[1.2.5a] Labour demand & supply
The Labour Market
The labour market brings together employers (who demand labour) and workers (who supply it). It is analysed using supply and demand, with the wage rate on the vertical axis and the quantity of labour on the horizontal axis. Equilibrium determines the market wage (W*) and employment level (Q*).
Demand for Labour
The demand for labour is a derived demand — firms hire workers to produce goods and services, so demand for labour depends on consumer demand for the final product. Three key factors determine how much labour firms demand:
- Demand for the final product: if consumer demand for a product rises, firms need more workers to produce it — labour demand shifts right. A fall in product demand shifts it left.
- Availability of substitutes (including machines): if capital (machinery, automation) can replace labour more cheaply, firms substitute capital for labour, shifting demand left. Where labour is cheaper relative to capital, demand rises.
- Productivity of the workforce: more productive workers generate more output per hour, making them more valuable. Rising productivity shifts labour demand right — each worker is worth more to the employer.
Supply of Labour
The supply of labour is determined by how many people are willing and able to work at a given wage. Eight key factors shift the labour supply curve:
| Factor | Effect of an increase |
|---|---|
| Population size | Larger population → more potential workers → supply shifts right |
| Migration | Net immigration → more workers → supply shifts right; emigration shifts left |
| Age distribution | More working-age adults → supply shifts right; ageing population shifts left |
| Retirement age | Higher retirement age → workers stay in labour force longer → supply shifts right |
| School-leaving age | Lower school-leaving age → more young workers enter earlier → supply shifts right |
| Female participation | Higher participation rates → more workers → supply shifts right |
| Skills and qualifications | More skilled workers → supply shifts right in skilled labour markets |
| Geographic/occupational mobility | Greater mobility → workers move where needed → supply in those markets shifts right |
The Labour Market Diagram
When labour demand increases (DL → DL₂), both the equilibrium wage and employment level rise to W₂ and Q₂. A fall in demand, or a rise in supply, shifts the relevant curve and the new equilibrium is read directly from the diagram.
Key Takeaways
- The demand for labour is a derived demand — driven by product demand, worker productivity, and availability of substitutes.
- Labour supply depends on population, migration, age, participation rates, skills and mobility.
- Equilibrium determines market wage (W*) and employment level (Q*).
- A rise in labour demand → higher wages and more employment; a rise in labour supply → lower wages but more employment.