Why does a heart surgeon earn ten times a care worker who arguably does more good? The labour market is just demand and supply — but with humans on the supply curve, which changes everything.
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Labour is not wanted for its own sake. The demand for labour is a derived demand — derived from the demand for the output it produces. When demand for new housing collapses, demand for bricklayers collapses with it.
A profit-maximising firm hires a worker if that worker adds at least as much to revenue as to cost. That is marginal revenue product (MRP):
The firm hires up to the point where MRP = the wage. Because of diminishing marginal returns, MPP eventually falls as more workers are added to fixed capital — so the MRP curve slopes downward, and the MRP curve IS the firm's demand curve for labour.
An extra worker produces 12 extra units a day. The firm is a price taker and sells each unit for £9.
MRP = 12 × £9 = £108 a day. If the daily wage is £90, hire them — they add £18 to profit. If the wage were £120, do not.
Shifters of labour demand: demand for the final product; labour productivity (training, technology); the price of capital (if machines get cheaper, firms substitute capital for labour); employment taxes and regulation; the number of firms.
Wage elasticity of demand for labour is higher when: labour is a large share of total costs; capital is a close substitute; demand for the final product is price elastic; and in the long run (firms have time to reorganise and automate).
Criticisms of MRP theory: MPP is often impossible to measure (what is a teacher's marginal physical product?); output is usually the result of teamwork, not individuals; it ignores trade unions, monopsony, discrimination and imperfect information; and wages in reality are sticky and set by bargaining, not recomputed daily.
The supply of labour to an industry slopes upward: a higher wage attracts workers from other occupations and encourages more hours.
Shifters of labour supply: population and net migration; the wage in alternative occupations; non-monetary benefits (job satisfaction, status, holidays, danger); the qualifications and training required; barriers to entry (professional licensing); the value of leisure; taxes and benefits; and the mobility of labour.
Wage elasticity of supply is low (inelastic) where long training or rare talent is required (surgeons, airline pilots, Premier League strikers) and high (elastic) for low-skilled work where anyone can step in. Supply is more elastic in the long run, as people retrain.
The backward-bending supply curve. For an individual, above some wage the income effect can outweigh the substitution effect: you are now rich enough to buy more leisure, so you work fewer hours as the wage rises. It is one of the few places in economics where a supply curve bends back on itself.
Transfer earnings = the minimum payment needed to keep a factor in its present use — its opportunity cost (what it could earn in its next best job).
Economic rent = any payment above transfer earnings — a pure surplus.
A footballer earns £80,000 a week. His next best job (coaching) would pay £900 a week.
Transfer earnings = £900 (he would still play for anything above that). Economic rent = 80,000 − 900 = £79,100 a week — almost the entire wage, because his talent is in near-perfectly inelastic supply.
The competitive model assumes many buyers and many sellers of labour. Reality is lumpier.
Trade unions act as a monopoly seller of labour, bargaining collectively to raise the wage above the competitive level.
Monopsony — a single (or dominant) buyer of labour: the NHS for nurses, a large employer in a one-industry town, a supermarket chain in a small local market.
Bilateral monopoly — a monopoly union facing a monopsony employer. The outcome is indeterminate in theory: it depends on relative bargaining power. But the striking result is that a union facing a monopsonist can raise the wage AND raise employment at the same time — because it removes the monopsonist's incentive to restrict hiring. The union simply claws back the surplus the monopsonist was extracting.
This is the key to the minimum wage debate. In a competitive labour market a minimum wage above equilibrium causes unemployment. In a monopsonistic one it can raise wages and employment. Which world we are in is an empirical question — and the modern evidence (Card & Krueger onwards) suggests low-wage labour markets have significant monopsony power, which is why the UK's National Living Wage has raised pay with far less job loss than the competitive model predicted.
A national minimum wage (NMW) is a price floor in the labour market. To bite, it must be set above the market equilibrium wage.
The competitive-market prediction: at the higher wage, quantity of labour supplied rises and quantity demanded falls → excess supply = unemployment. The job losses are larger where labour demand is elastic (labour is a big share of costs, capital substitutes easily, the product's demand is price elastic).
Arguments for: reduces in-work poverty and inequality; raises the incentive to work rather than claim benefits; higher pay can raise motivation and productivity (efficiency wage theory), partly paying for itself; higher incomes for low earners (who have a high MPC) raise aggregate demand; counters monopsony exploitation.
Arguments against: possible unemployment among the least skilled — the very group it aims to help; firms may cut hours, training, or non-wage benefits instead; higher costs may be passed on as prices (cost-push inflation) or trigger automation; small firms may fail; and it does not help the unemployed or those in workless households at all.
The evaluation that scores: the effect depends entirely on (a) how far above equilibrium the wage is set, (b) the wage elasticity of demand for labour, and (c) whether the market is competitive or monopsonistic. The UK Low Pay Commission raises the rate gradually and evidence-led precisely to stay on the right side of that line.
Why wages differ between occupations, regions, genders and ethnic groups:
Discrimination occurs when workers of equal productivity are paid differently, or hired differently, because of gender, ethnicity, age or disability. Model it as the employer perceiving a lower MRP for the discriminated group: their demand curve shifts left, so the wage and employment level both fall — while the favoured group's rises.
Labour market flexibility — how quickly wages, hours and employment adjust. Flexible markets (weak unions, easy hiring/firing, zero-hours contracts) can cut structural unemployment and help firms adjust to shocks — but at the cost of insecurity, lower training investment and in-work poverty. That trade-off is a live UK policy debate.
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Derived demand. Labour is wanted for what it produces. D for labour = MRP = MPP × MR; hire while MRP ≥ W.
Supply. Driven by wages elsewhere, training requirements, non-monetary factors and mobility. Long training → inelastic supply.
Wage = transfer earnings + economic rent. The more inelastic supply, the greater the rent.
Trade unions. Monopoly seller: raise the wage, but risk unemployment — unless they raise productivity or face a monopsonist.
Monopsony. MCL lies above supply → fewer workers, lower wage. This is why a minimum wage can raise pay AND jobs.
Wage differentials. MRP differences, supply elasticity, compensating differentials, immobility, imperfect information and discrimination.
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