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Factors Determining Wages Beyond Supply and Demand

Consider whether wages are only determined by the market forces of supply and demand. [25]

Category:

Labor Market and Income Distribution

[CIE A level November 2018]

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Answer

Consider each part of the statement. Do not go out of subject, for example, the analysis about profit maximisation and pricing for a product would be irrelevant.


Step ➊ : Define ‘wages’ in the introduction.


The wage rate can be determined by the market forces of demand and supply. Wages are the price paid to labour for its contribution to the process of production. In a perfectly competitive labour market, the equilibrium wage is determined where the market demand for labour equals the market supply of labour. In this essay, we will discuss whether wages are only determined by the market forces of supply and demand. It will be seen that, in imperfect markets, the demand and supply of labour are affected by other factors such as the actions of trade unions and governments.


Step ➋ : How wages are determined in perfectly competitive markets.


In perfect markets, the wage for labour will be determined through the forces of demand and supply.

➤ 2.1 The demand for labour.

The demand for labour is a derived demand, this, means that labour is not demanded for its own sake but because it is essential for the production of goods or services

The market wage is determined by the marginal revenue product of labour. The marginal revenue that the firm gains from employing one more worker is called the marginal revenue product of labour (MRPL). The MRPL is found by multiplying the marginal physical product of labour (MPPL) and the marginal revenue gained by selling one more unit of output (MR). The marginal revenue product curve is, therefore, the firm’s demand curve for labour

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In the diagram above, as more workers are employed, there will come a point when diminishing returns set in (point b). The MRPL curve thus slopes down after this point.

Profits will be maximised at an employment level of Qe. This is where the wage (Wm) is equal to the marginal revenue product of labour MRPL. The firm will thus set a wage of Wm. At levels of employment below Qe, MRPL exceeds MCL. The firm will increase profits by employing more labour. At levels of employment above Qe, MCL exceeds MRPL. In this case, the firm will increase profits by reducing employment.

➤ 2.2 The supply of labour.

The supply of labour is the total number of hours that labour is able and willing to work at a particular wage rate

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The labour supply curve to a firm or industry curve consists of the sum of the individual supply curves of all workers employed.

➤ 2.3 The price of labour depends on demand and supply in perfect markets.

The figure below shows the wage and quantity of labour are determined by demand and supply. As the demand curve reflects the value of the marginal product of labour, in equilibrium workers receive the value of their contribution to the production of goods and services.

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High skilled workers will be paid a high wage of W. This is because the demand and supply curve for skilled workers is inelastic. The more skills required, the more inelastic will be the supply of labour (S). This is because a great amount of education, training and experience may be required for a highly skilled job. The demand curve for high skilled labour (D) is inelastic because the worker may have higher productivity. Examples of high skilled and well-paid jobs are doctors, accountants and footballers.

Low skilled workers will be paid a lower wage of W1. This is because the demand and supply curve for the worker is elastic. The supply (S1) is likely to be that for an industry where there is a plentiful supply of labour with no particular skills or training.

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Step ➌ : Discuss how wages are determined in imperfect markets
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It was assumed that wages were determined by the forces of demand and supply operate without any other intervention. However, this is an unrealistic assumption as in many labour markets, the demand and supply of labour affected by the actions of trade unions and governments.

➤ 3.1 Governments may introduce a national minimum wage

Governments can introduce a national minimum wage in order to increase wages. The introduction of a minimum wage can be shown in the figure below.

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It can be seen that the higher the minimum wage (Wu) is set above the competitive equilibrium (W). However, at the wage of Wu the number of workers who are offered jobs by employers falls to Lu. At this wage, the number of people who would like to work is higher. This is shown by Lc. Consequently, there is a shortage of labour. This is shown as the difference between Lc and Lu.

➤ 3.2 There may be monopsony power in the market.

A monopsony occurs when there is a sole or a dominant employer in the labour market.

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A monopsony employer can use their buying power to pay a wage lower than the value of the marginal revenue product of workers employed at Lm. The wage that the monopsonist pays to hire labour is Wm. This is actually below the wage that should be paid if they were paying the full value of their marginal revenue product, that is Wmrp.

➤ 3.3 There may also be a bilateral monopoly

A bilateral monopoly is a labour market with a union on the supply side and a monopsony on the demand side. A trade union is a group of employees who join together to maintain and improve their conditions of employment. Through collective bargaining with employers to protect and improve the real wages of their members.

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A Monopsony would maximise profits by employing Q1 workers at a wage rate of W1. (Q1 is where MRPL=MCL). A trade Union can use collective bargaining to bargain for higher wages of W2 without causing a fall in employment.

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Step ➍ : Conclude whether wages are only determined by the market forces of supply and demand.
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To conclude, the wage rate is not always determined by the forces of demand and supply. In perfect markets the wage for labour will be determined through the forces of demand and supply, however, this is different in imperfect markets. In imperfect markets, the government may intervene by setting a minimum wage. There may also be monopsony power whereby A there is a sole or a dominant employer in a labour market. Monopsony employer can use their buying power to pay a wage lower than the value of the marginal revenue There may also be a bilateral monopoly which a labour market with a union on the supply side and a monopsony on the demand side.

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♕ Marking scheme
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The use of supply and demand to explain the determination of wages. The demand for labour explained through the marginal revenue productivity theory. Consideration of elasticities of supply and demand on wage level. A discussion of the impact of minimum wage levels, government, the intervention of a Trade Union, and monopsonistic employers.

L4 (18–25 marks): For an analysis of the determination of wages showing differing level of supply and demand and a consideration of the impact of elasticity on wages. 2 examples non-market forces are analysed, such as government and trades union. An analysis of MRP. A conclusion is required. Max 21 no conclusion

L3 (14–17 marks): For an analysis of the determination of wages showing differing level of supply and demand and a consideration of the impact of elasticity on wages, with 1 example of analysis of non-market forces

L2 (10–13 marks): For an explanation based on only supply and demand, lacks consideration of non-market forces.

L1 (1–9 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial.

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♕ Examiner’s report
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The question required a discussion of wage determination. The question refers to any labour market so both perfect and imperfect markets could have been considered. There were some well-reasoned answers to this question. Candidates ought to have considered each part of the statement. The theory of wage determination needed to be explained and a comment given on how the outcome may be affected by the existence of trade union bargaining, by minimum wages affecting the supply, by large monoposonies forcing down wages from the competitive level, by whether the worker is in the private or public sector.

This analysis could then have been linked to the payment of wages for the different examples given. Skill levels and elasticity from the supply side, productivity from the demand side and whether external factor such as trade unions or government minimum wage levels were applicable. Most candidates who answered this question presented well-informed answers. The most common difficulty found in answers that were less precise was that the answers related to the product market and the analysis was of profit maximisation and pricing for the product rather than the analysis of the factor market.

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