Labor Economics: How Does It Work?

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Abstract

The labor market is the market in which workers are assigned to jobs and employment decisions are organized. For about 150 million employees in the United States and about 8 million employers, thousands of career choices, recruiting, firing, benefits, and innovation decisions have to be made and planned every day. This paper offers a description of what the labor market is doing and how it operates. After seeing how labor market procurement and sales sides are structured at a level of overall.

Introduction

The labor market is the position where supply and job demand intersect, with jobs and employees providing the services that employers require. In short, this is where employees can find work that matches their skills and qualifications provided by employers, and where both decide on pay, benefits. Each market has buyers and sellers, and there is no exception to the labor market: buyers are employers, and sellers are employees. To a certain degree, all the specific labor markets we may describe on the basis of sector, profession, geography, transaction rules and work character.

There are exceptions in some particular cases. Many labor markets, particularly those where labor sellers are represented by a union, operate under a very specific set of rules which regulate buyer-seller transactions in part. The markets for government jobs and workers with large nonunion employees often tend to operate under laws that limit the management authority and ensure that employees are treated equally.

The Labor Force and Unemployment

The term labor force refers to all those over 16 years people with jobs are employed, people who are jobless, looking for a job, and available for work are unemployed. The labor force is made up of the employed and the unemployed. People who are neither employed nor unemployed are not in the labor force.

There are four major flows between labor market states:

Employed workers become unemployed by quitting voluntarily or being laid off (being involuntarily separated from the firm, either temporarily or permanently).
Unemployed workers obtain employment by being newly hired or being recalled to a job from which they were temporarily laid off.
Those in the workforce, whether they are working or unemployed, may leave the workforce by withdrawing or otherwise deciding not to take or seek work.

Those who have never worked or found a job, by entering it, increase the labor force, while those who have fallen out by re-entering the labor force.

Industries and Occupations: Adapting to Change

The system by which workers and employers are balanced is the labor market. The number of certain types of jobs has increased over the past half-century and the number of others has been declining. In response to labor market signals, both workers and employers had to respond to these changes. The labor market is influenced by just about everything that happens in the economy. Economic changes may have the most significant impact on the labor market as a whole. Rapid economic growth due to rising demand for goods and services could generate a multitude of new job opportunities for employees.

The Earnings of Labor

From the point of view of the workers, earnings are significant and provide a measure of the rate and pattern of their purchasing power and an estimation of their living standards, while labor costs provide an indicator of employers ‘ spending on their workforce jobs.

Nominal and Real Wages

Wage rate is the rate of pay based on per unit of production or per period of worktime on the job. The nominal wage is what workers get paid per hour in current dollars; nominal wages are most useful in comparing the pay of various workers at a given time. Real wages, nominal wages divided by some measure of prices, suggest how much can be purchased with workers’ nominal wages.

The economic condition of a worker depends on the amount of goods and services he/she can purchase with nominal wages. In case, the prices of goods and services are doubled, the worker would need the double amount of his/her nominal wages what he/she is getting at present to purchase goods and services.

The Consumer Price Index (CPI) is the most frequently used indicator to compare costs consumers face over several years. This index is usually extracted from the determination of what a fixed package of consumer goods and services each year. There are several alternative ways to calculate real wages. The

Wages, Earnings, Compensation, and Income

Both wages and earnings are normally defined and measured in terms of direct monetary payments to employees. Total compensation, on the other hand, consists of earnings plus employee benefits—benefits that are either payments in kind or deferred. Examples of payments in kind are employer-provided health care and health insurance, where the employee receives a service or an insurance policy rather than money. Paid vacation time is also in this category, since employees are given days off instead of cash.

Deferred payments can take the form of employer-financed retirement benefits, including Social Security taxes, for which employers set aside money now that enables their employees to receive pensions later.

Income the total command over resources of a person or family during some time period (usually a year) includes earnings, benefits, and unearned income, which includes dividends or interest received on investments and transfer payments received from the government in the form of food stamps, welfare payments, unemployment compensation, and the like.

How the Labor Market Works

The labor market is where people and employers come together to bargain for labor and wages or other forms of compensation. The number of people willing to work is based upon the level of pay that employers are offering.

