The wage rate is not the only factor that affects the demand for labour; there are other factors that will influence the position of the demand curve for labour. The amount of output that labour is able to produce is one factor. If labour becomes more productive for some reason, then this will lead to an increase in the demand for labour. For example if a technological advance raises the
productivity of labour then their will be a rightward shift (positive) of the labour demand curve and so more labour would be demanded per time period.
A negative leftward shift of the labour demand curve could also occur. One reason for this is if the revenue that a firm receives from selling the output that labour produces falls. If less is demanded then this will have a knock on effect on labour as it is a derived demand. Initially the firm was demanding L0 but the fall in demand for the product leads to a fall in the revenue that the firm receives from selling the good so the labour demand curve shifts leftward.
Elasticity
of Demand for Labour
Elasticity of Demand for Labour measures the sensitivity of a
firm’s demand for labour to a change in the wage rate. One significant effect
on the elasticity of demand for labour is the extent to which other factors of
production such as capital can be substituted for labour in the production
process. If capital or some other factor can be readily substituted for labour,
then an increase in the wage rate (ceteris paribus) will induce the firm to
reduce its demand for labour by relatively more than if there were no
substitute for labour. The extent to which labour and capital are substitutable
varies between economic activities and depending on the technology of
production as there may be some sectors in which it is relatively easy for
labour and capital to be substituted.
Another factor is the share of labour costs in the firm’s
total costs, in many service activities labour is a highly significant share of
total costs and so firms tend to be sensitive to changes in the cost of labour.
Thirdly capital will tend to inflexible in the short run. Therefore if a fi
faces an increase in wages it may have little flexibility in substituting
towards capital in the short run so the demand for labour may be relatively
inelastic. However in the long run the firm will be able to adjust the factors
of production towards a different overall balance. Therefore the elasticity of
demand for labour is likely to be higher in the long run than in the short run.
As demand for labour is a derived demand, the price
elasticity of demand for the product must also be taken into account. The more
price elastic in demand the product is, the more sensitive the firm will be to
a change in the wage rate, as high elasticity of demand for the product limits
the extent to which an increase in wage costs can be passed onto consumers in
the form of higher prices.
The Supply
of Labour
On the supply side of the labour market there are factors to
consider that will influence the quantity of labour that workers wish to
supply.
For an individual worker, the supply will be determined
mostly by the wage rate. At a higher rate, an individual worker will generally
be prepared to work for a longer quantity of time. This produces an upward
sloping curve for an individual’s supply of labour.
In overall terms of labour supply, there is also an upward
sloping curve. Wages act as a signal to workers about which industry is
offering the best return for work. If an industry is offering a higher wage
then they will reallocate their resources to this industry (providing they have
sufficient education for this).
Leftward and Rightward Shifts of the Labour Supply Curve
A factor that could induce a leftward (negative) shift of the labour supply curve is a rise in the rate of unemployment benefits. A rightward shift could be induced by a rising population or increased immigration.
Labour Market Equilibrium
Equilibrium is found where the demand and supply curves for labour intersect. If the wage is lower than W* then firms will not be able to fill all their vacancies, and so will have to offer higher wages to attract more workers. If the wage is higher than W* there will be an excess supply of labour and the wage will drift down until W* is reached and equilibrium is obtained.
This equilibrium point is constantly changing, as higher wages in this market now encourages workers to switch from other industries in which wages have not risen which will lead to a long term shift to the right of the labour supply curve.
If the Demand for labour shifts right then there will be an increase in the wage and a higher quantity of labour. If there is a leftward shift in demand then there will be a fall in wages and a lower quantity of labour.
Wage Differentials
Wage differential is the difference in wages that someone in a different profession would earn to someone else. Highly skilled workers have relatively inelastic supply due to the length of time they have to spend in education. This means that wages don’t massively influence their decision to do the job. Therefore wage rises or decrease don’t affect the supply massively and currently skilled workers are unlikely to exit the market for a small wage decrease as they have spent so long training to do that particular profession.
On the other hand unskilled workers have more elastic supply, so a wage rise will encourage more workers to switch to the trade and so wages would eventually fall and vice versa.
The Effects of Migration
By adding to labour supply, migration enables an expansion in the productive capacity of the economy, thus enabling economic growth to take place.
