Wage determination in competitive and non-competitive labour markets

Competitive labour markets

Many employers and many workers, none able to influence the wage alone. The equilibrium wage and employment are where demand for labour (MRP) = supply of labour.

• A rise in demand (higher product demand, higher productivity) raises the wage and employment.
• A rise in supply (migration, more people trained) lowers the wage and raises employment.

Wage differences between jobs reflect differences in demand (productivity, product demand) and supply (skills, training, conditions).

Non-competitive markets: monopsony and trade unions

• Monopsony employer: hires where MCL = MRP and pays the wage on the supply curve, so wages and employment are below the competitive level.
• Trade union in a competitive market: if it negotiates a wage above equilibrium, employment falls along the demand curve and there is excess supply of labour (unemployment in that job).
• Bilateral monopoly: a union facing a monopsony. The union can raise the wage towards the competitive level and raise employment at the same time, because the wage floor makes the employer's MCL horizontal up to the supply curve. The outcome depends on bargaining power.

Public sector wage setting

Many public sector workers (teachers, nurses, civil servants) have their pay set by the government, often after advice from independent pay review bodies. The government balances recruitment and retention, fairness, comparison with private sector pay, and the cost to taxpayers. If pay is set below the market wage, shortages and vacancies may arise; above it, there may be queues for jobs.

In state-owned enterprises pay may be set by negotiation between managers and unions, within limits set by the government as owner. As SOEs may face little competition and soft budget constraints, wages can drift above the market level, or be held down to meet public spending targets.

Worked example

Labour demand is L = 1000 - 20W and labour supply is L = 40W - 200. Find the equilibrium wage and employment. A union then sets a wage of $25. Find the excess supply.

1. 1000 - 20W = 40W - 200, so 60W = 1200, W = $20.
2. L = 1000 - 20 x 20 = 600.
3. At $25: demand = 500, supply = 800.
4. Excess supply = 800 - 500 = 300.

Answer: Equilibrium $20 and 600 workers; at $25, excess supply of 300 workers.

Check yourself

1. Labour demand is L = 600 - 10W and supply is L = 20W - 300. Find the equilibrium wage.
   Show answer

   $30. 600 - 10W = 20W - 300, so 30W = 900 and W = $30.

2. For the same market, find equilibrium employment.
   Show answer

   300 workers. L = 600 - 10 x 30 = 300 workers.

3. A union sets the wage at $36 in that market. Find the excess supply of labour.
   Show answer

   180 workers. Supply = 720 - 300 = 420; demand = 600 - 360 = 240; excess supply = 180.

4. In a competitive labour market, a rise in labour productivity will
   • lower the wage and employment
   • raise the wage and employment
   • raise the wage but lower employment
   • have no effect
   Show answer

   raise the wage and employment. Higher MP raises MRP, shifting demand right.

5. When a trade union bargains with a monopsony employer, the wage can rise
   • only if employment falls
   • only to below the monopsony wage
   • only if the government intervenes
   • without necessarily reducing employment
   Show answer

   without necessarily reducing employment. The wage floor removes the employer's incentive to restrict hiring to keep wages down.

6. Pay for many public sector workers is set by
   • the forces of demand and supply alone
   • the government, often advised by pay review bodies
   • individual workers
   • trade unions alone
   Show answer

   the government, often advised by pay review bodies. The government is the employer and pays from taxes.

7. An increase in the supply of trained engineers will
   • raise engineers' wages
   • lower employment of engineers
   • shift the demand for engineers right
   • lower engineers' wages and raise their employment
   Show answer

   lower engineers' wages and raise their employment. Supply shifts right along a given demand curve.

Practise with instant feedback Print this lesson

Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (XEC11/YEC11), Unit 3 Business behaviour and Appendices 6 and 7
• Pearson Edexcel IAL Economics WEC13/01 mark scheme, January 2021

Last updated 8 November 2026. Spotted a mistake? Tell us.