The Impact of Supply and Demand on the Labor Market
Supply and demand is one of the central concepts of capitalism, the leading economic system of the Western World as well as in such individual nations as Japan or Singapore. The basic idea behind it is that the prices of goods and services are determined by the availability of these things (the supply) and the level of economic activity, or the amount of money people are willing to spend on them (the demand).
In a free market, capitalists are able to choose what to produce and how to produce it, guided only by their own self-interest and market conditions. In particular, they will aim to produce those goods or offer those services for which there is high demand and low supply (so-called “economic rent”), thereby maximizing their profits.
The labor market operates under similar principles: businesses will employ workers only if they think they can make a profit from doing so, and workers will offer their labor only if they feel they are getting a fair wage for it. The interaction between employers and workers in the labor market determines wages and employment levels.
2. The basics of supply and demand
The most fundamental analysis of any market is a supply-and-demand diagram, which plots the quantity supplied against the quantity demanded at different prices (see Figure 1). The point where these two lines intersect is called the equilibrium point. This is the price at which there is neither a surplus nor a shortage of the good or service in question; in other words, it is the price at which quantity demanded equals quantity supplied.
![Figure 1: A basic supply-and-demand diagram](https://i1.wp.com/blog.stcloudstate.edu/engr4960/files/2013/10/Screen-Shot-2013-10-28-at-12.21.51-AM1.png?w=584&h=328&ssl=1)
_Figure 1: A basic supply-and-demand diagram_
If the price is above equilibrium (point A in Figure 1), there is a surplus of the good or service; that is, more is being produced than people want to buy. Producers will respond by reducing production and lowering prices until equilibrium is reached again. Conversely, if the price is below equilibrium (point B), there is a shortage; not enough is being produced to meet people’s needs. In this case, producers will raise prices and/or increase production until equilibrium is restored.
It should be noted that the equilibrium point is not necessarily static; it can shift over time as people’s tastes change or as new technologies are introduced which affect either production or consumption patterns (or both). When this happens, we say that there has been a change in “supply” or “demand”, respectively.
3. The labor market
In order to understand how wages and employment levels are determined in the labor market, we need to consider both sides of the market: employers (the “demanders” of labor) and workers (the “suppliers”).
Employers demand labor because they need workers to help them produce goods or provide services. The number of workers they hire depends mainly on two things: how much profit they expect to make and how much it costs to hire workers (wages). If the expected profit is high, they will be more willing to pay higher wages and vice versa. In other words, the demand for labor is inversely related to wages: when wages are high, the demand for labor is low and when wages are low, the demand for labor is high. This relationship is represented by the “demand curve for labor” in Figure 2.
![Figure 2: The labor market](https://i0.wp.com/blog.stcloudstate.edu/engr4960/files/2013/10/Screen-Shot-2013-10-28-at-12.23.09-AM1.png?w=584&h=328&ssl=1)
_Figure 2: The labor market_
The other side of the market is composed of workers who want to sell their labor in exchange for a wage. The amount of labor they are willing to supply depends on how much they need or want to work (this could be for financial reasons or because they enjoy their work, for example) and how much they think their labor is worth (wages). In general, the higher the wages, the more labor workers will be willing to supply. This relationship is represented by the “supply curve for labor” in Figure 2.
As in any other market, the point where these two curves intersect gives us the equilibrium wage and employment levels in the labor market (point E in Figure 2). In this case, the equilibrium wage is W* and the equilibrium employment level is L*.
It should be noted that the shapes of these curves can vary depending on a number of factors, such as technological change, taxes, or unionization. We will discuss some of these later on. For now, let’s assume that both curves are “normal”, which means that they slope upwards from left to right (as in Figure 2).
4. The impact of supply and demand on wages and employment
We have seen that wages and employment levels are determined by the interaction of employers and workers in the labor market. But what happens when there are changes in either the demand for or supply of labor?
If there is an increase in demand (to D1 in Figure 3), this means that employers need more workers than before and are willing to pay higher wages to get them. The result is an increase in both wages and employment (to W1 and L1). Similarly, if there is a decrease in demand (to D2), this will lead to a fall in both wages and employment (to W2 and L2). These relationships are represented by the “demand Curve 1” and “demand Curve 2” lines in Figure 3.
![Figure 3: Changes in labor demand](https://i2.wp.com/blog.stcloudstate.edu/engr4960/files/2013/10/Screen-Shot-2013-10-28-at-12.25.19-AM1.png?w=584&h=328&ssl=1)
_Figure 3: Changes in labor demand_
Changes in supply can also impact employment and wages levels, although the effect is not as straightforward as it is with changes in demand. If there is an increase in supply (to S1), this means that more workers are looking for jobs than before and employers can be more choosy about who they hire. As a result, wages fall and employment rises (to W3 and L3). However, if there is a decrease in supply (to S2), this will lead to an increase in wages and a decrease in employment (to W4 and L4). These relationships are represented by the “supply Curve 1” and “supply Curve 2” lines in Figure 4.
![Figure 4: Changes in labor supply](https://i0.wp.com/blog.stcloudstate.edu/engr4960/files/2013/10/Screen-Shot-2013-10-28-at-12.26.02-AM1.png?w=584&ssl=1)
_Figure 4: Changes in labor supply_
5. The role of government intervention
In a completely free market, the government does not intervene in the labor market except to enforce property rights and contracts. This hands-off approach is sometimes called “laissez faire”. However, most modern capitalist economies have some form of government intervention, either to protect workers’ rights or to influence the level of economic activity.
One common form of intervention is to set a minimum wage, which is the lowest hourly wage that employers are legally allowed to pay their workers. This is intended to help low-paid workers earn a “living wage” that meets their basic needs. In practice, however, it can sometimes have the opposite effect, leading to higher unemployment levels among the very people it is meant to help. This is because when the minimum wage is set above the equilibrium wage, it becomes unprofitable for employers to hire low-skilled workers and they will instead look for alternatives, such as automation or outsourcing.
Another way in which governments can intervene in the labor market is through taxation. For example, employers may be required to pay taxes on each worker they hire (known as an “employment tax”) or workers may have to pay taxes on their earnings (known as an “income tax”). These taxes make it more expensive for businesses to hire workers and/or reduce the amount of money that workers take home, which can lead to lower employment and wages levels.
In conclusion, we can say that the labor market is complex and ever-changing, and that the level of government intervention can have a significant impact on wages and employment levels. However, the basic principles of supply and demand still apply: businesses will only hire workers if they think they can make a profit from doing so, and workers will only offer their labor if they feel they are getting a fair wage for it.
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