AQA A-level Economics: Demand and supply of labour and competitive labour markets (7136)

This guide follows the AQA AS and A-level Economics specification (version 1.3, 29 June 2022) for the A-level, first taught from September 2015. It covers three parts of the labour market content: the demand for labour and marginal productivity theory, influences upon the supply of labour, and wage determination in perfectly competitive labour markets. The AQA website numbers them 3.1.6.1 to 3.1.6.3 and the combined specification PDF prints them as 4.1.6.1 to 4.1.6.3. The specification states no AS-only or A-level-only labels for this content. Imperfect labour markets, trade unions, the National Minimum Wage and discrimination are separate units and are not taught here. All firms, places and figures below are invented for illustration.

For quick recall use the revision notes, then try the practice questions. The AQA A-level Economics hub, the printable checklist and the free 10-minute diagnostics help you plan your revision.

What you must be able to do

Section	Content	What to show
3.1.6.1	Derived demand, marginal productivity theory, the demand curve, shifts, elasticity	Calculate MPP and MRP, find the profit-maximising employment, explain shifts and elasticity determinants
3.1.6.2	Monetary and non-monetary influences on occupational labour supply, the supply curve, shifts	Explain why people choose an occupation and what shifts market supply
3.1.6.3	Wage determination in a perfectly competitive labour market, market forces, relative wages	Draw and use the model, explain wage differences, appreciate its limits

The specification says you are not required to understand the determinants of an individual’s supply of labour or the backward-bending supply curve. Everything below is about the supply of labour to an occupation or market.

1. The demand for labour (3.1.6.1)

Derived demand

Firms do not want workers for their own sake. They want the output workers help to produce. The demand for a factor is derived from the demand for the product. If demand for the product rises, firms want more output and so want more workers. If households stop buying a product, the demand for the workers who made it falls too.

Marginal productivity theory

The theory says a profit-maximising firm hires labour up to the point where the value of the last worker’s contribution equals the cost of employing that worker.

• Marginal physical product (MPP): the extra output from employing one more worker, holding other factors fixed.
• Marginal revenue product (MRP): the revenue earned by the output of one additional worker. MRP = MPP × marginal revenue. If the firm sells at a fixed price, marginal revenue equals price.
• Marginal cost of labour: the extra cost of one more worker. In a competitive labour market this is the wage.

The rule: hire another worker while MRP is at least the wage. Stop when the next worker would add less than the wage.

MPP falls as more workers share fixed capital (diminishing marginal returns), so MRP falls, and the MRP curve slopes downwards.

Worked example. A small ceramics studio (illustrative) sells mugs at £8 each and has a fixed number of kilns. Its daily output depends on the number of workers.

Workers	Total output (mugs)	MPP	MRP at £8	MRP at £10
1	14	14	£112	£140
2	26	12	£96	£120
3	36	10	£80	£100
4	44	8	£64	£80
5	50	6	£48	£60
6	54	4	£32	£40
7	56	2	£16	£20

Working for worker 4: MPP = 44 − 36 = 8 mugs, so MRP = 8 × £8 = £64.

If the market wage is £58 a day, the fourth worker adds £64 and costs £58, so she is worth hiring. The fifth adds £48 and costs £58, so the studio stops at 4 workers.

The demand curve for labour

The firm’s demand curve for labour shows the relationship between the wage rate and the number of workers employed. It is the MRP curve. From the table at £8: a wage of £58 gives 4 workers; £70 gives 3 (the fourth adds only £64); £30 gives 6. A change in the wage causes a movement along the curve.

Shifts in the demand curve

A shift means a different number of workers at every wage. Causes:

• Demand for the product. If the mug price rises from £8 to £10, MRP rises at every level of employment. At £58 the fifth worker now adds £60, so employment rises from 4 to 5 and the curve shifts right. This is the derived demand link.
• Productivity. Better training or better kilns raise MPP and so MRP.
• Price of other factors. If machines become cheaper and can replace workers, demand for labour falls. If a complement becomes cheaper, demand may rise.
• Technology and the size of the market. More firms in the industry add to market demand for labour.

Elasticity of demand for labour

Wage elasticity of demand for labour is found by dividing the percentage change in employment by the percentage change in the wage.

Worked example. A textile mill (illustrative) raises its wage from £15.00 to £16.50 an hour. Employment falls from 800 to 728 workers.

• Wage change: (16.50 − 15.00) ÷ 15.00 × 100 = +10%
• Employment change: (728 − 800) ÷ 800 × 100 = −9%
• Elasticity: −9 ÷ 10 = −0.9. Demand is inelastic.
• Hourly wage bill: £12,000 before (800 × £15.00), £12,012 after (728 × £16.50), up by 0.1%.

If employment had fallen to 640 (−20%), elasticity would be −2.0 (elastic) and the bill would fall from £12,000 to £10,560, down 12%.

Determinants of the elasticity of demand for labour:

1. Substitutability of capital for labour. If machines can easily do the job, a wage rise sends employment down sharply. Demand is more elastic.
2. Price sensitivity of customers (the elasticity of demand for the product). Where a wage rise lifts prices and customers walk away, output and employment fall a lot.
3. Labour’s share of total costs. Suppose labour is 70% of costs. A 10% wage rise raises total costs by about 7%. If labour is 10% of costs, the same rise lifts costs by about 1%. The first firm feels more pressure to cut jobs.
4. Time period. Over a long period firms can change their methods and find substitutes, so demand is more elastic.

