The Labor Market: Supply and Demand

The Labor Market: Supply and Demand The labor market is the most important of all factor markets. Producers spend more on labor services than on everything else combined. On the other side of the coin, more income is derived from the sale of labor services than from all other sources combined. Adam Smith and his followers, in effect, started their models of the supply of labor from models of population or fertility, the most famous of which is arguably credited to the Reverend Thomas Robert Malthus. Fertility and population models are fun to play with and I will start there. As time goes on the new born reach working age and decide the extent to which the hours of their lives will be devoted to marketed work. This is the source of the basic inflow into the existing stock of labor. The most important outflow is retirees. Given the natural resources, technology, and fixed capital available to the economy, the labor supply is crucial in determining the magnitude of its production. But it is not merely the number in the supply which counts; it is the number of them who are employed, the hours they work, their skill, and the level of their effort. The abstraction of the aggregate supply becomes more concrete as incentives

draw workers from this supply to smaller constituencies: the supply to regions, industries, occupations, and firms. Generally, the smaller the supply going to a user, the greater is the wage elasticities of supply. Thus, while the overall supply of labor has close to zero elasticity, the supply to the firm in the competitive labor market is infinitely elastic. Atomistic firms can employ as many workers as they want without raising the price paid for labor services. The demand for the factors of production is derived from the demand for pro-

ducts. The neoclassical model of factor demand is based on the marginal productivity of each particular factor of production. Product price or marginal revenue is used to transform demand from product to dollar terms. Much information about production functions and marginal productivity was presented in Chapter 5. Some of that presentation will be reinforced and critically viewed here. It would be nice to say that the overall supply and demand functions equilibrate

the economy. But the matter is more complex than that. In the presence of equilibrium there should be zero unemployment. But there is always some and sometimes large amounts of unemployment and other forms of disequilibrium. Unemployment is generally assumed to be non-existent in microeconomics texts but this aspect of the labor market is too important, sometimes too tragic, to ignore. Labor market equilibria and disequilibria are covered in the following chapter.