Supply and Demand and the Labor Market

The supply and demand for labor is much like the supply and demand for any other
service. Consistent with the law of supply and demand (as price rises, quantity
demanded falls and quantity supplied rises), the demand curve has a negative slope
and the supply curve has a positive slope.
The supply of labor, like the supply for other services, merely indicates how much
labor workers are willing to offer at various prices. The supply curve for each
worker will be different as each worker has different opportunity costs and
preferences.
The demand for labor indicates how much labor a firm desires at different prices.
The demand curve for each firm will differ as each firm faces different labor
substitutes (differing rates of potential capital substitution, for instance),
preferences, demand curves for the products they produce, and alternative
employments for their resources.
Wage rates are simply the price of labor and as such, are determined like all other
prices on the market. The intersection of the supply and demand curves for labor
indicates the equilibrium, or market clearing, wage rate for certain types of labor.
(In a free economy, unhampered by government regulation, wage rates for the
same type of labor tend to equalize across markets).
This wage rate at the point of curve intersection tends to equal the discounted
value of the marginal productivity of labor (DMVP). I know that sounds like a
mouthful but it simply means that workers tend to earn the market value of what
they produce (less the rate of interest).
Any worker employed for less than this amount will likely be bid away by another
firm, as the firm stands to earn profit by doing so. The process of firms hiring away
laborers earning less than their DMVP pushes the wage rate to the point where no
firm stands to generate additional profit by bidding away the worker. At this point,
the wage rate equals the DMVP. This argument, of course, assumes an efficient,
undistorted market.
Source: https://www.mackinac.org/3818
Economics: Labor Demand
Overview
Labor economists, also referred to as demographic economists, study the
relationship between labor supply and demand, wage distribution across industries,
and changing demographic trends in an effort to explain and predict economic
activity and business cycles. Labor economists argue that the aggregate labor, or
productive work, of the population drives the economy and economic growth.

Economic growth, the quantitative change or expansion in a country's economy, is

measured as the percentage increase in a nation's gross domestic product (GDP)
during one year. Gross domestic product refers to the market value of goods and
services produced by labor and property in the United States. The United States
government, recognizing the importance of a strong labor market, develops and
implements labor demand policies to promote the creation of new jobs and work
industries. Labor demand refers to both the total labor costs for a particular skill
level and total output the firm is capable of producing to meet customer needs for
profit maximization as well as the aggregate need for labor in a given region or
sector. Increased labor demand will theoretically draw more workers into the
workforce and increase productivity and economic growth.
Importance of Labor Demand
The public and private sectors, and economic stakeholders in general, rely on labor
market information, economic analysis, and short and long-term forecasting for
effective economic planning. For example, information about forecasted labor
demand in different sectors and industries allows individuals to strategically plan
their education and training to capitalize on labor demand. In addition, information
about forecasted labor demand in different sectors and industries allows
organizations to make strategic hiring decisions and investigate technology to
lessen the burden of forecasted employee shortages. Businesses, industries, and
occupations generally have differing levels of labor demand.
Labor Demand in Microeconomics
The concept of labor demand is a fundamental building block in microeconomics.
Microeconomics, in contrast to the large-scale inquiry of macroeconomics, studies
the behavior of small economic units including households, organizations, and
individual consumers. The concepts of labor demand and labor supply are based on
the economic theory of supply and demand that refers to the relationships between
a product's place in the market and the market's valuing of the product. The theory
of supply and demand is a fundamental economic theory applied to multiple
businesses, industries, and issues. Labor economics, which refers to the area of
economics concerned with labor markets, adopted the theory of supply and demand
to help explain how labor markets function. Labor economists often represent
demand and labor supply in a graphical way as supply-demand curves. These
curves, which are common conceptual tools in economics, are two lines on a graph
representing people's willingness to buy or sell a product depending on its price.
The labor supply curve is likely to be different for different individuals and the labor
demand curve will be different for various businesses, industries, and sectors.
Factors Affecting Labor Demand
The following factors and variables affect labor demand and labor supply in the
United States: Budget constraint, rate of substitution, income effect, substitution

