AQA GCSE Economics: The labour market: wage determination, differentials and gross and net pay (8136)

This guide covers section 3.1.5.4, The labour market, in AQA’s GCSE Economics (8136) specification, which was first taught from September 2017. It sits inside 3.1.5, Competitive and concentrated markets, which belongs to Paper 1, How markets work. The specification has no tiers, so everything here is for every candidate. All places, firms and figures are invented for practice. For fast recall, turn to the revision notes, and then try the practice questions. To plan your revision, see the course hub, the printable checklist and the free diagnostics.

What you must be able to do

Spec point	What it asks of you
3.1.5.4 role and operation of the labour market	Explain who buys and sells labour and what the wage does
Determination of wages through supply and demand	Use simple demand and supply analysis to find and change a wage
Wage differentials	Explain pay gaps within and between occupations
Gross and net pay	State the difference between them
Calculating income	Work out gross pay, deductions, net pay and total income

The role and operation of the labour market

A labour market is where workers (the sellers of labour) and employers (the buyers) meet. The price is the wage. The market does three jobs. It matches people to jobs, it signals where workers are scarce through higher wages, and it gives workers an income.

Demand for labour is what firms want to hire. It is derived demand, because a firm values a worker only through the goods or services that worker helps to sell. If customers buy more bread, bakeries want more bakers. Demand for labour slopes downwards: a higher wage makes each worker cost more, so firms hire fewer, and may swap to machines.

Supply of labour comes from people. A higher wage makes the job more attractive, so more people are willing and able to do it. The supply curve slopes upwards.

Factors that shift demand (change the number wanted at every wage):

• Demand for the product. A boom raises it; a fall lowers it.
• Productivity, meaning output per worker. More productive workers are worth more to the firm.
• The cost and quality of substitutes such as machines.

Factors that shift supply (change the number willing at every wage):

• The number of people with the skills, which depends on population, training places and migration.
• The pay and conditions in other jobs. If a rival job pays more, supply to this job falls.
• The qualifications, training time or risk the job involves.
• Non-wage benefits such as hours, location and holidays.

Wage determination by demand and supply

The equilibrium wage is the wage at which the number of workers wanted equals the number willing to work. Below it, there is a shortage of workers, and employers compete by raising pay. Above it, there is a surplus, so some people are unemployed or accept lower pay.

Worked example 1. Region C (illustrative) has a market for care workers. Demand is Qd = 240 − 12W and supply is Qs = 12W − 48, where W is the hourly wage in pounds and Q is the number of workers.

Wage (£ per hour)	Demanded	Supplied	Result
8	144	48	Shortage of 96
10	120	72	Shortage of 48
12	96	96	Equilibrium
14	72	120	Surplus of 48
16	48	144	Surplus of 96

Equilibrium: 240 − 12W = 12W − 48, so 288 = 24W and W = £12. Then Q = 240 − 144 = 96 workers. At £10 there is a shortage of 120 − 72 = 48, so employers bid pay up towards £12.

Sketch in words: put the wage on the vertical axis and the number of workers on the horizontal axis. The demand curve falls from left to right, the supply curve rises, and they cross at £12 and 96 workers.

A change in demand. Suppose a new care home opens, raising demand by 24 workers at every wage: Qd = 264 − 12W. Then 264 − 12W = 12W − 48, so 312 = 24W, W = £13 and Q = 108. Wage and employment both rise.

A change in supply. Suppose more people train as carers, raising supply by 24 at every wage: Qs = 12W − 24. Then 240 − 12W = 12W − 24, so 264 = 24W, W = £11 and Q = 108. Employment rises but the wage falls.

Learn the pattern. A rise in demand pushes the wage up. A rise in supply pushes it down. A fall in demand or supply does the reverse.

Wage differentials

A wage differential is a difference in pay. It can be between occupations (a surgeon and a cleaner) or within an occupation (a trainee and an experienced worker doing the same kind of job). Both can be explained with demand and supply.

Between occupations, the usual causes are:

• Skills and qualifications. Few people can do the job, so supply is low and the wage is high.
• Training time and cost. Workers need pay that makes years of study worthwhile.
• Risk and conditions. Dangerous, unsocial or stressful jobs may need higher pay to attract workers.
• Demand and productivity. If each worker brings in a lot of revenue, firms bid wages up.

Within an occupation, the usual causes are:

• Experience and seniority. Experienced staff are more productive.
• Performance. Bonuses and commission reward results.
• Extra qualifications or responsibility. A supervisor is paid more than a team member.
• Location. Some areas have a higher cost of living or fewer workers.

