Pearson Edexcel International Advanced Level Economics: Labour market failure (YEC11)

Written against the Pearson Edexcel International Advanced Subsidiary/Advanced Level Economics specification (YEC11), Issue 2, June 2018, this guide covers 3.3.4 item 4 (market failure in the labour market) and 3.3.5 item 2 (government intervention in labour markets), both in Unit 3 Business behaviour. In the specification, Units 1 and 2 make up the International AS and Units 3 and 4 add the International A2 content, so this material belongs to the full International A Level only.

All data below is invented and illustrative. Start with the free diagnostics, then move to the revision notes and the practice set. Course links: hub, checklist and exam preparation.

What this guide covers

Specification	You must be able to
3.3.4 item 4a	Explain causes and consequences of geographical immobility of labour
3.3.4 item 4b	Explain causes and consequences of occupational immobility of labour
3.3.5 item 2a	Make the case for government intervention in labour markets
3.3.5 item 2b	Explain and evaluate maximum and minimum wage controls, direct taxes (national insurance contributions, corporation tax), measures to reduce immobility, and measures to reduce discrimination and exploitation

Wage determination, and demand and supply of labour, are taught elsewhere. Here you need the market-failure and policy layer.

1. Geographical immobility (3.3.4 item 4a)

Geographical immobility is a barrier to workers relocating towards available work.

Causes

• High house prices or rents in job-rich areas, and a shortage of affordable housing.
• Removal costs, agency fees and deposits.
• Family, school and community ties.
• Poor information about vacancies elsewhere.
• Weak transport links, which make commuting an unrealistic alternative.

Consequences

• Regional unemployment alongside labour shortages elsewhere.
• Wage differences between regions that persist.
• Lower output than the economy could produce, so the workforce is under-used.
• Firms in shortage areas face higher wage costs.

Worked example: why a pay gap does not always cause a move. In Country A, a worker in Region North earns 24,000 a year. The same job in Region South pays 31,000. Moving costs 9,500 once, and housing in South costs 4,000 a year more.

Pay gap           = 31,000 - 24,000 = 7,000   (7,000/24,000 = 29.2%)
Net annual gain   = 7,000 - 4,000   = 3,000
Payback period    = 9,500 / 3,000   = 3.17 years
Ignoring housing  = 9,500 / 7,000   = 1.36 years

A 29% pay gap looks large, but housing cuts the gain by more than half, so payback stretches to over three years. Add family ties and an uncertain job, and many workers stay. The gap therefore persists.

2. Occupational immobility (3.3.4 item 4b)

Occupational immobility means workers cannot easily switch between jobs or industries.

Causes

• Skills mismatch: a person’s skills do not fit the vacancies.
• Qualifications or licences are required.
• Retraining costs money and income is lost while studying.
• Age, caring responsibilities, or lack of confidence.
• Little information about which occupations are growing.

Consequences

• Structural unemployment when an industry declines.
• Skill shortages in growing sectors, pushing up wages and costs there.
• Lost output and lower tax revenue, with higher benefit spending.
• Long spells out of work can erode skills, so unemployment becomes harder to reverse.

Worked example: structural unemployment. Country A has a labour force of 400,000 and 20,000 unemployed (5.0%). A declining sector sheds 12,000 jobs. An expanding sector has 9,000 vacancies, but only 2,500 of the displaced workers have the skills required.

Displaced workers still unemployed = 12,000 - 2,500 = 9,500
Unemployed now   = 20,000 + 9,500 = 29,500
Unemployment rate = 29,500 / 400,000 = 7.4%
Vacancies unfilled = 9,000 - 2,500 = 6,500

Vacancies and unemployment exist together. That is the signature of occupational immobility.

3. The case for intervention (3.3.5 item 2a)

Left alone, labour markets may fail. Reasons to intervene:

• Immobility leaves resources unemployed or mismatched.
• Monopsony power lets a dominant employer pay below the value of workers’ output.
• Discrimination means pay or hiring depends on characteristics unrelated to productivity.
• Positive externalities from training: firms fear trained workers will leave, so they under-provide it.
• Information gaps about jobs, skills and rights.
• Equity: low pay and inequality can be unacceptable even if the market clears.

Intervention has costs too: government failure, administration, and unintended effects on employment. Always weigh both.

4. Minimum and maximum wage controls (3.3.5 item 2b)

A minimum wage is a legal floor on hourly pay. A maximum wage is a legal ceiling, for example on pay in a particular occupation.

Competitive market. Take a market where demand (marginal revenue product, MRP) is w = 20 - L and supply is w = 2 + L, with L in thousands of workers and w in currency units per hour.