Evaluating marginal productivity theory. It assumes the firm can measure each worker’s contribution, which is hard in team work or in jobs such as teaching where output is not sold at a price. It assumes workers are identical, the firm maximises profit, and other factors can be held fixed. Even so, it explains why firms respond to changes in wages and product demand.

2. The supply of labour (3.1.6.2)

The supply of labour to a particular occupation is influenced by monetary and non-monetary considerations.

Monetary: the wage on offer, bonuses, overtime, pension contributions, and the pay in other occupations. A higher wage relative to other jobs attracts more people into the occupation.

Non-monetary: job satisfaction (or dissatisfaction) and working conditions. Examples: meaningful work, status, hours, flexibility, safety, risk, location, job security, and the length of training needed. Pleasant jobs attract workers at lower pay. Unpleasant or dangerous jobs need higher pay to attract the same numbers. This is one reason pay differs between occupations.

The supply curve for labour shows the relationship between the wage rate and the number of workers willing to work in an occupation. It slopes upwards because a higher wage in this occupation, relative to others, draws in more workers. A wage change moves you along the curve.

Shifts in market supply. The curve shifts when the quantity supplied changes at every wage. Causes:

• Changes in the size and age structure of the working population, including migration.
• Wages and conditions in other occupations. If a rival occupation improves its pay, supply here shifts left.
• Qualifications and training: a new licence requirement shifts supply left, while cheaper or shorter training shifts it right.
• Changes in non-monetary features, such as a reputation for stressful work.
• Barriers to entry and the willingness of workers to move between regions or jobs.

3. Wage determination in a perfectly competitive labour market (3.1.6.3)

The economists’ model

The model assumes:

• many employers and many workers, so none can influence the wage;
• identical (homogeneous) workers, so one is a perfect substitute for another;
• full information about wages and jobs;
• workers can move freely between jobs and areas.

Each firm is then a wage taker: it finds all the workers it wants available at the going market wage. The supply of labour to one firm is perfectly elastic (a horizontal line at the market wage), and the firm hires up to where MRP = wage.

The market

Worked example. In the market for qualified electricians in Country A (illustrative), with W the wage per hour in £ and quantities in workers:

• Demand: QD = 1,260 − 40W
• Supply: QS = 25W − 300

Wage (£)	Demand	Supply	Position
18	540	150	Shortage of 390
21	420	225	Shortage of 195
24	300	300	Equilibrium
27	180	375	Surplus of 195
30	60	450	Surplus of 390

Equilibrium: 1,260 − 40W = 25W − 300, so 1,560 = 65W and W = £24, with 300 workers employed.

Wage
 |  \                /  S
 |   \              /
 |    \     E     /
 |     \    *    /       E: wage 24, 300 workers
 |      \       /
 |       \    / \
 |        D       \
 +----------------------- Number of workers

Market forces. Below £24 employers cannot fill vacancies and bid the wage up, which draws in more workers and reduces the quantity demanded. Above £24 more people seek work than firms want to hire, and competition among job seekers pulls the wage down.

A demand shift. Demand for electricians rises by 130 at every wage: QD = 1,390 − 40W. Then 1,390 − 40W = 25W − 300 gives W = £26 and Q = 350. Both wage and employment rise.

A supply shift. A new licence requirement cuts supply by 65 at every wage: QS = 25W − 365. With the original demand, 1,260 − 40W = 25W − 365 gives W = £25 and Q = 260. The wage rises and employment falls.

Relative wage rates

Market forces explain why wages differ between occupations. Take two markets with the same demand, QD = 900 − 20W.

• Market P needs no formal training and supply is QS = 30W − 100. Equilibrium: W = £20, Q = 500.
• Market T needs a long qualification and supply is QS = 10W. Equilibrium: W = £30, Q = 300.

The relative wage T : P is 30 ÷ 20 = 1.5. Scarce skills and costly training make supply of T small and the wage high.

Now demand for T rises to QD = 1,050 − 20W. Then 1,050 − 20W = 10W gives W = £35, Q = 350, and the relative wage is 35 ÷ 20 = 1.75. High wages attract entrants, so supply shifts right, say to QS = 10W + 60. Then 1,050 − 20W = 10W + 60 gives W = £33, Q = 390, and the relative wage falls to 33 ÷ 20 = 1.65. Entry narrows the gap, but long training can mean this takes years.

Evaluation. The specification asks you to appreciate that all real-world markets are imperfectly competitive to a greater or lesser extent. Workers differ, information is poor, moving home is costly, and some employers or workers have market power. Wages may also be slow to adjust. The model is still a useful benchmark for predicting the direction of change.

Common errors

• Drawing a new demand curve when only the wage has changed. A wage change is a movement along the existing curve.
• Using MRP = MPP × wage. The correct formula is MPP × marginal revenue (price when price is fixed).
• Forgetting that derived demand means a change in product demand shifts labour demand.
• Mixing up shifts and movements on the supply curve when the wage in another occupation changes.
• Writing about individual labour supply or the backward-bending curve, which the specification does not require.

Official syllabus

AQA AS and A-level Economics (7135 and 7136), specification version 1.3, 29 June 2022, published by AQA. A-level content: the labour market sections on the demand for labour, influences upon the supply of labour, and perfectly competitive labour markets.