Why do economists describe the demand for labour as a derived demand?

Firms do not want workers for their own sake; they hire labour because labour produces goods and services that customers buy. The demand for labour is therefore derived from the demand for the output it makes. If demand for the final product rises, firms need more workers and labour demand rises; if the product falls out of favour, labour demand falls even though nothing about the workers themselves has changed. This is why employment in an industry tracks the fortunes of that industry's product market.

A UK housebuilder finds that demand for new homes has fallen sharply. What happens to its demand for bricklayers, and why?

Its demand for bricklayers falls. Labour demand is derived from demand for the output, so fewer homes sold means fewer homes worth building, and the firm needs fewer bricklaying hours at every wage rate. The whole labour demand curve shifts to the left rather than the firm simply moving along it, because the cause is something other than the wage. At the new intersection with labour supply, both the wage and the number of bricklayers employed are lower.

Why does the demand curve for labour slope downwards, if a wage rise makes labour more expensive?

For three reasons. As the wage rises, capital equipment becomes relatively cheaper, so firms substitute machines for workers. Higher labour costs raise total production costs, so firms must charge more, sell less output and therefore need less labour. And firms can reorganise the work, combining roles and cutting hours, so that fewer workers are needed. Each effect points the same way, so a higher wage is associated with a smaller quantity of labour demanded.

How do employer pension contributions and employment taxes affect the demand for labour?

They are non-wage labour costs, so they raise the total cost of employing someone above the wage the worker actually receives. A rise in these costs makes labour dearer relative to capital and relative to the price the firm can charge, so at any given wage the firm wants fewer workers and the labour demand curve shifts left. A cut has the opposite effect. This is why employers talk about the cost of a job rather than just the salary.

Why can a rise in labour productivity raise both employment and wages in an industry?

More productive workers produce more output per hour, so each worker is worth more to the firm and labour demand shifts right. Against an upward-sloping labour supply curve, the new intersection is at a higher wage and a higher quantity of labour employed. Productivity growth is therefore the main way real wages can rise without firms losing competitiveness, because higher pay per hour is offset by more output per hour, leaving the labour cost of each unit of output roughly unchanged.

CCEA AS-Level Economics 4410

Key Economic Concepts

Topic overview The four factors of production Positive statements and normative judgements Economic agents and what they are trying to achieve Capital goods and consumption goods Product markets and factor markets

The Basic Economic Problem of Scarcity and Choice

Topic overview Scarcity, choice and opportunity cost Drawing and reading the production possibility frontier Using a PPF to show choice, opportunity cost, efficiency and growth Why an economy operates inside its frontier Specialisation and the division of labour Free market, planned and mixed economies

Demand and Supply in Product Markets

Topic overview What determines demand and what determines supply Movements along a curve versus shifts of a curve Why the demand curve slopes downwards Why the supply curve slopes upwards: marginal cost and the profit incentive Consumer surplus and producer surplus When consumers do not behave rationally

Markets and Equilibrium

Topic overview Market equilibrium and how markets clear How shifts in demand and supply change the equilibrium Price signals, incentives, rationing and the role of profit Joint, composite and derived demand and joint supply Tracing effects between interrelated markets Community surplus and allocative efficiency Demand and supply in housing, energy and commodity markets Indirect taxes and subsidies: impact and incidence

Elasticity of Demand and Supply

Topic overview Price elasticity of demand: measuring and interpreting Income and cross elasticity: normal, inferior, substitutes and complements Price elasticity of supply What determines the value of an elasticity Elasticity and total revenue How useful is elasticity for firms and government?

Factor Markets: Labour

Topic overview How a competitive labour market sets the wage Elasticity of labour demand and labour supply Wage differentials and why they persist Economic rent and transfer earnings Flexibility: trade unions, welfare and migration Minimum wages and government intervention in the labour market

Market Failures and Imperfections

Topic overview Market equilibrium, the social optimum and the meaning of market failure Externalities: private, external and social costs and benefits Community surplus and the externality diagrams Calculating and interpreting welfare loss Public goods, quasi-public goods and the free rider problem The consequences of missing markets for public goods Merit goods and demerit goods Information gaps and asymmetric information The consequences of merit goods, demerit goods and information failure Market power and other market imperfections Income and wealth inequality Absolute and relative poverty

Government Intervention in Markets

Topic overview Why governments step into markets Indirect taxes Subsidies, and choosing between taxes and subsidies Maximum and minimum prices State provision Regulation Information provision Tradeable pollution permits Government failure

