OCR A Level Economics: Supply of labour, economic rent and wage models (H460)

This guide follows the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. It covers the supply side of the Wage determination topic and the wage models, in the Labour market area of study, which is examined in Component 1, Microeconomics. The specification labels no content as AS or Extension. Every figure below is invented and illustrative.

Start from the OCR Economics hub and the printable checklist. Then use the revision notes and the practice questions. For elasticity method see the elasticity guide, and try the free diagnostics.

What this unit covers

Specification statement	What you need to do
Monetary and non-monetary factors affecting supply	Explain both kinds, for an industry or the economy
Wage elasticity of supply; short and long run	Explain, calculate, compare
Substitution and income effects (diagram)	Evaluate their effect on one person’s hours
Economic rent and transfer earnings (diagram)	Distinguish, calculate, explain determinants
Highly competitive labour market (diagram)	Explain how the wage is set
Unions, monopsony, bilateral monopoly (diagrams)	Evaluate effects on wages and employment
Wage differentials	Explain why pay differs
Usefulness of wage theories by region and occupation	Evaluate

Marginal revenue product (MRP) theory is used here only where the models need it. Demand-side topics belong to another page.

Factors affecting the supply of labour

Supply of labour to an industry shows how many people offer to work there at each possible wage.

Monetary factors: the wage rate, overtime and bonus rates, cash benefits such as pensions, and tax. Higher take-home pay relative to other industries pulls workers in; higher income tax cuts the net reward.

Non-monetary factors: job satisfaction, hours and flexibility, risk, location and commuting time, status, training and promotion prospects, job security and working environment. Workers compare the whole package, not the wage alone.

Other shifters: population, migration, childcare costs, training costs and pay in competing occupations.

A wage change moves you along the supply curve. Any other factor shifts the curve.

Wage elasticity of supply, short run and long run

Wage elasticity of supply of labour (EWS) = percentage change in labour supplied ÷ percentage change in the wage.

Worked example. Wages for care workers in Country A rise from £10.00 to £10.50 an hour. The number of workers offering their labour rises from 400 to 428.

Wage change   = (10.50 - 10.00) / 10.00 = 5%
Supply change = (428 - 400) / 400       = 7%
EWS = 7 / 5 = 1.4  (elastic)

Determinants of EWS:

• Training time and qualifications: long training makes supply inelastic.
• Occupational and geographical mobility: easy movement makes supply elastic.
• Spare capacity: unemployed or inactive people who could enter.
• Time period: more elastic the longer workers have to respond.
• Barriers to entry, such as licences.

Short run versus long run. In the short run the workforce is largely fixed: firms rely on overtime or poaching. In the long run people can train, move region and enter from education or abroad.

Illustration. A 5% pay rise in an invented technical occupation raises supply 1% in year one (EWS = 0.2) and 7.5% after seven years (EWS = 1.5).

Substitution and income effects on an individual’s labour supply

A person divides time between work, which earns income, and leisure, which has an opportunity cost: the wage lost. When the wage rises, two forces pull in opposite directions:

• Substitution effect: leisure becomes dearer in terms of lost income, so the person substitutes work for leisure and supplies more hours.
• Income effect: the person can reach a target income with fewer hours. If leisure is a normal good, they buy more of it and supply fewer hours.

Diagram described in words. Put leisure hours on the horizontal axis and income on the vertical axis. The budget line runs from the total hours available (zero income) up to the left, with slope equal to the wage; a wage rise makes it steeper. The original indifference curve touches the old line. The substitution effect is the move along that curve to where a line parallel to the new budget line touches it: less leisure. The income effect is the move out to the new, higher indifference curve: more leisure if leisure is normal. The net change in hours is the sum.

Worked table (invented individual, hours per week):

Wage (£/h)	Hours	Weekly income (£)	Hours change on previous wage
8	25	200
12	32	384	up 28% on a 50% wage rise
16	38	608	up 18.8% on a 33.3% wage rise
20	40	800	up 5.3% on a 25% wage rise
24	38	912	down 5% on a 20% wage rise
28	35	980	down 7.9% on a 16.7% wage rise

From £8 to £12 the elasticity of hours is 28 ÷ 50 = 0.56. From £20 to £24 it is -5 ÷ 20 = -0.25, so the curve bends backward after £20. Illustrative split for £20 to £24: substitution effect +3 hours, income effect -5 hours, net -2.

Evaluation. The income effect is likelier to dominate at high pay or with a target income. The substitution effect dominates at low pay and where overtime is easy to get. Fixed contract hours limit adjustment. The market supply curve for an occupation still slopes upward because new workers enter as the wage rises.

Economic rent and transfer earnings

• Transfer earnings are what a worker must be paid to stay in the present job, which equals the pay in the next best alternative.
• Economic rent is the payment above transfer earnings.

Individual: a skilled glassblower earns £60,000; the next best job pays £35,000. Transfer earnings = £35,000. Economic rent = £25,000, which is 41.7% of earnings.

Diagram. Wage is on the vertical axis and workers on the horizontal. Economic rent is the triangle between the supply curve and the wage line. Transfer earnings are the area below the supply curve, up to the quantity employed.

Worked example. Supply is w = 2 + 0.02L and the equilibrium is L = 400, w = £10.

Total earnings   = 10 x 400                  = 4,000
Transfer earnings = 2x400 + 0.5x0.02x400^2   = 2,400
Economic rent    = 0.5 x (10 - 2) x 400      = 1,600
Check: 2,400 + 1,600 = 4,000

If demand rises so that w = £12 and L = 500, total earnings are 6,000, transfer earnings 3,500 and rent 2,500.

