Equilibrium in the Labor Market

As in goods markets, equilibrium in labor markets occurs at the intersection of the demand for labor and the supply of labor. Note that in this model of labor markets, there is no involuntary unemployment, wherein a person desires to work at the minimum or accepted wage but is instead unemployed, since every unit of labor that is willing to work at the equilibrium wage gets hired. If the wage is below the market equilibrium wage, a shortage of labor occurs, and a surplus of labor occurs at wages higher than the market equilibrium wage. In this context, a surplus of labor is referred to as unemployment.

When society considers the wage determined by equilibrium in the labor market to be too low, policy makers often intervene and establish a minimum wage. Legislating a minimum wage is commonly believed to be an effective way of providing raises to hourly, low-wage workers. Unfortunately, establishing a minimum wage can stifle job opportunities for low-skill workers, youth, and minorities, which are the groups that policymakers are often trying to help. A minimum wage is a type of price control that effectively establishes a price floor; a price below which the market price cannot go. In this case “price” is the price of labor or the wage rate. Price floors result in reduced quantity demanded and an increase in quantity supplied of a good or service. The minimum wage, like any price floor, creates a surplus of labor. There are more workers willing to work at the minimum wage than there are employers willing to hire at the minimum wage. Labor markets have their own demand shifters (factors that shift the demand curve) and supply shifters (factors that shift the supply curve).

A change in wage results in movement along a labor demand curve just as a change in the price of the good causes movement along the demand curve for a good. Wages that rise too high can decrease the quantity of labor demanded, while as labor gets cheaper it increases the quantity of labor demanded. There are a number of factors that can shift a demand curve for labor.

Because the marginal revenue product of labor is the price of a firm's output multiplied by the marginal product of labor, changes in the price of a firm's output will result in corresponding changes in the marginal revenue product of labor. Because the firm's demand curve for labor is just the marginal revenue product curve, the labor demand curve shifts when the price of the firm's output changes. Specifically, price increases will result in the labor demand curve shifting to the right, and price decreases will result in a shift to the left. When grapes become more popular, the price of grapes rises. To capitalize on this, a firm would want to hire more workers. The firm is motivated to do this because the more employees it has picking grapes, the more it can profit on the rising grape prices.

When demand for a firm's output rises, the firm can increase revenue by producing more output. This eliminates a shortage caused by demand exceeding supply. To produce more units of output, the firm will hire more workers. For example, if a clothing manufacturer gets a prominent celebrity to endorse their goods, demand for their clothing may increase. In order to keep up with this demand, they will hire new workers to produce even more clothing. This will increase their overall revenue.

Price changes when the quantity of a product changes: less of a product raises the price. In a similar manner, the labor demand curve shifts when workers' marginal product of labor changes. Specifically, the labor demand curve will shift to the right when the marginal product of labor increases, and the curve will shift to the left when the marginal product of labor decreases.

In general, economists refer to factors that change workers' marginal product of labor as changes in technology, and technology, such as the use of computers in offices, can either make workers more productive (and thus increase their marginal product of labor) or replace them (thus lowering their marginal product of labor). The improvements in computer processing power have made workers who use computers much more productive, which increases their productivity. At the same time, improvements in cell phones and social media have lowered workers’ productivity at the workplace. As a result, changes in technology can result in shifts in labor demand in either direction.

Substitutes (replacements for a product that are similar but not the same) in production are resources that are used instead of another in a production process. Complements in production are resources that are used together in a production process. When the supply of a substitute for labor increases, the price of that resource decreases, and that substitute resource is more attractive in the production process. If the price of the substitute decreases enough, the firm may be able to lower the price it sells its product enough that they end up using more of both inputs. For example, legal software has become significantly cheaper over the past decade and, instead of replacing paralegals, firms have started using more software and more workers because they were able to lower their prices. This is often known as the automation paradox. The demand for labor actually increases when the supply of substitutes increases. A more traditional use of substitutes in production is where firms switch between the substitutes so that the demand for labor decreases when the supply of a substitute for labor increases, and demand for labor increases when the supply of a substitute for labor decreases. In this traditional case, a substitute for labor could be a new type of technology, as in an increasingly automated factory, which replaces workers. A factory making perfume bottles may become so automated that it only needs people to supervise the machines; thus, the demand for labor decreases.

When the supply of a complement to labor increases, the price of that resource still decreases, but because labor is used together with its complements in the production process, the price decrease makes both labor and its complement more attractive resources. Therefore, demand for labor increases when the supply of a complement to labor increases, and demand for labor decreases when the supply of a complement to labor decreases. For example, technology can also at times be a complement. Technology to store and transport avocados makes them more profitable, increasing the demand for labor.

While a change in the wage results in movement along a labor supply curve, there are a number of factors that can shift a supply curve for labor.

Because leisure time is the time spent not working, the supply of labor changes when leisure time is valued more or when the taste for leisure changes. Specifically, labor supply increases when the taste for leisure decreases (leisure is not liked as much), and labor supply decreases when the taste for leisure increases (when leisure is liked more). The taste for leisure changes over time as a result of environment and personal circumstances. For example, an individual's taste for leisure might increase if they like dogs and then get their own, or if they enjoy being outside and the weather is nice. These circumstances might lead the individual to want to work less, changing the amount of labor they would add to the supply.

Even though economists sometimes refer to the labor market, there are actually a number of different labor markets: the market for factory workers, the market for hairdressers, and so on. If an individual has the skills to take on various jobs, then they can choose which markets to supply labor to, depending on the relative wages in different markets among other factors.

When the alternative opportunities for a worker increase, labor supply in the market under consideration decreases because the worker is switching some of their labor supply to other markets. Conversely, when the alternative opportunities for a worker decrease, labor supply in the market under consideration increases, since the individual no longer has as many places to potentially provide their services. If an individual is trained as a teacher and a plumber, they may get a teaching job and spend less time plumbing, taking away supply from the plumbing labor market. But if the local college where the person was teaching closes, they would likely spend more time plumbing because their teaching services were no longer needed, thus adding to the plumbing labor market.

Changes in population of an area impact the labor supply. Immigration, where individuals move to an area (often seen as the movement between different countries), can greatly impact the labor supply. Skilled laborers such as scientists, doctors, and engineers often immigrate to a country or place that needs those services. Immigration can also supply needed workers in fields such as hospitality and farming. The demographics of an area also change, thus changing the labor supply. Skilled laborers could all leave an area, diminishing that specific labor market. Populations in certain areas can grow, making the labor market larger.

Just as the number of sellers is a supply shifter in goods markets, it is also the case that the number of sellers is a supply shifter in labor markets. In labor markets, however, the sellers of labor are people looking to work, so the movement of people around the world causes labor supply curves to shift. Specifically, immigration (increases in the number of people) shifts the labor supply curve to the right, and emigration (decreases in the number of people) shifts it to the left.