How the labour market works
The labour market is where workers and employers meet: workers offer their labour and employers offer jobs and wages. It is a factor market, so the sides are the reverse of a product market — and that reversal is what makes it confusing at first.
Workers supply labour. The higher the wage, the more people are willing to work, and the more hours they will work, so the supply curve slopes upwards.
Employers demand labour. The higher the wage, the more each worker costs, so firms hire fewer, and the demand curve slopes downwards.
Where they cross is the equilibrium wage, and the number of workers employed at it. Everything else in this sub-topic is about what moves those two curves.
Demand for labour is described as derived demand: firms do not want workers for their own sake, they want them because of what those workers produce. So demand for labour rises when demand for the firm's product rises, and collapses when it falls. That is the link between 2.2 and unemployment in 3.2.
What shifts the demand for labour:
• Demand for the product — more customers means more workers needed • Productivity — a more productive worker is worth more to the firm, so demand rises • The price of capital — if machines become cheaper than workers, firms substitute machinery for labour and demand for labour falls • The state of the economy — in a recession firms cut hiring across the board
What shifts the supply of labour:
• Qualifications and training required — the more demanding these are, the fewer people can do the job, so supply is lower • Length and cost of training — a job requiring seven years of study has a small supply • Working conditions — dangerous, unpleasant or unsociable work attracts fewer people • Population and migration — a larger working-age population raises supply • Non-wage benefits — pensions, holidays and job security attract workers at any given wage
Worked example
Explain why a surgeon is paid far more than a shop assistant, using supply and demand.
- Take supply first, since it does most of the work here.
- Becoming a surgeon requires many years of expensive education and training, and high ability, so very few people can do the job — the supply of labour is very low.
- Working as a shop assistant requires little formal training, so almost anyone can do it — supply is very high.
- Now demand. Hospitals need surgeons and there is no substitute for one, so demand is strong and inelastic.
- Demand for shop assistants exists but each one is easily replaced, and self-service checkouts substitute for them.
- Put the two together, since the wage is set by both, not by one.
Answer: The supply of surgeons is very low, because the qualifications take many years and few people can obtain them, while demand from hospitals is high and there is no substitute. Low supply and high demand together produce a high equilibrium wage. The supply of shop assistants is very high because little training is needed, and demand is more easily satisfied because workers are readily replaced or substituted by machines, so the equilibrium wage is low.
- Labour market
- the factor market where workers supply their labour and employers demand it, offering jobs and wages; the sides are the reverse of a product market
Gross and net pay
- Gross pay
- Total earnings before any deductions are taken off.
- Net pay
- What is actually received — gross pay minus deductions. Also called take-home pay.
- Income tax
- A tax on earnings, paid to the government. There is a personal allowance that is not taxed at all, and higher earnings are taxed at higher rates.
- National Insurance
- A further deduction from earnings, funding the state pension and some benefits.
- Pension contribution
- Money taken from pay and put into a pension scheme for the worker's own retirement.
The calculation the specification asks for is:
net pay = gross pay − income tax − National Insurance − pension contributions
Exam questions supply the rates rather than expecting you to know them, so the skill is applying whatever figures are given carefully and in the right order — deductions come off the gross, not off each other.
Worked example
A worker earns £2,400 gross a month. Income tax takes 20%, National Insurance 8%, and a pension contribution 5%, each of gross pay. Calculate the deductions and the net pay.
- Income tax: 20% of £2,400 = £480.
- National Insurance: 8% of £2,400 = £192.
- Pension: 5% of £2,400 = £120.
- Total deductions: £480 + £192 + £120 = £792.
- Net pay: £2,400 − £792 = £1,608.
- Check the proportion: the deductions come to 33% of gross, so net pay should be 67% of £2,400, which is £1,608.
Answer: Deductions are £480 income tax, £192 National Insurance and £120 pension, totalling £792. Net pay is £1,608 — 67% of gross pay.
The link worth carrying into Component 2: income tax is a direct tax, and changing its rate is fiscal policy (3.5). A cut in income tax raises net pay without changing gross pay at all, so consumers have more to spend — which shifts demand right across many markets. That is the chain a question about a tax cut is looking for.
Common mistake
Deductions are taken from gross pay, not from each other. Calculate each as a percentage of the gross figure, then subtract the total once.
Before you practise
- Workers supply labour and firms demand it — the reverse of a product market.
- The supply of labour slopes upwards; the demand for labour slopes downwards.
- Demand for labour is derived demand: it comes from demand for the product.
- Demand for labour shifts with product demand, productivity, the cost of machinery and the state of the economy.
- Supply of labour shifts with qualifications, length of training, working conditions, population and non-wage benefits.
- Wages are high where supply is low and demand is high.
- Gross pay is before deductions; net pay is what is received.
- net pay = gross − income tax − National Insurance − pension contributions.
- Calculate each deduction from gross pay, then subtract the total.