising employment rates indicate a robust labor market and a growing
economy.
Unemployment:
Unemployment is a concern, representing individuals actively seeking employment but unable to find
jobs. The unemployment rate shows the percentage of the labor force affected by unemployment.
Job Openings:
Job openings indicate demand for labor and can indicate a healthy labor market. The job openings rate
represents the percentage of total employment comprised of available positions.
Factors affecting the Labor Market trends:
Labor market trends are influenced by factors such as technology, globalization, and economic
policies. Understanding trends helps policymakers, businesses, and job seekers adapt to changing
dynamics. Labor market challenges encompass issues like skills gaps, inequality, and
discrimination. Addressing these challenges requires collective efforts from policymakers,
businesses, and individuals to promote fairness and equal opportunities.
Conclusion:
In conclusion, the labor market is a complex system that significantly impacts the economy and
society. Understanding its components, trends, and challenges is crucial for informed decision-
making. Ongoing monitoring and addressing of labor market dynamics are essential for a sustainable
and thriving workforce.

Labor Supply
Definition: Labor supply is the total hours that workers or employees are willing to work at a given
wage.
A look at factors that determine an individuals supply of labor and the market supply of labor.
 Higher wages usually will encourage a worker to supply more labor because work is more
attractive compared to leisure.

 Therefore the supply curve for labor tends to be upwardly sloping.

  However, a worker isn’t just interested in earning money; they are also interested in leisure.
Therefore, there is a choice between working more (higher wage) and working less (more
leisure).

Two factors that influence a workers supply of labor

1. Substitution effect of a rise in wages

With higher wages, workers will give greater value to working than leisure. With work more
profitable, there is a higher opportunity cost of not working. The substitution effect causes more hours
to be worked as wages rise.

2. Income effect of a rise in wages

This occurs when an increase in wages causes workers to work fewer hours. This is because workers
can get a higher income by working fewer hours. Therefore they may work less.Therefore, after wage
rise, workers may work less because they can get their target income with fewer hours spent working.

 Up to W1, the substitution effect is greater than the income effect, and higher wages causes
more hours worked.
 After W2, the income effect outweighs the substitution effect. Now people work fewer hours
because they can get their target income from a lower number of hours
Market Supply of Labor

Market supply of labor for a particular vocation depends upon:

1. The number of qualified people
For example, the number of qualified accountants is low, therefore supply is quite inelastic. For a job
such as fast-food operator, the number of potentially qualified people is a high percentage of the labor
force, therefore supply is much more elastic
2. Difficulty of getting qualifications
If it is difficult to get particular qualifications, supply will be inelastic. For example, even if wages of
economics teachers rose, the supply would be quite inelastic – to become qualified would take several
years.
3. The non-wage benefits of a job
Unpleasant jobs will have fewer people willing to do them therefore supply will be relatively lower.
Although many unpleasant jobs, such as cleaning are relatively low-skilled so may still be low paid.
4. The wages and conditions of other jobs
If many jobs in a local area are considered unpleasant – e.g. fruit pickers, then the supply of
alternatives will be relatively higher.
 Labor Market Equilibrium
Definition
Order is not pressure which is imposed on society from without, but an equilibrium which is set
up from within.
The labor market is in equilibrium when supply equals demand; E* workers are employed at a
wage of w*. In equilibrium, all persons who are looking for work at the going wage can find a
job.

