The Determination of Relative Wage rates and Levels of Employment in Perfectly Competitive Labour Markets

AQAMicroeconomics1.6.3 Updated

Written by — First-Class BSc (Hons) Economics, University of Bath · 6+ years teaching A-Level Economics · Edexcel A, Edexcel B, AQA and OCR

Specification Coverage: AQA unit 1.6.3 - The Determination of Relative Wage rates and Levels of Employment in Perfectly Competitive Labour Markets. Students should be able to explain the model of wage determination in a perfectly competitive labour market, and the role of market forces in determining relative wage rates.

Wage Determination in a Competitive Labour Market

Perfectly competitive labour market: A labour market where there are an infinite number of identical buyers of labour (businesses) and an infinite number of identical workers.

In a competitive labour market, there are many firms demanding labour and many workers supplying labour.

Both firms and workers are wage takers, so they accept the market equilibrium wage.

Competitive labour market diagram where labour demand and supply intersect to set the equilibrium wage and employment
Figure 1: In a competitive labour market, the equilibrium wage (W1) is determined at the intersection of the labour supply (SL) and labour demand (DL) curves, with the equilibrium quantity of labour (Q1) also determined at this point.

This results in an equilibrium wage at W1 and an equilibrium quantity of labour at Q1 being established in the market.

Role of Market Forces in Determining Wages and Employment

Similarly to markets for goods and services, market forces of supply and demand determine the equilibrium wage and employment levels in a competitive labour market.

  • If the wage is above the equilibrium level, there will be an excess supply of labour. This will lead to a surplus of workers, and workers will reduce wage demands to enter employment, resulting in a fall in the wage rate and an increase in employment until the market reaches equilibrium again.
  • If the wage is below the equilibrium level, there will be an excess demand for labour, leading to a shortage of workers. Firms will compete for workers by offering higher wages, resulting in an increase in the wage rate and an increase in employment until the market reaches equilibrium again.

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