Determinants. Rent grows as supply becomes less elastic (scarce talent, lengthy training, entry barriers) and as demand strengthens. Perfectly inelastic supply means all earnings are rent; perfectly elastic supply means all are transfer earnings. Transfer earnings depend on the next best alternative, so they rise if other sectors offer better pay or conditions.

A highly competitive labour market

Assumptions: many employers and workers, identical labour, perfect information, free mobility. Each firm is a wage taker facing a horizontal supply curve.

MRP = marginal physical product x marginal revenue (equal to price in perfect competition). A firm hires while the next worker’s MRP is at least the wage.

Workers	MPP (units)	MRP at £1 a unit
1	20	£20
2	18	£18
3	15	£15
4	12	£12

At a wage of £13 the firm hires 3 workers, because the 4th adds only £12. At £16 it hires 2. The firm’s MRP curve is its labour demand curve.

Industry. The market wage is where industry demand (the sum of firms’ MRP curves) meets industry supply. In the invented market below, MRP is w = 34 - 0.06L and supply is w = 2 + 0.02L:

34 - 0.06L = 2 + 0.02L  ->  32 = 0.08L  ->  L = 400
w = 2 + 0.02 x 400 = £10   (check: 34 - 24 = 10)

Now a licensing rule shifts supply to w = 4 + 0.02L. Then 30 = 0.08L, so L = 375 and w = £11.50. Wage +15%, employment -6.25%.

Trade union activity

In the competitive market above, suppose a union secures £13.

Demand at 13: L = (34 - 13)/0.06 = 350 workers employed
Supply at 13: L = (13 - 2)/0.02  = 550 workers willing
Unemployment (excess supply) = 200
Wage bill: 10 x 400 = 4,000  ->  13 x 350 = 4,550

Midpoint method: employment change = -50 ÷ 375 = -13.3%, wage change = +3 ÷ 11.5 = +26.1%, so wage elasticity of demand = -0.51. Demand is inelastic, so the wage bill rises. Insiders gain, 50 workers lose their jobs, and 200 are unemployed (those 50 plus 150 new entrants) for 350 jobs. If demand were elastic the wage bill would fall.

Evaluation. The effect depends on wage elasticity of demand, union density, the threat of strikes, and whether the firm can substitute capital or move abroad. Unions may also raise productivity, shifting MRP right.

Monopsony

A monopsonist is a single (or dominant) buyer of labour. It faces the whole upward-sloping supply curve, its average cost of labour (ACL). Hiring one more worker means raising the wage for all, so marginal cost of labour (MCL) lies above ACL.

Same market: supply w = 2 + 0.02L, so total labour cost = 2L + 0.02L^2 and MCL = 2 + 0.04L.

Profit-maximising: MCL = MRP
2 + 0.04L = 34 - 0.06L  ->  L = 320
Wage read off supply: 2 + 0.02 x 320 = £8.40
MRP at 320 = 34 - 19.2 = £14.80 (equals MCL: 2 + 12.8 = 14.80)
Gap between MRP and wage = £6.40

Against competition (400 workers at £10), employment is 20% lower and the wage 16% lower. The wage is below the worker’s MRP.

Evaluation of a union or wage floor. A binding wage between £8.40 and £14.80 can raise employment. A wage floor at £10 makes the firm face a flat supply curve, so it hires 400. A wage of £12.40 gives employment of 360 (MRP = 12.40 at L = 360). A floor set too high cuts employment below 320. The result depends on the size of the gap and the elasticity of supply.

Bilateral monopoly

A bilateral monopoly has a single buyer (monopsonist) and a single seller of labour (a union covering the whole workforce). The employer pushes towards £8.40 and 320 workers. The union pushes towards a higher wage. Theory gives no unique answer: the outcome is a bargaining range, set by bargaining power, the threat of strikes against relocation, and the cost to each side of disagreeing.

In the invented market, a settlement at £10 gives employment of 400, at £12.40 gives 360, and at £8.40 gives 320. A union that offsets monopsony power (“countervailing power”) may raise both wages and employment. If it overreaches, employment can fall.

Reasons for wage differentials

• Compensating differentials: unpleasant or unsocial work pays more. A night job at £17.50 against £14 by day is a 25% premium.
• Skills and human capital: these raise MRP.
• Scarcity and barriers: licences and rare talent restrict supply.
• Demand and productivity differences between sectors.
• Union strength and bargaining coverage.
• Monopsony power and discrimination: pay below MRP for some groups.
• Public versus private pay systems, regional living costs, imperfect information and mobility.

How useful are the wage theories?

Theory	Works best when	Weakest when
Competitive MRP	Many employers, output easily measured, mobile workers	Team output, public services, immobile workers
Monopsony	One big employer in a small town or a specialist occupation	Many employers within commuting distance
Union bargaining	High union density, strong sector	Low density, flexible workforce
Economic rent	Rare talent	Easily substituted labour

Regional: monopsony power is likelier where jobs and mobility are limited, and living costs shape regional pay. Occupational: competitive theory explains pay where output is measurable but struggles in public-sector roles with national pay scales. No model suffices alone. Judge by the number of employers, how visible output is, union coverage and mobility, then say which fits the case given.

Common errors

• Shifting the supply curve when only the wage has changed.
• Calling the whole wage “economic rent”.
• Using MCL as the wage; the monopsonist pays the wage on the supply curve.
• Claiming a union always reduces employment; under monopsony it may raise it.
• Stopping at “wages rise” without checking elasticity.

Official syllabus

OCR, A Level in Economics (H460), specification Version 3.0 (June 2026), for first assessment in 2021, published by OCR.