Workers prefer to work when the wage is high, and firms prefer to hire when the wage is low. Labor
market equilibrium “balances out” the conflicting desires of workers and firms and determines the
wage and employment observed in the labor market. By understanding how equilibrium is reached,
we can address what is perhaps the most interesting question in labor economics: Why do wages and
employment go up and down?
In this chapter we analyzes the properties of equilibrium in a perfectly competitive labor market. We
will see that if markets are competitive and if firms and workers are free to enter and leave these
markets, the equilibrium allocation of workers to firms is efficient; the sorting of workers to firms
maximizes the total gains that workers and firms accumulate by trading with each other.
We also will analyze the properties of labor market equilibrium under alternative market structures,
such as monopsonies and monopolies.
monopsonies (where there is only one buyer of labor) and monopolies (where there is only one
seller of the output). Each of these market structures generates an equilibrium with its own unique
features. Monopsonists, for instance, generally hire fewer workers and pay less than competitive
firms.
Equilibrium in a Single Competitive Labor Market
Once the competitive wage level is determined in this fashion, each firm in this industry hires workers
up to the point where the value of marginal product of labor equals the competitive wage. The first
firm hires E1 workers; the second firm hires E2 workers; and so on. The total number of workers
hired by all the firms in the industry must equal the market’s equilibrium employment level, E *
FIGURE 4.1 Equilibrium in a Competitive Labor Market
The labor market is in equilibrium when supply equals demand; E* workers are employed at a wage
of w*. In equilibrium, all persons who are looking for work at the going wage can find a job. The
triangle P gives the producer surplus; the triangle Q gives the worker surplus. A competitive market
maximizes the gains from trade, or the sum P+Q dollars.
Efficient Allocation
The allocation of persons to firms that maximizes the total gains from trade in the labor market is
called an efficient allocation . A competitive equilibrium generates an efficient allocation of labor
resources.
Competitive Equilibrium across Labor Markets
The discussion in the previous section focused on the consequences of equilibrium in a single
competitive labor market. The economy, however, typically consists of many labor markets, even for
workers who have similar skills. These labor markets might be differentiated by region (so that we
can talk about the labor market in the Northeast and the labor market in California), or by industry
(the labor market for production workers in the automobile industry and the labor market for
production workers in the steel industry).
Suppose there are two regional labor markets in the economy, the North and the South. We assume
that the two markets employ workers of similar skills so that persons working in the North are perfect
substitutes for persons working in the South. Figure 4-2 illustrates the labor supply and labor demand
curves in each of the two labor markets (S N and DN in the North, and SS and DS in the South). For
simplicity, the supply curves are represented by vertical lines, implying that supply is perfectly
inelastic within each region. As drawn, the equilibrium wage in the North, w N , exceeds the
equilibrium wage in the South, wS
Can this wage differential between the two regions persist and represent a true competitive
equilibrium? No. After all, workers in the South see their northern counterparts earning more. This
wage differential encourages southern workers to pack up and move north, where they can earn higher
wages and presumably attain a higher level of utility. Employers in the North also see the wage
differential and realize that they can do better by moving to the South. After all, workers are equally
skilled in the two regions, and firms can make more money by hiring cheaper labor.
If workers can move across regions freely, the migration flow will shift the supply curves in both
regions. In the South, the supply curve for labor would shift to the left (to S’S ) as southern workers
leave the region, raising the southern wage. In the North, the supply curve would shift to the right (to
S’N ) as the southerners arrived, depressing the northern wage. If there were free.
FIGURE 4-2 Competitive Equilibrium in Two Labor Markets Linked by Migration
The wage in the northern region ( wN ) exceeds the wage in the southern region ( w S ). Southern
workers want to move north, shifting the southern supply curve to the left and the northern supply
curve to the right. In the end, wages are equated across regions (at w * ). The migration of workers
reduces the gains from trade in the South by the size of the shaded trapezoid in the southern labor
market, and increases the gains from trade in the North by the size of the larger shaded trapezoid in
the northern labor market. Migration increases the total gains from trade in the national economy by
the triangle ABC.

entry and exit of workers in and out of labor markets, the national economy would eventually be
characterized by a single wage, w * . Note that wages across the two labor markets also would be
equalized if firms (instead of workers) could freely enter and exit labor markets. When northern firms
close their plants and move to the South, the demand curve for northern labor shifts to the left and
lowers the northern wage, whereas the demand curve for southern labor shifts to the right, raising the
southern wage. The incentives for firms to move across markets evaporate once the regional wage
differential disappears. As long as either workers or firms are free to enter and exit labor markets,
therefore, a competitive economy will be characterized by a single wage. 2
Policy Application: Payroll Taxes and Subsidies
Payroll tax:
A payroll tax is a percentage withheld from an employee's salary and paid to a government to
fund public programs.
What Makes Up Payroll Taxes?
Payroll taxes include all of the taxes on an individual's salary, wage, bonus, commission, and tips.
These taxes are used to pay for Social Security, Medicare, unemployment, government programs, and
local infrastructure.
Does Everyone Pay a Payroll Tax?

Yes, for the most part, everyone pays a payroll tax, which is automatically deducted from one's
paycheck. The Social Security and Medicare taxes are regressive (everyone pays the same amount),
while income tax is progressive (those that make more are taxed at a higher rate).
Figure 4.3 The Impact of a Payroll Tax Assessed on Firms:
 A payroll tax of $1 assessed on employers shifts down the demand curve (from D0 to D1 ). The
payroll tax cuts the wage that workers receive from w0 to w1 and increases the cost of hiring a worker
from w0 to w1+ 1.

