Labor Demand and Labor Supply

A market for time and skills

Labor markets coordinate firms that want productive effort with people who decide whether, where, and how much to work. The price of labor is the wage, usually measured per hour, day, or year. Employment is the quantity traded, such as worker-hours or number of jobs.

Labor is not an ordinary object: workers have rights, families, identities, and different job conditions. Still, supply and demand provide a useful starting model for understanding wage and employment pressures.

Labor demand

A firm's labor demand comes from marginal revenue product. At a lower wage, more potential workers have MRP high enough to cover their cost, so quantity of labor demanded rises. This gives the labor-demand curve its downward slope.

Product demand, output price, technology, and prices of other inputs shift labor demand. A boom in restaurant meals may raise demand for cooks; labor-saving ordering kiosks may reduce demand for some tasks while increasing demand for technicians.

Labor supply

Workers compare a job's wage and non-wage benefits with the opportunity cost of time, effort, and forgone alternatives. A reservation wage is the lowest wage at which a person is willing to accept a particular job. As the market wage rises, more people or hours generally enter the market, producing an upward-sloping supply curve.

Population, migration, education, taxes, childcare availability, and preferences can shift labor supply. For one individual at very high wages, an income effect can eventually reduce desired hours, so upward slope is not universal.

Equilibrium and adjustment

Competitive equilibrium occurs where quantity of labor demanded equals quantity supplied:

$Q_D^L(W^*) = Q_S^L(W^*)$

Below $W^*$, firms seek more labor than workers offer: a shortage creates upward wage pressure. Above $W^*$, workers offer more labor than firms seek: a surplus creates downward wage pressure.

Worked numerical example

Suppose $Q_D^L = 100 - 4W$ and $Q_S^L = 10 + 2W$, with labor measured in shifts. Set demand equal to supply:

$100 - 4W = 10 + 2W$

Then $90 = 6W$, so $W^* = 15$ and $Q^* = 40$ shifts. At $W = 10$, firms demand 60 shifts while workers supply 30, leaving a shortage of 30.

Reading changes correctly

A wage increase caused by movement along fixed curves reduces quantity demanded and raises quantity supplied. A surge in customer orders shifts labor demand right, typically raising both wage and employment. A larger working-age population shifts supply right, typically lowering wage and raising employment, other things equal.

The model does not guarantee instant adjustment. Search costs, contracts, credentials, geography, discrimination, and imperfect information can leave vacancies and unemployment at the same time. Job quality also matters: a safer or more flexible job may attract workers at a lower money wage.

Wage/hour       $10  $12  $14  $16  $18
Shifts demanded  90   80   70   60   50
Shifts supplied  40   50   60   70   80

Supply and demand explain a market wage, but they do not explain why workers bring different productivity to that market. The next section studies education, training, experience, and wage differences through human capital.