The Circular Flow of Income

Topic overview Households, firms and the two-way flow Injections and withdrawals in an open economy with government Equilibrium and change in the circular flow

Measuring National Income

Topic overview Three routes to the same total: income, expenditure and output GDP as a measure of welfare and its limitations Domestic or national? GDP and GNP compared Nominal and real values: correcting for price changes Total and per capita measures

Aggregate Demand

Topic overview The four components of aggregate demand Why the aggregate demand curve slopes downwards Movements along and shifts in aggregate demand Factors that shift aggregate demand Investment: gross, net and fixed capital

Aggregate Supply

Topic overview Why short-run aggregate supply slopes upwards Factors that shift short-run aggregate supply Movements along and shifts in aggregate supply From the short run to the long run What determines long-run aggregate supply Keynesian and neoclassical views of long-run aggregate supply

Macroeconomic Equilibrium

Topic overview How aggregate demand and aggregate supply determine equilibrium Applying AD-AS analysis to growth and unemployment Applying AD-AS analysis to inflation

Macroeconomic Objectives

Topic overview Why governments target inflation, unemployment, the external balance and growth Objectives beyond the main four: the environment and the distribution of income and wealth Picturing inequality: the Lorenz curve and the Gini coefficient Where the objectives collide: the main policy conflicts Judging the trade-offs: how sharp is a conflict?

Inflation

Topic overview Inflation, deflation and disinflation: what the words actually mean Measuring the rate: the CPI and the RPI Working with index numbers Building a price index: the basket and the significance of weights Demand-pull and cost-push inflation The costs and consequences of inflation and deflation The policy response to inflation

Unemployment

Topic overview The claimant count and the ILO measure of unemployment Calculating and interpreting unemployment statistics Unemployment and economic inactivity: a distinction that changes the numbers The types of unemployment and what distinguishes them The causes of unemployment and of economic inactivity The costs and consequences of unemployment and inactivity Policies for unemployment and intervention in the labour market

Economic Growth

Topic overview Actual and potential growth on a production possibility frontier Measuring economic growth The economic cycle and output gaps The causes of economic growth Benefits, costs and the sustainability of growth Policies to promote economic growth using AD–AS analysis

Fiscal Policy and Its Effects

Topic overview What fiscal policy is and how it works Government spending and taxation: the main categories Direct and indirect taxation Fiscal policy in the AD-AS model Evaluating the impact of fiscal policy on output, employment, prices and agents

Monetary Policy

Topic overview The nature of monetary policy and the interest rate instrument The transmission mechanism from interest rates to aggregate demand Monetary policy in the AD-AS model Evaluating the impact of monetary policy on output, employment, prices and agents

Supply-Side Policies

Topic overview The nature of supply-side policy and tax cuts Deregulation and evaluating market-based supply-side policy Competition and innovation as supply-side policy Infrastructure as supply-side policy Labour market reform Education, training and the skills of the workforce Labour productivity: determinants and significance Supply-side policies in the AD-AS model Evaluating the impact of supply-side policies

Exchange Rates and the National Economy

Topic overview What an exchange rate is and how it is measured Exchange rate changes in the AD-AS model Holding the exchange rate above or below the market clearing level Why a government might have an exchange rate policy Evaluating the impact of exchange rate changes on output, employment, prices and agents

Quantitative Skills in Economics

Topic overview Ratios, shares and proportions in economic data Percentages and percentage changes in economic data Averages, medians and quantiles Index numbers, weighting and rebasing Converting money values to real values Cost, revenue and profit Elasticity: calculating the number and reading its meaning Choosing and reading economic charts and diagrams Interpreting economic data critically

Factor Markets: Labour

6 subtopics
12 things to know
Unit AS 1

What Factor Markets: Labour covers

Factor markets: labour is examined in Unit AS 1, Markets and Market Failure. It covers how a competitive labour market sets the wage, elasticity of labour demand and labour supply, wage differentials and why they persist, economic rent and transfer earnings, flexibility: trade unions, welfare and migration and minimum wages and government intervention in the labour market.

Where it is assessed

Unit AS 1

Markets and Market Failure, written examination, 20% of A level.

Check the CCEA specification ↗

The 6 subtopics

Each one has its own page. CCEA AS Economics students sit this topic in the first year.

What you need to know

Answer each one before you reveal it.

