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Explain how wages are determined in a perfectly competitive labour market.

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Introduction

a) Explain how wages are determined in a perfectly competitive labour market (20 marks) As in other markets, the supply and demand of labour determines the price (wage rate) and the quantity (number of people employed). The labour market is different from other markets (like the markets for goods) in several ways. The most important of these differences is the function of supply and demand in setting price and quantity. In markets for goods, if the price is high, in the long run more goods will probably be produced until the demand is satisfied. However, with labour, overall supply cannot in fact be fixed because people have a limited amount of time in the day, and people are not manufactured. A rise in overall wages will, in many situations, not result in a higher supply of labour. It may actually result in less supply of labour as workers take more time off to spend their increased wages because they no longer have to work the longer hours to gain the same amount of money, or it may result in no change in supply. Within the overall labour market, particular parts are thought to be subject to more normal rules of supply and demand as workers are likely to change job types in response to inconsistent wage rates. Many economists have thought that, in the absence of laws or organisations such as unions or large multinational corporations, labour markets can be close to perfectly competitive in the economic sense - because there are many workers and employers both having perfect information about each other. ...read more.

Middle

This could be a long-term supply increase, however, because worker training takes time e.g. doctors training is 6 years. Labour mobility could also be a limiting factor here. b) Discuss the extent to which demand and supply analysis explains the differences in earnings between professional football players and hotel workers (30 marks) The demand for labour is derived demand. Firms only demand employees because of the demand for actual goods or services. Demand is derived from the marginal product of labour - the extra output produced by an additional worker. People are employed because of the value of their output. This depends on the extra output they produce (their marginal product) and the extra revenue this generates when it is sold (the marginal revenue). The MRP is downward sloping because of the law of diminishing returns. This is as additional units of a variable factor (e.g. labour) are added to a fixed factor (e.g. capital) the extra output (marginal product) of the variable factor will eventually diminish. The MRP of a football player is a lot higher than the MRP of a hotel worker. A hotel worker, say, a maid, has a relatively small output and works along with a very large number of employees i.e. they clean say, 50 rooms in one day. A football player, however, has a much larger output. They work in a smaller team of 'employees' and if a match is won, the club gains a lot more than if a maid cleaned one more room in a day. ...read more.

Conclusion

The substitution effect is usually greater than the income effect and people will want to work more hours when there is a wage increase. However, at some wages the income effect outweighs the substitution effect and people will decide to work less hours when wages increase. This causes a backward sloping curve for the supply of labour. Football players will have the opportunity to work fewer hours than hotel workers as they have a hugely high wage, and can therefore let leisure time be more of an option than hotel workers, who have to work longer hours for less money. This means a change in the number of hours a hotel worker works without an increase in wages effects the hotel worker much more than it would affect the football player, so the hotel worker would be much more prepared to supply more of their labour. Trade unions are organisations of workers that seek through collective bargaining with employers to protect and improve the real incomes of their members, provide job security, protect workers against unfair dismissal and provide a range of other work-related services including support for people claiming compensation for injuries sustained in a job. Hotel workers are not heavily unionised. This means that they are on their own, and are more likely to settle for a lower wage than a football player who is protected by the PFA. Laura Half term homework ...read more.

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