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Economic Theory

4. LABOR MARKET

Content

1. Definition of labor market. Mechanism of function.
2. Employment and unemployment.
3. Wages. Nominal, real and minimum wages.

Key words: labor market, labor demand, labor supply, labor market
equilibrium, employed, unemployed, out of the labor force, labor force,
unemployment rate, frictional unemployment, structural unemployment,

cyclical unemployment, natural rate of unemployment, nominal wages,
real wages, minimum wages.

1. Definition of Labor Market. Mechanism of Function
In the markets for goods and services, the supply side usually comes

from firms, and the demand side comes from households. In the labor
market, by contrast, firms and households switch roles: firms demand
labor, and households supply labor. Labor market is the market that brings
together households who supply labor services and firms who demand

labor as an input into the production process.
Markets for labor have demand and supply curves, just like markets
for goods. The law of demand applies in labor markets this way: a higher

salary or wage – that is, a higher price in the labor market – leads to a
decrease in the quantity of labor demanded by employers, while a lower
salary or wage leads to an increase in the quantity of labor demanded. The
law of supply functions in labor markets, too: a higher price for labor leads

to a higher quantity of labor supplied; a lower price leads to a lower
quantity supplied. Figure 4.1 illustrates how demand and supply determine
equilibrium in the labor market.

The labor market is the market in which labor services are traded.
Labor supply comes from the choices of individuals or households about
how to allocate their time. As the real wage (the nominal wage divided by

the price level) increases, households supply more hours to the market, and
more households decide to participate in the labor market. Thus the
quantity of labor supplied increases. The labor supply curve of a household

is shifted by changes in wealth. A wealthier household supplies less labor
at a given real wage.

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