LABOUR MARKETS

THE DEMAND FOR LABOUR

The demand for labour is the firm’s willingness to employ labour at each given 

wage rate.  As the wage rate rises the demand for labour will fall and vice 

versa.

The reasons for this are:

•  As wages increase firms will look to substitute labour for something 

cheaper i.e. capital (machinery). 

•  As wages increase, this puts up costs of production, which will in turn 

put up the price of the product, as prices rise demand falls, therefore 

with less of the product demand there will be less need for labour. 

THE SUPPLY OF LABOUR

The supply of labour is the employees willingness to work at each given wage 

rate.  As the wage rate rises more labour will be supplied and vice versa.

The reasons for this are:

•  Higher wages attract worker from other industries.

•  Higher wages attract people who are currently unemployed.

•  In the long term higher wages encourage people to train to work in that 

occupation.

EQUILIBRIUM

This is established where demand for labour equals supply of labour.  As 

shown in the following diagram: 

SHIFTS IN DEMAND AND SUPPLY

The demand for labour can shift to the right because:

•  Demand for the product has increased.

•  Labour productiveness has increased (through better training, 

education and technology). 

•  Price of capital increases making it relatively cheaper to employ labour.

The diagram below shows the effects:

An increase in the demand for labour also increases both wages and the 

quantity of labour employed.

The supply of labour can shift to the right because:

•  Increase in population.

•  Working conditions have improved (or deteriorated in an alternative 

industry).

•  Increase in training and education (long term).

The effects are shown below:

An increase in the supply of labour causes wages to fall and a rise in the 

quantity of labour employed.

EFFECTS OF A MINIMUM WAGE

A minimum wage is very similar to a minimum price.  The idea of a minimum 

wage is to guarantee a reasonable wage to workers in low paid industries.  

The diagram below shows the effects of a minimum wage: 

The minimum wage is set at Wm above the equilibrium wage W1.  The workers 

in the industry have indeed benefited from higher wages, but there are a few 

negative effects:

The minimum wage has cause a surplus (excess supply of workers), as far as 

the labour market is concerned this has created unemployment in the industry 

equal to Qs – Qd.

Q1 – Qd have now lost their jobs (these people were originally working before 

the minimum wage was introduced). 

INCOME ELASTICITY OF DEMAND

The demand for a good will change if consumers' incomes change, income
elasticity of demand measures that change. If the demand for housing were to
increase by 20% in response to a 5% increase in income, the income
elasticity of demand would be positive and relatively high.


If the demand for corned beef fell by 8% in response to the 5% increase in
income, then income elasticity of demand would be negative and relatively
small.


If the demand for food remained unchanged in response to an increase in
income, then the income elasticity of demand would be zero.


It is important to note that the distinction between income elasticity of demand
and price elasticity of demand here. Whether income elasticity has a positive
or negative sign is of vital importance. A positive income elasticity of demand
means that an increase in income will lead to an increase in demand for the
good in question. Conversely a negative income elasticity of demand means
that an increase in income will lead to a fall in demand for the good in
question.

The formula for measuring income elasticity of demand is:

%percentage change in quantity demanded/%percentage change in income  

(Not quite QPR, but Q is still on the top!)

Some simple calculations are shown below.

VALUES OF INCOME ELASTICITY

•  Income elastic demand - a good or service has an income elastic 

demand if income elasticity is greater than 1. A 1% change in income 

causes a greater than 1% change in quantity demanded. These are 

called luxury goods, e.g. foreign holidays.

•  Income inelastic demand - the value of income elasticity is between 0 

and 1. A 1% change in incomes causes a less than 1% change in 

quantity demanded. As the quantity demanded doesn't change a great 

deal in response to income we can assume the good is a necessity, 

e.g., food and clothes.

•  Negative income elasticity - in this case a change in income will bring 

about an opposite change in quantity demanded. If income goes up the 

quantity demanded will go down. The good is described as inferior, 

e.g., happy shopper bread.

Different income elasticities of demand are shown in the table below: 

CROSS ELASTICITY OF DEMAND

CROSS ELASTICITY OF DEMAND

The quantity demanded of a particular good varies according to the price of 

other goods. Cross elasticity of demand measures the responsiveness of the 

quantity demanded of one good to changes in the price of another. 

The formula for measuring cross elasticity of demand for good X is:

% change in quantity demanded of good X/% change in price of another good Y   OR  

% change in quantity demanded of good X DIVIDED BY% change in price of another good Y 

Two goods which are substitutes will have a positive cross elasticity. An 

increase in the price of one good (e.g. mars bars) will lead to an increase in 

the quantity demanded of a substitute (e.g. snickers).

Two goods which are complements will have a negative cross elasticity. An 

increase in the price of one good (e.g. computers) will lead to a fall in demand 

of a complement (e.g. computer games). 

The cross elasticity of two goods which have no relationship to each other 

would be 0 (e.g. jelly and pot plants).