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Key term

Distinguish transfer earnings from economic rent, and state how they relate to total pay.

Key term

What is a flexible labour market, and how does collective bargaining raise pay?

Key term

Name four influences that shift the demand curve for labour in an industry to the right.

Key term

List five influences on the supply of labour to a particular occupation.

Key term

How do occupational and geographical mobility affect the supply of labour to a particular job?

Key term

Which four factors determine how elastic the demand for labour is?

Key term

Why is the demand for labour more elastic when demand for the final product is price elastic?

Key term

Which factors make the supply of labour to an occupation inelastic?

Key term

How does the elasticity of labour supply help explain very high pay in some occupations?

Key term

List the main ways a government intervenes in the labour market.

Key term

Assess whether government subsidies for training and apprenticeships are a good use of public money.

Key term

What unintended consequences can well-meant labour market intervention produce?

Take Factor Markets: Labour further

The same content, four other ways.

Questions from this topic

Each one with the model answer underneath.

1
Why do economists describe the demand for labour as a derived demand?
Model answer
Firms do not want workers for their own sake; they hire labour because labour produces goods and services that customers buy. The demand for labour is therefore derived from the demand for the output it makes. If demand for the final product rises, firms need more workers and labour demand rises; if the product falls out of favour, labour demand falls even though nothing about the workers themselves has changed. This is why employment in an industry tracks the fortunes of that industry's product market.
2
A UK housebuilder finds that demand for new homes has fallen sharply. What happens to its demand for bricklayers, and why?
Model answer
Its demand for bricklayers falls. Labour demand is derived from demand for the output, so fewer homes sold means fewer homes worth building, and the firm needs fewer bricklaying hours at every wage rate. The whole labour demand curve shifts to the left rather than the firm simply moving along it, because the cause is something other than the wage. At the new intersection with labour supply, both the wage and the number of bricklayers employed are lower.
3
Why does the demand curve for labour slope downwards, if a wage rise makes labour more expensive?
Model answer
For three reasons. As the wage rises, capital equipment becomes relatively cheaper, so firms substitute machines for workers. Higher labour costs raise total production costs, so firms must charge more, sell less output and therefore need less labour. And firms can reorganise the work, combining roles and cutting hours, so that fewer workers are needed. Each effect points the same way, so a higher wage is associated with a smaller quantity of labour demanded.
4
Name four influences that shift the demand curve for labour in an industry to the right.
Model answer
A rise in demand for the industry's final product, since labour demand is derived from it. A rise in labour productivity, which makes each worker more worthwhile to employ. A rise in the price of capital equipment, which makes labour the cheaper way to produce. And an increase in the number of firms competing in the industry, which adds to total hiring. A cut in employment taxes or other non-wage costs would also shift the curve right.
5
How do employer pension contributions and employment taxes affect the demand for labour?
Model answer
They are non-wage labour costs, so they raise the total cost of employing someone above the wage the worker actually receives. A rise in these costs makes labour dearer relative to capital and relative to the price the firm can charge, so at any given wage the firm wants fewer workers and the labour demand curve shifts left. A cut has the opposite effect. This is why employers talk about the cost of a job rather than just the salary.
6
Why can a rise in labour productivity raise both employment and wages in an industry?
Model answer
More productive workers produce more output per hour, so each worker is worth more to the firm and labour demand shifts right. Against an upward-sloping labour supply curve, the new intersection is at a higher wage and a higher quantity of labour employed. Productivity growth is therefore the main way real wages can rise without firms losing competitiveness, because higher pay per hour is offset by more output per hour, leaving the labour cost of each unit of output roughly unchanged.

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Key Economic Concepts

The Basic Economic Problem of Scarcity and Choice

Demand and Supply in Product Markets

Markets and Equilibrium

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Factor Markets: Labour revision questions

Is Factor Markets: Labour examined at AS in CCEA Economics?: Yes. It sits in Unit AS 1, which you take in the first year, so it is on the AS paper as well as counting towards the full A level.
What does Factor Markets: Labour cover in CCEA AS-Level Economics?: 6 subtopics: how a competitive labour market sets the wage, elasticity of labour demand and labour supply, wage differentials and why they persist, economic rent and transfer earnings, flexibility: trade unions, welfare and migration and minimum wages and government intervention in the labour market. Each one has its own page with questions and model answers.
How is Factor Markets: Labour organised?: By the CCEA 4410 specification, subtopic by subtopic, so it matches the order you are taught it in.

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