Pearson Edexcel IAL Economics: Labour demand, supply and wage determination (YEC11) – Revision Notes

These notes condense 3.3.4 Labour markets, items 1 to 3, in the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11) specification, Issue 2, June 2018. The content is in Unit 3, Business behaviour, which the specification places in the additional International A2 (IA2) content, so it is for the full International Advanced Level and not the IAS. For full explanations read the study guide, then test yourself with the practice questions. Also see the course hub, the checklist and the diagnostics. All figures here are invented.

Key definitions

• Derived demand: demand for a factor such as labour that exists only because the final product is wanted.
• Productivity of labour: output per worker, often per hour.
• Wage rate: the price of labour per unit of time.
• Elasticity of demand for labour: responsiveness of the number of workers hired to a change in the wage.
• Elasticity of supply of labour: responsiveness of the number of workers willing to work to a change in the wage.
• Net migration: immigration minus emigration.
• Equilibrium wage: the wage at which employers want as many workers as are willing to work.
• Public sector: organisations owned and funded by government; a state-owned enterprise is a business owned by the state.

Formulas

Measure	Formula
Elasticity of demand for labour	% change in workers hired / % change in wage
Elasticity of supply of labour	% change in workers supplied / % change in wage
Extra revenue from a worker	Extra output x product price
Labour cost per unit	Wage per period / output per worker per period
Take-home pay	Gross pay x (1 - tax rate)
Real change in pay	(1 + nominal rise) / (1 + inflation) - 1
Wage bill	Wage x number employed

Demand for labour: factors in one table

Factor	Change	Labour demand curve
Demand for the final product	Rises	Shifts right
Productivity	Rises	Shifts right
Price of the product	Rises	Shifts right
Price of capital relative to wages	Capital becomes cheaper	Shifts left
The wage itself	Rises	Movement up the curve, fewer hired

Factors affecting elasticity of demand for labour

1. How easily capital can replace labour.
2. The share of labour in total costs.
3. How elastic the demand for the product is.
4. The time period.

Supply of labour: factors in one table

Factor	Change	Supply of labour
Size of population	Rises	Right
Net migration	More positive	Right
Income tax rates	Fall	Right
Welfare benefits	Rise	Left (smaller gain from work)
Government regulations	Depends on the rule	Right or left
Trade unions	Restrict entry	Left

Factors affecting elasticity of supply of labour

1. Skills and training time needed.
2. Spare capacity: unemployed people and workers in other jobs who could switch.
3. The time period.
4. How easily people can move between jobs and places.

Method in steps

Finding an equilibrium wage

1. Express demand and supply as QD and QS in terms of W.
2. Make QD equal QS and solve the equation for W.
3. Put W back into either equation to find the quantity.
4. State the units: currency per hour and number of workers.

Shifting the curves

1. Name the curve that moves and the direction.
2. State the shortage or surplus created at the old wage.
3. Explain how the wage adjusts.
4. State the new wage and employment.

Worked reminder

Demand QD = 500 - 20W and supply QS = -100 + 40W (illustrative).

• 500 - 20W = -100 + 40W gives 600 = 60W, so W = 10 and quantity = 500 - 200 = 300.
• Supply rises by 60 at each wage: 500 - 20W = -40 + 40W, so 540 = 60W, W = 9 and quantity = 500 - 180 = 320.
• Result: the wage falls by 1 and employment rises by 20. A supply shift moves them in opposite directions.

Worked reminder: elasticity

Wage rises from 8 to 9 (+12.5%) and a firm cuts workers from 160 to 152 (-5%). Elasticity = -5/12.5 = -0.4, inelastic. A wage rise lifts the wage bill when demand for labour is inelastic.

Chains of reasoning

Why demand for chefs rises More diners, more meals sold, more revenue per chef, restaurants hire more at each wage, the demand curve shifts right, the wage and employment rise.

Why a fall in machine prices cuts labour demand Machines become cheaper per unit of output, firms substitute capital for labour, labour demand shifts left, the equilibrium wage and employment fall. The effect is bigger if the product demand is elastic and the machines are close substitutes.

