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

Wage Determination in a Competitive Labour Market

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.

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.