The Markets in Which Firms Must Operate

Labor market is one of three markets in which firms must successfully operate if they are to survive; the other two are the capital market and the product market. The labor market research begins and ends with an evaluation of labor demand and supply. On the demand side of the labor market, there are employers whose employment decisions are influenced by conditions in all three markets. On the supply side of the labor market are workers and potential workers, whose decisions about where (and whether) to work must take into account their other options for how to spend time.

Any labor market outcome is always affected, to one degree or another, by the forces of both demand and supply.

The Demand for Labor

The demand for labor is an economics principle derived from the demand for a firm’s output. That is, if demand for a firm’s output increases, the firm will demand more labor, thus hiring more staff. Businesses demanding labor from workers will pay for their time and skills.

Wage Changes

First, higher wages mean higher costs and usually higher prices of goods. Since consumers respond by purchasing less to higher prices, companies tend to lower their production and employment levels (other things being equal). The reduction in employment is called an effect of scale — the effect of a larger scale of production on desired employment.

Second, as wages rise (assuming, at least initially, the price of capital does not change), companies have opportunities to cut costs by implementing a system that relies more on capital than on labor. Due to a shift to a more capital-intensive mode of production, desired jobs will decline. The second effect is called an effect of substitution.

Changes in Other Forces Affecting Demand

Labor demand when one of the forces other than the wage rate changes. First, suppose that demand for the product of a particular industry were to increase, so that at any output price, more of the goods or services in question could be sold. Suppose in this case that technology and the conditions under which capital and labor are made available to the industry do not change. Output levels would clearly rise as firms in the industry sought to maximize profits, and this scale (or output) effect would increase the demand for labor at any given wage rate.

Since the technology available and the conditions under which capital and labor are supplied have remained constant, this change in product demand would increase the labor desired at any wage level that might prevail. In other words, the entire labor demand curve shifts to the right.

The second effect of a fall in capital prices would be a substitution effect. With less labor being desired at each wage rate and output level, the labor demand curve tends to shift to the left. A fall in capital prices, then, generates two opposite effects on the demand for labor. The scale effect will push the labor demand curve rightward, while the substitution effect will push it to the left.

Market, Industry, and Firm Demand

Labor demand can be measured at three levels:

To assess a particular company’s demand for labor, they would investigate how, say, a rise in machine workers ‘ salaries would impact a specific aircraft manufacturer’s employment.
The market demand curve would be used to evaluate the impact of this wage increase on the jobs of machinists in the aircraft industry as a whole.
Finally, to see how the wage increase would affect the entire labor market for machinists in all industries in which they are used, we would use a market demand curve.

Long Run versus Short Run

We can also distinguish between the curves of demand for long-run and short-run labor. Employers find it difficult to replace capital with labor over very short periods of time (or vice versa), and customers may not very much change their product demand in response to a price increase. Reactions to increases in wages or other factors influencing labor demand are, of course, greater and more comprehensive over longer periods of time.

The Supply of Labor

The labor supply is the total hours (adjusted for intensity of effort) that workers wish to work at a given real wage rate. It is frequently represented graphically by a labor supply curve, which shows hypothetical wage rates plotted vertically and the amount of labor that an individual or group of individuals is willing to supply at that wage rate plotted horizontally.

Market Supply

The supply of labor to a given market is positively related to the prevailing wage rate in that country, holding other wages stable. As with curves of demand, each curve of supply is drawn keeping constant certain prices and wages. If one or more of these other prices or wages were to change, the supply curve would change.

If insurance agents ‘ salaries are kept constant and paralegal pay increase, more people will want to become paralegals due to the relative change in compensation.

Supply to Firms

Any business that is unwise enough to try to pay a salary below what others do will find that it cannot retain any workers. On the other hand, no organization would be greedy enough to charge more than the current wage, because it would pay more than it would have to pay to retain an acceptable number of employees and performance.

At the going wage, a firm could get all the paralegals it needs. If the paralegal wage paid by others in the market is W0, then the firm’s labor supply curve is S0; if the wage falls to W1, the firm’s labor supply curve becomes S1.

If a company lowered its pay rates below those of other firms, it would lose all of its applicants. Therefore, the horizontal supply curve represents supply decisions made between alternatives that are ideal alternatives to each other.