effect, and opportunity cost. Budget constraint refers to the consumption options
available to someone with a limited income to allocate among various goods. The
rate of substitution refers to the least-favorable rate at which a business is willing to
exchange units of one good or service for units of another. Income effect refers to
the influence that a change in income will have on consumption decisions. The
substitution effect is a price change that changes the budget constraint but leaves
the consumer on the same indifference curve. Opportunity cost refers to the cost of
passing up the next best choice when making a decision. Labor economists consider
labor demand to be a derived demand. The demand for labor is dependent on or
derived from the demand for particular goods in a particular market. A business'
overall labor demand is determined by its marginal physical product of labor (MPL).
The marginal physical product of labor refers to the additional output that results
from an increase of one unit of labor. Ultimately, the demand for labor is an
important economic indicator for the health of the labor market and the economy in
general.
The following section provides an overview of U.S. labor demand policy. This section
serves as the foundation for later discussion of how and why the U.S. government
measures labor demand with the Job Openings and Labor Turnover Survey. The
issues associated with forecasting labor demand across industries are addressed.
U.S. Labor Demand Policies
The federal government, recognizing the importance of a strong labor market,
develops and implements labor demand policy to promote the creation of new jobs
and work industries. The United States government creates policies and programs
to increase labor demand. Labor demand policies are developed to increase the
number of poor and disadvantaged persons hired into gainful employment.
Significant labor demand policies of the twentieth century included the public works
programs of the 1930s, public service jobs of the 1970s that were funded by the
Comprehensive Employment and Training Act (CETA), and tax credits for employers
hiring poor and disadvantaged individuals (Bartik, 2001).
Labor Demand Policies
Economists and government stakeholders in general debate the development and
use of labor demand policy as a solution for the public problem of poverty and
unemployment. Labor economists in favor of the use of labor demand policies to
eradicate poverty argue that an increase in the number and scope of labor demand
policies is necessary for several reasons. First, America's poor need significantly
more jobs made available to them. The U.S. labor market would need at least 9
million additional full-time jobs to provide each poor, non-elderly U.S. household
with one full-time worker. Second, labor supply policies alone may be insufficient to
solve job shortages. Labor supply policies, such as welfare reform, are generally a
costly way to increase employment opportunities for the poor. For example, welfare

reform, which has brought millions of workers into the labor force, has required the
development and implementation of extensive job and workforce training programs.
Third, aggregate labor demand policies are necessary but insufficient to eradicate
poverty and its related conditions. For example, in 1999, the U.S. unemployment
rate was 4.2 percent and the poverty rate was 11.8 percent. As a result of the
difference between poverty and unemployment rates, lowering unemployment to
zero would not fully eliminate poverty. Fourth, targeted labor demand programs,
such as programs that hire targeted low-employment groups for public service jobs
or subsidized jobs with private employers, can be effective in addressing poverty
and its related conditions.
Recommended Labor Policies
Labor economists generally recommend three types of labor demand policies: Tax
credits, wage, subsidies and wage redistribution. First, a tax credit program can be
implemented to provide subsidies to all employers who expand their labor force.
Second, a wage subsidy program can be implemented which awards wage subsidies
to selected employers that hire selected individuals from disadvantaged groups
(Bartik, 2001). Third, a wage redistribution program can be implemented to
redistribute and equalize wages. The main types of wages manipulated in labor
demand policies include reservation wage, market clearing wage, real wage,
minimum wage, and nominal wage. A reservation wage refers to the lowest possible
real wage that makes workers indifferent between consumption and leisure. Market
clearing wage are the wages necessary to clear the labor market of all surpluses
and shortages. Real wages refer to wage amounts, useful for economic analysis and
comparisons, which have been adjusted for inflation. Minimum wage refers to the
lowest hourly wage, determined by the Fair Labor Standards Act (FLSA), that may be
legally paid to full-time and part-time workers in the private sector and in federal,
State, and local governments. Nominal wages are wages, written down in contracts
between the employee and the organizations, which are unadjusted for inflation.
Source: http://www.enotes.com/research-starters/labor-demand