Worked example 2. In Country A (illustrative), the market for skilled welders has Qd = 120 − 4W and Qs = 4W − 40. Then 160 = 8W, so W = £20 and Q = 40. For general helpers, Qd = 300 − 10W and Qs = 20W, so 300 = 30W, W = £10 and Q = 200.

The differential is 20 − 10 = £10 per hour. Welders earn (10 ÷ 10) × 100 = 100% more than helpers. Chain of reasoning: welding needs training, so few people can supply the skill (supply is low). Firms still value welders, so demand is strong. A small supply with strong demand gives a high wage. Helpers are plentiful, so supply is large and the wage is lower.

Within an occupation, example. A trainee electrician earns £9.50 an hour and an experienced one £19. The gap is £9.50, which is (9.50 ÷ 9.50) × 100 = 100% more. Notice the base: the trainee earns 50% less than the experienced worker, while the experienced worker earns 100% more than the trainee. Say which pay you are comparing against.

Evaluation. Differentials need not close quickly. Training takes years, workers may not be able or willing to move, and some people choose a job for reasons other than pay.

Gross and net pay

Gross pay is total pay before anything is taken off. It includes basic pay, overtime, bonuses and commission. Net pay, also called take-home pay, is what is left after deductions.

Common deductions are income tax, National Insurance (a payment by employees and employers that helps pay for state benefits) and pension contributions.

Gross pay − deductions = net pay

Rates and allowances change over time and between countries. In exam questions, use the rates given in the question.

Worked example 3. A shop assistant (illustrative) works a 35-hour week at £12 an hour, plus 5 hours of overtime paid at time and a half. In this illustration, income tax is 20% of gross pay above £110 a week, National Insurance is 10% of gross pay above £110, and a pension contribution is 5% of gross pay.

• Basic pay: 35 × 12 = £420.
• Overtime rate: 12 × 1.5 = £18 an hour. Overtime: 5 × 18 = £90.
• Gross pay: 420 + 90 = £510.
• Pay above £110: 510 − 110 = 400.
• Income tax: 20% × 400 = £80. National Insurance: 10% × 400 = £40. Pension: 5% × 510 = £25.50.
• Total deductions: 80 + 40 + 25.50 = £145.50.
• Net pay: 510 − 145.50 = £364.50.

Deductions are 145.50 ÷ 510 × 100 = 28.5% of gross pay (to 1 decimal place).

Calculating income

Worked example 4: annual to monthly. A salary of £36,000 a year (illustrative). Tax is 20% of pay above a £12,000 allowance, National Insurance is 6% of gross pay, and the pension is 5% of gross pay.

• Tax: 20% × (36,000 − 12,000) = £4,800.
• National Insurance: 0.06 × 36,000 = £2,160. Pension: 0.05 × 36,000 = £1,800.
• Net pay: 36,000 − 4,800 − 2,160 − 1,800 = £27,240 a year.
• Monthly: gross 36,000 ÷ 12 = £3,000; net 27,240 ÷ 12 = £2,270.

Worked example 5: a pay rise. The salary rises 4% to 36,000 × 1.04 = £37,440. Tax is 20% × 25,440 = £5,088; National Insurance is £2,246.40; pension is £1,872. Net pay is 37,440 − 9,206.40 = £28,233.60. Net rises by £993.60, which is 3.6% (to 1 decimal place), less than the 4% rise in gross because the allowance stays the same, so the extra pay is taxed in full and also bears the other deductions.

Total income. A worker’s income may include more than one source. If the monthly net pay of £2,270 is joined by £340 net from a weekend job and £25 interest, total monthly income is 2,270 + 340 + 25 = £2,635. Always add net amounts, not gross, if the question asks what the person actually receives.

Common errors

• Treating the wage as fixed. In the market it moves to remove a shortage or surplus.
• Shifting the wrong curve. A rise in product demand shifts labour demand, not supply.
• Moving along a curve when the question describes a shift, or the reverse.
• Reading a shortage as a surplus. A shortage means more workers wanted than willing.
• Giving a differential without a cause. Say what makes supply or demand different.
• Mixing up the base in a percentage gap.
• Subtracting deductions from net pay, or applying a rate to the whole of gross pay when the question gives an allowance.
• Mixing annual and monthly figures.

Next steps

Condense this page with the revision notes, practise with the practice questions, and take a free 10-minute diagnostic.

Official syllabus

Source: AQA, GCSE Economics (8136) specification, Version 1.0, for first teaching from September 2017. Content follows 3.1.5.4, The labour market.