It is worth noting that even though the legislation clearly states that employers must pay the payroll
tax, the labor market shifts part of the tax to the worker. After all, the cost of hiring a worker rises at
the same time that the wage received by the workers declines. In a sense, therefore, firms and workers
“share” the costs of the payroll tax.
A Tax Assessed on Workers :
The political debate over payroll taxes often makes it appear that workers are better off when the
payroll tax is assessed on the firm, rather than on the worker. In short, there seems to be an implicit
assumption that most workers would rather see the payroll tax imposed on firms, whereas most firms
would rather see the payroll tax imposed on workers. It turns out, however, that this assumption
represents a complete misunderstanding of how a competitive labor market works. It does not matter
whether the tax is imposed on workers or firms. The impact of the tax on wages and employment is
the same regardless of how the legislation is written.
FIGURE 4-4 The Impact of a Payroll Tax Assessed on Workers:
A payroll tax assessed on workers shifts the supply curve to the left (from S0 to S1). The payroll tax
has the same impact on the equilibrium wage and employment regardless of who it is assessed on.
The labor market equilibrium then shifts from A to B. At the new equilibrium, workers receive a wage
of w1 dollars from the employer, and total employment falls from E0 to E1 . Note, however, that
because the worker must pay a $1 tax per hour worked, the actual after-tax wage of the worker falls
from w0 to w1 1. The payroll tax assessed on the worker, therefore, leads to the same types of
changes in labor
market outcomes as the payroll tax assessed on firms. Both taxes reduce the take home pay of
workers, increase the cost of an hour of labor to the firm, and reduce employment.
FIGURE 4-5 The Impact of a Payroll Tax Assessed on Firms with Inelastic Supply:
A payroll tax assessed on the firm is shifted completely to workers when the labor supply curve is
perfectly inelastic. The wage is initially w0. The $1 payroll tax shifts the demand curve to D1, and the
wage falls to w0 1.

FIGURE 4-6 Deadweight Loss of a Payroll Tax

In a competitive equilibrium, E0 workers are hired at a wage of w0. The triangle P gives the
producer surplus and Q gives the worker surplus. The total gains from trade equal P Q. (b) The
payroll tax reduces employment to E1; raises the cost of hiring to w TOTAL; and reduces the worker’s
take-home pay to wNET. The triangle P* gives the producer surplus; the triangle Q* gives the worker
surplus; and the rectangle T gives the tax revenues. The net loss to society, or deadweight loss, is
given by the triangle DL.

Deadweight Loss :
Because payroll taxes typically increase the cost of hiring a worker, these taxes reduce total
employment—regardless of whether the tax is imposed on workers or firms. The after-tax
equilibrium, therefore, is inefficient because the number of workers employed is not the number
that maximizes the total gains from trade in the labor market.
Employment Subsidies The labor demand curve is shifted not only by payroll taxes but also by
government subsidies designed to encourage firms to hire more workers. An employment subsidy
lowers the cost of hiring for firms. In the typical subsidy program, the government grants the firm
a tax credit, say of $1, for every person-hour it hires. Because this subsidy reduces the cost of
hiring a person-hour by $1, it shifts the demand curve up by that amount, as illustrated in Figure
4-8 . The new demand curve ( D1 ) gives the price that firms are willing to pay to hire a particular
number of workers after they take account of the employment subsidy. Labor market equilibrium
shifts from point A to point B. At the new equilibrium, there is more employment (from E0 to E1
). In addition, the subsidy increases the wage that workers actually receive (from w0 to w1 ), and
reduces the wage that firms actually have to pay out of their own pocket (from w0 to w1 1).
FIGURE 4-7 The Impact of an Employment Subsidy :
An employment subsidy of $1 per worker hired shifts up the demand curve, increasing
employment. The wage that workers receive rises from w0 to w1. The wage that firms actually
pay falls from w0 to w1 1.
Summary
• A competitive economy where a homogeneous group of workers and firms can freely enter and exit
the market has a single equilibrium wage across all labor markets.
• There is no unemployment in a competitive labor market because all workers who wish to work can
find a job at the going wage.
• A competitive equilibrium leads to an efficient allocation of resources. No other allocation of
workers to firms generates higher gains from trade.
• A fraction of the payroll taxes imposed on firms is passed on to workers. The more inelastic the
labor supply curve, the higher the fraction of payroll taxes that is shifted to workers.
• The payroll tax creates a deadweight loss.
• A payroll tax has the same impact on wages and employment regardless of whether it is imposed on
workers or on firms.