Cambridge International AS and A Level Economics: Labour demand, supply and wages in perfect markets (9708)

This guide covers sections 8.3.1 to 8.3.7 of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028: how labour demand, labour supply and the wage are determined when the labour market is perfect. Topic 8 is A Level content. The syllabus says AS Level content is assumed knowledge for A Level Papers 3 and 4, so keep your AS supply and demand analysis to hand. Imperfect markets, wage differentials, transfer earnings and economic rent are separate sections and are not covered here.

Work through it with the revision notes and the practice set. Check gaps with the free diagnostics, use the course hub and tick progress off on the checklist. Every firm, market and figure below is invented for illustration.

What this unit covers

Section	You must be able to
8.3.1	Explain labour demand as a derived demand
8.3.2	Explain the factors affecting demand for labour in a firm or occupation
8.3.3	Explain shifts in, and movements along, the demand curve for labour
8.3.4	Define and calculate marginal revenue product (MRP), and derive a firm’s demand for labour from it
8.3.5	Explain wage and non-wage factors affecting labour supply to a firm or occupation
8.3.6	Explain shifts in, and movements along, the supply curve of labour
8.3.7	Determine the equilibrium wage rate and employment in a perfect labour market

8.3.1 Labour demand is a derived demand

Nobody wants a bricklayer for its own sake. A firm hires labour because workers help produce goods or services that consumers buy. So the demand for labour is a derived demand: it is a by-product of consumers wanting the goods or services that labour produces.

The chain runs like this. Consumer demand for houses rises, so builders expect to sell more, so they want more output, so they hire more bricklayers. If demand for houses collapses, the derived demand for bricklayers falls with it, even if bricklayers have done nothing different.

8.3.2 and 8.3.3 Factors affecting demand, shifts and movements

The labour demand curve for a firm or occupation puts the wage rate on the vertical axis and the quantity of labour (workers or hours) on the horizontal axis. It slopes downward.

A change in the wage rate causes a movement along the curve. A wage rise gives a contraction in the quantity of labour demanded. A wage fall gives an extension.

Anything else that changes the value of what workers add shifts the curve.

Factor	Effect on demand for labour	Why
Demand for the product rises	Shifts right	More output is wanted, and the extra output sells at a better price
Labour productivity rises (training, better tools)	Shifts right	Each worker adds more output, so each is worth more
Price of a substitute factor rises (for example machinery)	Shifts right	Labour becomes the cheaper way to produce
Price of a complement rises	Shifts left	Output becomes more costly, so fewer workers are wanted
Technology replaces tasks	Often shifts left	Capital does what labour did. It can also raise productivity and shift demand right for other roles
Government costs on employing labour (employer taxes, for example)	Shifts left	Each worker costs more relative to what they add

Do not draw a shift when the wage changes. The wage is the vertical axis, so it moves you along the curve.

Worked chain. A rise in the price of machinery used by a small packing firm (illustrative) makes capital dearer, so labour is now the cheaper way to pack. At every wage the firm wants more packers, so its labour demand curve shifts right. If the wage then rises, the firm moves up this new curve and hires fewer packers than it would have at the old wage.

The same factors apply to an occupation as a whole, but an occupation’s demand depends on the combined decisions of every firm that hires that kind of worker.

8.3.4 Marginal revenue product theory

Start with marginal physical product (MPP), which is the extra output gained by employing one more worker.

Marginal revenue product (MRP) is the extra revenue a firm gains from employing one more worker. The calculation depends on the product market.

• MRP = MPP × marginal revenue (MR).
• If the firm sells at a fixed price, MR equals price, so MRP = MPP × price.
• Equivalently, MRP = change in total revenue ÷ change in labour employed.

Worked example 1: a firm selling at a fixed price

A small bakery sells every loaf at 2.50. Output rises as it adds workers, but each extra worker adds less (diminishing marginal returns, because the oven and counter space are fixed).

Workers	Total output (loaves/day)	MPP	MRP = MPP × 2.50
1	36	36	90
2	68	32	80
3	96	28	70
4	120	24	60
5	140	20	50
6	156	16	40
7	168	12	30
8	176	8	20

For the second worker: MPP = 68 − 36 = 32, so MRP = 32 × 2.50 = 80.

Worked example 2: a firm whose price falls as it sells more

A craft workshop faces a downward-sloping demand curve, so it must cut its price to sell more. Here you cannot use price as MR.

Workers	Output	Price	Total revenue	MRP = change in TR
1	10	100	1,000	1,000
2	19	95	1,805	805
3	27	90	2,430	625
4	34	85	2,890	460
5	40	80	3,200	310

Check the link with the formula for worker 2: MPP = 9 and MR = 805/9 = 89.44, so MPP × MR = 805. MRP falls faster here than in the first example because two things work together: diminishing returns lower MPP, and the falling price lowers MR.

Deriving a firm’s demand for labour

A profit-maximising firm in a perfect labour market is a wage-taker. It pays the same wage for every worker, so the extra cost of one more worker equals the wage. It compares that with the extra revenue.

