Labor Market: Demand, Supply, Equilibrium

The labor market is one of the most important factor markets. Its analysis is critical for understanding wages, employment, and economic policy.

Supply of Labor

Individual supply: a compromise between labor and leisure. When wages increase:

Substitution effect: leisure becomes more expensive → we work more.
Income effect: richer → can afford more leisure → we work less.

"Backward-bending" curve: at low wages, the substitution effect dominates. At high wages, the income effect can prevail, and labor supply decreases.

Market supply: usually upward sloping — high wages attract more workers.

Equilibrium in the Labor Market

Equilibrium wage ($w^*$): where demand for labor equals labor supply.

Equilibrium employment ($L^*$): the number of hired workers.

In competitive equilibrium: $w = MRP = VMP$. Workers receive their marginal product.

Minimum Wage

Binding minimum wage: if the minimum is higher than the equilibrium wage.

Consequences (standard model):

Employment falls ($L_d$)
Unemployment: $L_s - L_d$
Those who keep their jobs—winners
Those who lose their jobs—losers

Empirical debates: Card-Krueger and other studies show smaller or zero effect on employment in some cases. Labor markets are more complex than the model.

Monopsony

Monopsony: a single buyer in the labor market.

Characteristics:

The firm is a wage setter, not a wage taker
To hire more, must raise wages for all
Marginal cost of labor
gt;$ $w$

Result: employment and wages are lower than the competitive level.

Minimum wage under monopsony: can increase employment! Paradoxical, but possible.

For the Investor

Labor market tightness: affects companies’ ability to hire and costs.

Regulation: minimum wage, labor legislation—affects costs and flexibility.

Labor unions: can raise wages, but also reduce flexibility.