The Determination of the Wage

Labor supply and demand strongly influence the wage which prevails in a specific labor market, irrespective of whether the market includes a labor union or other non-market forces.

The Market-Clearing Wage

The curve of market demand demonstrates how many companies would want to keep asset costs and consumer demand stable at each wage rate.

Suppose the market wage were set at W1. At this low wage, indicates that demand exceeds supply. Employers will be competing for the few workers in the market, and a shortage of workers would exist. If wages were to rise to W2, supply would exceed demand. Employers would desire fewer workers than the number available, and not all those desiring employments would be able to find jobs, resulting in a surplus of workers. The wage rate at which demand equals supply is the market-clearing wage.

The curve of market demand demonstrates how many companies would want to keep asset costs and consumer demand stable at each wage rate.

The market-clearing wage, is thus the wage that particular employers and employees have to pay. In other words, the market determines wage rates and the individual market participants are ‘announced.’

Disturbing the Equilibrium

Changes could result from shifts in either the demand or the supply curve to change the market clearing wage once it has been reached.

The greater demand would be represented as a rightward shift of the labor demand curve. If We were to persist, there would be a labor shortage in the paralegal market (because demand would exceed supply). This shortage would induce employers to improve their wage offers. Eventually, the paralegal wage would be driven up to We*.

The equilibrium level of employment will also rise. The market wage can also increase if the labor supply curve shifts to the left. Such a shift creates a labor shortage at the old equilibrium wage of We, and as employers scramble to fill their job openings, the market wage is bid up to We ‘. In the case of a leftward-shifting labor supply curve, however, the increased market wage is accompanied by a decrease in the equilibrium level of employment.

Applications of the Theory

Above-Market Wages

First, employers are paying more than necessary to produce their output (they pay WH instead of We); they could cut wages and still find enough qualified workers for their job openings. In fact, if they did cut wages, they could expand output and make their product cheaper and more accessible to consumers. Second, more workers want jobs than can find them (Y workers want jobs, but only V openings are available). If wages were reduced a little, more of these disappointed workers could find work. A wage above market thus causes consumer prices to be higher and output to be smaller than is possible, and it creates a situation in which not all workers who want the jobs in question can get them.

Below-Market Wages

Employees can be defined as underpaid if their wage is below market-clearing levels. At below-market wages, employers have difficulty finding workers to meet the demands of consumers, and a labor shortage thus exists. They also have trouble keeping the workers they do find. If wages were increased, output would rise and more workers would be attracted to the market. Thus, an increase would benefit the people in society in both their consumer and their worker roles. Figure below shows how a wage increases from WL to We would increase employment from V to X (at the same time wages were rising).

Economic Rents

The concepts of underpayment and overpayment have to do with the social issue of producing desired goods and services in the least-costly way; therefore, we compared wages paid with the market-clearing wage. At the level of individuals, however, it is often useful to compare the wage received in a job with one’s reservation wage, the wage below which the worker would refuse (or quit) the job in question. The amount by which one’s wage exceeds one’s reservation wage in a particular job is the amount of his or her economic rent.

Consider the labor supply curve to, say, the military. As shown in the figure if the military is to hire L1 people, it must pay W1 in wages. These relatively low wages will attract to the military those who most enjoy the military culture and are least averse to the risks of combat. If the military is to be somewhat larger and to employ L2 people, then it must pay a wage of W2. This higher wage is required to attract those who would have found a military career unattractive at the lower wage. if W2 turns out to be the wage that equates supply and demand, and if the military pays that wage, everyone who would have joined up for less would be receiving an economic rent.

Conclusion

The labor market, also known as the job market, refers to the supply and demand for labor in which employees provide the supply and employers the demand. It is a major component of any economy and is intricately tied in with markets for capital, goods and services. It’s a vast subject matter with a lot of factor playing important roles to determine the supply & demands of the market.

Reference

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Employment and the Labor Market in Bangladesh: Overview of Trends and Challenges. (2016). Retrieved from https://www.adb.org/publications/employment-and-labor-market-bangladesh-trends-challenges
Labour Market – an overview | ScienceDirect Topics. (2011). Retrieved November 11, 2019, from https://www.sciencedirect.com/topics/social-sciences/labour-market

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