The labour market.

HookThe minimum wage that kept not causing unemployment

ModelThe demand for labour — derived demand and marginal productivity theory

Labour demand is a derived demand: no firm wants workers for their own sake, only for what they produce and what that output sells for. That gives the theory of the demand for labour — marginal revenue productivity. A worker's MRP is the extra revenue the firm earns by employing one more of them: marginal physical product (the extra output that worker adds) multiplied by the marginal revenue from selling it. A profit-maximising firm hires up to the point where the MRP of the last worker equals the wage — take on anyone who adds more to revenue than to cost, stop where they no longer do.

MRP theory explains why wages differ across occupations: surgeons, software engineers and Premier League footballers command high pay because they are highly productive and their output is highly valued. It also identifies what shifts labour demand — a rise in the price of the product, a jump in productivity through training or capital, or a fall in the price of a substitute input such as automation. But treat it as a tendency, not a law. MRP is genuinely hard to measure for a teacher or a nurse, and it says nothing about the bargaining power that decides how the surplus between wage and MRP is actually split.

ModelThe supply of labour — far more than the wage

The supply of labour to a particular market depends on much more than the pay on offer. Monetary factors matter — the wage itself, overtime, bonuses, pensions — but so do non-monetary ones: job satisfaction, status, danger, hours, holidays and working conditions. Adam Smith called the whole package the net advantages of a job, and it explains why nurses accept lower pay than a pure productivity story predicts, and why deep-sea fishing or offshore work must pay a premium to fill posts at all.

Supply to an occupation also depends on the qualifications and training it requires — the barrier that keeps the supply of anaesthetists tiny and the supply of shelf-stackers vast — plus the size of the working-age population, migration and how mobile workers are between jobs and places. Occupational immobility (a redundant miner cannot become a radiographer overnight) and geographical immobility (housing costs trap workers away from where the jobs are) both make labour supply to specific markets inelastic. That inelasticity is precisely why shortages in nursing, HGV driving or fruit-picking can persist for years rather than clearing in a single season.

MechanismWages in a perfectly competitive labour market

In a perfectly competitive labour market there are many small firms and many workers, everyone has good information, the work is homogeneous and no single party can set the wage. The market wage is determined where total labour demand — the sum of firms' MRP curves — meets total labour supply. Each individual firm is then a wage taker: it faces a perfectly elastic supply of labour at the going wage and can hire as many workers as it likes at that rate, because if it offered a penny less every worker would walk to an identical job next door.

The model delivers a clean result — workers are paid their MRP and the market clears with no involuntary unemployment. It is the benchmark, and a fair approximation of something like seasonal agricultural or gig work where switching is easy. Its predictions are also the ones that fail most spectacularly when applied to markets where one employer, or one union, actually holds power. Recognising that a real market departs from these assumptions is the first move in almost every top-band answer.

MechanismMonopsony — when the employer sets the wage

An imperfectly competitive labour market is one where a buyer or seller of labour can influence the wage. The sharpest case is monopsony: a single, dominant employer. Britain has real ones — the NHS is the overwhelming employer of nurses, and a rural town may host one big warehouse or processing plant. A monopsonist faces the whole upward-sloping market supply curve, so to hire one more worker it must raise the wage — and, crucially, pay that higher wage to everyone already on the books. That makes the marginal cost of labour rise faster than the wage itself and sit above the supply curve.

The profit-maximising monopsonist hires where MRP equals the marginal cost of labour, then reads off the wage it actually needs to pay from the supply curve below that point. The result is the signature monopsony outcome: both a lower wage and lower employment than a competitive market would deliver. This is the diagram that makes the section click, because it reverses the standard predictions — and it is exactly why a minimum wage or a trade union can, in a monopsonised market, raise pay without costing jobs.

MechanismTrade unions — the effect flips with the market

A trade union is a monopoly seller of labour: by bargaining collectively it tries to raise the wage above what individual workers could win alone. In a competitive labour market the textbook trade-off applies — force the wage above equilibrium and firms move up their MRP curve, so higher pay for those still in work comes at the cost of fewer jobs, the same logic as a minimum wage. How severe the job loss is depends on the elasticity of demand for labour: unions do least damage where that demand is inelastic, because labour is a small share of costs or has few substitutes.

But drop a union into a monopsony and the result inverts. Because the monopsonist was already suppressing both wages and employment, a union pushing the wage up removes the employer's incentive to restrict hiring — a bilateral monopoly in which a countervailing union can raise both wages and employment toward the competitive level. This is the serious economic case for unions, and AQA rewards students who know the effect is not fixed but depends entirely on the structure it is dropped into. UK union density has fallen from over half the workforce around 1980 to under a quarter today, concentrated in the public sector — itself part of the modern wage story.

CaseThe National Minimum Wage and the National Living Wage

The UK introduced a National Minimum Wage in 1999 against loud predictions of mass job losses, with rates set on the advice of the independent Low Pay Commission. In 2016 a higher National Living Wage was layered on top for older workers, and by April 2024 it reached £11.44 and was extended down to age 21. The simple competitive model says a wage floor above equilibrium must create unemployment — a surplus of labour. The evidence across a quarter-century is that the disemployment effect has been small to undetectable.

The monopsony model is the standard explanation: where employers held wages below MRP, a floor set carefully between the suppressed wage and the competitive wage raises pay and can even raise employment, because it stops the monopsonist from cutting hiring to hold the wage down. The evaluation examiners want is the balance. A minimum wage reduces in-work poverty and wage inequality, but set too high — or imposed on a genuinely competitive, internationally exposed sector — it risks job losses, cut hours, faster automation or higher prices passed to consumers. 'It depends where you set it, and on the structure of the market' is the whole answer.

ModelDiscrimination in the labour market

Labour market discrimination is when workers of equal productivity are paid or treated differently because of a characteristic — gender, ethnicity, age, disability — that is unrelated to their MRP. Economists split it two ways. Gary Becker's taste-based discrimination is prejudice: an employer, customer or fellow worker willing to sacrifice profit to avoid a group. Statistical discrimination is subtler — an employer with imperfect information judges an individual by a real or assumed average for their group, which is why it can persist even among firms that bear no ill will.

On a diagram, discrimination against a group shifts the employer's perceived MRP curve for that group leftwards, or lets the employer pay them below MRP, lowering their wage and employment while raising those of the favoured group. The UK gender pay gap — around 7% for full-time employees and roughly 14% across all employees in 2024 — is driven less by unequal pay for the same job, illegal since 1970, than by occupational segregation and the motherhood penalty. Becker's key insight is the exam's favourite evaluation: in a genuinely competitive market discrimination is expensive, because a firm that underpays productive workers hands a cost advantage to rivals who hire them — so competition erodes discrimination over time, though slowly and incompletely where prejudice is shared by customers or entrenched by information gaps.

VocabularyKey terms the mark scheme pays for

TrapsMisconceptions that cost marks

ExamWhat examiners want