Equilibrium: 20 - L = 2 + L  ->  L = 9, w = 11
Minimum wage 13: demand L = 7, supply L = 11 -> 4 thousand unemployed
Wage bill: 9 x 11 = 99  falls to  7 x 13 = 91
% change wage = +18.2%; % change employment = -22.2%
Elasticity of demand for labour = -22.2 / 18.2 = -1.22

Demand is elastic, so the wage bill falls. Workers who keep jobs gain; those who lose them are worse off. If demand were inelastic, the total wage bill would rise.

Monopsony. One employer faces supply w = 2 + L, so marginal cost of labour is MC = 2 + 2L.

Profit-maximising: MRP = MC -> 20 - L = 2 + 2L -> L = 6, w = 2 + 6 = 8
MRP at L = 6 is 14, so pay is 6 below MRP (6/14 = 42.9% of MRP)
Minimum wage 10: supply L = 8, demand L = 10 -> employment 8 (up from 6)
Minimum wage 12: supply L = 10, demand L = 8 -> employment 8, 2 thousand unemployed

Within a range, a minimum wage in a monopsony raises both pay and employment. Above the competitive wage of 11, employment falls as the floor rises (at 12 it is 8, still above the monopsony level of 6).

Maximum wage. In the competitive market, a cap at 8 gives demand L = 12 and supply L = 6: a shortage of 6 thousand. Firms may use non-wage rewards, hire elsewhere, or workers may emigrate. A cap may reduce inequality but weakens incentives and creates enforcement problems.

Evaluation: the answer depends on market structure, how elastic labour demand is, the size of the floor relative to the equilibrium, and the time horizon. The effect also depends on how many low-paid workers have alternatives.

5. Direct taxes (3.3.5 item 2b)

National insurance contributions (NICs) are payroll taxes paid by employees and employers on earnings.

• Employer NICs raise the cost of labour, shifting labour demand left.
• Employee NICs cut take-home pay, which may reduce labour supply or the incentive to work.
• Incidence depends on elasticities: wages may adjust so workers bear part of the employer’s tax.

Worked example. Wage 12.00, employer NIC 10%: labour cost = 12.00 x 1.10 = 13.20. If elasticity of demand for labour is -0.6, a 10% cost rise cuts employment by 0.6 x 10 = 6%. A firm with 200 workers falls to 188. Employee NIC of 8% leaves take-home pay of 12.00 x 0.92 = 11.04.

Corporation tax is charged on profits. A firm earning 400,000 profit at 25% pays 100,000 and keeps 300,000. A cut to 20% leaves 320,000: 20,000 more (6.7%) available for investment and wages. Lower rates may raise investment and labour demand, and attract firms, but lose tax revenue; some firms may simply distribute the extra profit.

6. Reducing immobility (3.3.5 item 2b)

Type	Measures	Limits
Geographical	Affordable housing, relocation grants, better transport, job-vacancy information	Costly, slow, and may not outweigh family ties
Occupational	Subsidised training, apprenticeships, retraining schemes, careers advice	Time lags; training may not match employers’ needs

Worked example: a retraining scheme. The state trains 1,000 workers at 6,000 each (6.0 million). 60% (600) find jobs paying 14,000 more a year. Each saves 4,000 in benefits and pays 20% tax on 14,000 (2,800).

Fiscal gain per year = 600 x (4,000 + 2,800) = 4.08 million
Payback = 6.0 / 4.08 = 1.47 years
Earnings gain to workers = 600 x 14,000 = 8.4 million a year

Evaluation: do not ignore the 400 who do not find work, the deadweight of workers who would have retrained anyway, and the time before the gain arrives.

7. Reducing discrimination and exploitation (3.3.5 item 2b)

• Legislation against discrimination and for equal pay, with penalties.
• Pay-gap reporting to make differences visible.
• Minimum wages and limits on working time reduce exploitation by monopsonists.
• Enforcement bodies that investigate complaints.

Measuring a gap: if mean hourly pay is 15.00 for one group and 13.20 for another, the gap is (15.00 - 13.20) / 15.00 = 12.0%. A gap does not by itself prove discrimination, because differences in hours, experience and occupation also matter.

Evaluation: laws are hard to enforce, firms may hide discrimination, and compliance raises costs. Gains include better matching of workers to jobs, higher output and fairness.

Common errors

• Drawing a minimum wage and always predicting unemployment, without checking market structure.
• Treating geographical and occupational immobility as the same thing.
• Calling a wage gap “discrimination” without evidence.
• Forgetting that taxes on firms and workers shift different curves.
• Listing policies without judging their cost, time lag or size of effect.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (YEC11), Issue 2, June 2018, first teaching September 2018, Unit 3: 3.3.4 item 4 and 3.3.5 item 2. Published by Pearson Education Limited.