Why net migration cuts wages More workers are willing to work at each wage, supply shifts right, a surplus appears at the old wage, the wage falls and employment rises. Wage falls are smaller if demand for labour is inelastic or demand rises at the same time.

Public sector pay Pay depends on the budget set by government, bargaining and pay scales, inflation and the need to recruit and keep staff. If pay is held below private sector rates, shortages may appear.

Must-know distinctions

• Movement along a curve (wage changes) versus shift of a curve (anything else).
• When demand shifts, wage and quantity move the same way; when supply shifts, they move apart.
• Nominal pay versus real pay.
• Elasticity of demand for labour (hiring response) versus elasticity of demand for the product (customer response).
• Tax cut (raises take-home pay) versus benefit rise (lowers the gain from working).

Quick self-test

1. State what is meant by “derived demand” for labour.
2. A worker makes 6 bags a day and bags sell at 15. Calculate extra revenue per worker per day. Is it worth paying 80?
3. The bag price falls to 12. Recalculate and say what happens to labour demand.
4. A machine costs 140 a day and makes 20 items. A worker costs 100 and makes 10 items. Which has the lower cost per item?
5. Wage rises 6% and the number of workers willing to work rises 9%. Calculate elasticity of supply.
6. Gross pay is 200 a week and the tax rate falls from 30% to 25%. Calculate the rise in take-home pay.
7. With QD = 500 - 20W and QS = -100 + 40W, what is the equilibrium wage?
8. Give two reasons why public sector pay may not respond quickly to shortages.
9. A pay budget of 600,000 is spread over average pay of 25,000. How many staff? What if pay rises 4%?
10. Nominal pay rises 3% and inflation is 4%. Calculate the real change.

Answers

1. Workers are wanted only because customers want what they make.
2. 6 x 15 = 90, above 80, so yes.
3. 6 x 12 = 72, below 80, so firms hire fewer and demand shifts left.
4. Machine 140/20 = 7.00; worker 100/10 = 10.00. The machine is cheaper.
5. 9/6 = 1.5, elastic.
6. Take-home was 200 x 0.70 = 140 and becomes 200 x 0.75 = 150, a rise of 10.
7. 600 = 60W, so W = 10.
8. Budgets are fixed by government in advance, and pay is often set through national scales or bargaining that change slowly.
9. 600,000/25,000 = 24 staff. With 4% more pay: 600,000/26,000 = 23.1, so 23 staff.
10. 1.03/1.04 - 1 = -0.96%, a small fall in real pay.

Quick reference: four shifts at a glance

Shift	Wage	Employment
Demand shifts right	Rises	Rises
Demand shifts left	Falls	Falls
Supply shifts right	Falls	Rises
Supply shifts left	Rises	Falls

With both curves moving, one outcome is certain and the other depends on size. Demand and supply both shifting right makes employment rise, while the wage may rise, fall or stay put. Check the answer with a sketch with the hourly wage on the vertical axis, the number of workers on the horizontal axis, both curves before and after, and the two meeting points. Name the axes and each curve (D1, D2, S1, S2) in a written answer, and state the old and new equilibrium.

Evaluation prompts

• How big is the shift, and how elastic are the curves?
• Is the effect short run or long run, given training time and technology?
• Is the occupation private or public sector, and does the budget or the market set pay?
• Do other factors move at the same time, such as migration alongside a rise in demand?

Where marks are usually lost

• Describing a movement along the curve when the question asks for a shift.
• Writing “more demand for workers” with no link to demand for the product.
• Using the wrong elasticity formula, such as dividing wage change by quantity change.
• Giving factors of elasticity with no direction, such as “time” without saying that longer time makes it more elastic.
• Quoting a new equilibrium wage with no employment figure, or the reverse.
• Treating all public sector pay as fixed by supply and demand.
• Stating that a tax cut always raises labour supply, with no mention of how large the response is.
• Ignoring inflation when judging pay changes.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11), Specification, Issue 2, June 2018, first teaching September 2018, published by Pearson Education Limited. Section 3.3.4 Labour markets, items 1 to 3.