• If MRP is above the wage, hiring adds more to revenue than to cost, so hire.
• If MRP is below the wage, hiring adds more to cost than to revenue, so stop.
• The firm hires up to the point where MRP = wage.

So at each wage, the firm’s labour demand is the number of workers whose MRP is at or above the wage. The MRP curve is the firm’s demand curve for labour. It slopes downward because of diminishing marginal returns (and, if the price falls with output, falling MR).

Using the bakery table:

Wage per day	90	80	70	60	50	40	30	20
Workers hired	1	2	3	4	5	6	7	8

At a wage of 50 the bakery hires 5 workers: the fifth adds 50 of revenue and costs 50, and the sixth would add 40 but cost 50. If the wage rises to 70, it hires 3 (a movement along the demand curve). If the wage falls to 30, it hires 7.

A shift. Suppose the price of bread rises from 2.50 to 3.25, a 30% increase. MRP becomes 117, 104, 91, 78, 65, 52, 39 and 26. At an unchanged wage of 50, the sixth worker’s MRP of 52 now exceeds the wage, so employment rises from 5 to 6. The whole curve has shifted right because the price changed, not the wage.

For the workshop in example 2, a wage of 600 gives 3 workers (the third adds 625, the fourth only 460).

Industry demand is found by adding the quantities demanded by all firms at each wage. In practice it is a little steeper than that sum, because if every firm hires more, product prices fall and MRP falls.

8.3.5 and 8.3.6 Labour supply to a firm or occupation

Supply of labour is the number of workers willing and able to work at each wage. It slopes upward in an occupation: a higher wage attracts workers from other jobs and from outside the labour force.

Wage factors. The wage on offer relative to the wage in other occupations is the main factor. A change in this wage causes a movement along the supply curve: higher wages give an extension, lower wages a contraction.

Non-wage factors shift the supply curve:

• Working conditions, hours, safety and job satisfaction. Better conditions shift supply right.
• Fringe benefits and job security, such as pensions, paid leave and training.
• The length and cost of training and the qualifications needed. Longer training shifts supply left.
• Wages and conditions in other occupations. A pay rise in a rival occupation shifts supply left.
• Population size, age structure and migration, which change the pool of available workers.
• Social attitudes and the number of workers willing to take part in the labour force, such as changes in retirement age.
• Mobility. Easier movement between regions and occupations shifts supply right.
• Non-wage income, such as the level of state benefits, which affects the incentive to take the job.

An occupation’s supply curve is typically more elastic over a long period because people can retrain, and less elastic where training is long or specialist.

8.3.7 Wage determination in perfect markets

A perfect labour market has many employers and many workers, none able to influence the wage. Workers of an occupation are identical, have full information about wages and jobs, and can move freely between jobs. The wage is set where demand for labour equals supply.

Worked example 3: equilibrium and shifts

In a market for warehouse pickers in an illustrative region, with the wage W in £ per hour and quantities in thousands of workers:

• Demand: QD = 120 − 4W
• Supply: QS = −20 + 6W

Equilibrium: 120 − 4W = −20 + 6W, so 140 = 10W and W = 14. Then Q = 120 − 56 = 64 thousand (check supply: −20 + 84 = 64).

Disequilibrium. At W = 16, QD = 56 and QS = 76. There is an excess supply of 20 thousand, so some workers are unemployed in this market and the wage is pushed down. At W = 10, QD = 80 and QS = 40. There is an excess demand of 40 thousand (vacancies), and the wage is pushed up.

Demand rises by 30 at every wage (QD = 150 − 4W): 150 − 4W = −20 + 6W, so W = 17 and Q = 82. Both the wage and employment rise.

Supply rises by 20 at every wage (QS = 6W), with original demand: 120 − 4W = 6W, so W = 12 and Q = 72. The wage falls and employment rises.

Both shift: 150 − 4W = 6W gives W = 15 and Q = 90.

The pattern to remember:

Change	Equilibrium wage	Employment
Demand rises	Rises	Rises
Demand falls	Falls	Falls
Supply rises	Falls	Rises
Supply falls	Rises	Falls

Evaluating the theory

• MRP is hard to measure when workers work in teams or when output has no sale price, as in many public services.
• The theory assumes diminishing returns, a profit-seeking firm, and identical workers and full information. Real markets rarely meet these conditions.
• Demand is derived, so a wage may reflect product-market conditions the worker does not control.
• Adjustment takes time. Training, moving house and recruitment make real supply less responsive than the simple model suggests, especially in the short run.
• The model shows a useful benchmark. Comparing real markets with it helps you judge how far wages depart from market forces.

Common errors

• Drawing a shift in the demand curve for a change in the wage. Wage changes cause movements.
• Writing MRP = MPP × price when the firm faces a falling price. Use MR.
• Saying the firm hires until MRP is zero. It stops where MRP equals the wage.
• Forgetting that supply and demand shifts both change employment as well as the wage.
• Describing demand as “caused by the workers”. It is derived from product demand.

Official syllabus

Source: Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028, published by Cambridge University Press & Assessment, sections 8.3.1 to 8.3.7.