How does supply and demand affect wages

How will firms and workers respond? One might be tempted simply to ask firms what they would do in the face of an increase in the minimum wage.

Unfortunately, this is likely to be both infeasible or at least prohibitively expensive and inaccurate. It would be an immense amount of work to interview all the firms in an economy. What is more, there is no guarantee that managers of firms would give accurate answers if they were asked hypothetical questions about a change in the minimum wage. For this we need more theory. Figure We suppose that the price level is constant, so an increase in the nominal minimum wage implies an increase in the real minimum wage.

The increase in the minimum wage leads to a reduction in the level of employment: employment decreases from 32, to 24, Labor is now more expensive to firms, so they will want to use fewer hours.

At the same time, the higher minimum wage means that more people would like jobs. The increase in the amount of labor that people would like to supply, and the decrease in the amount of labor that firms demand, both serve to increase unemployment.

Our model generates a qualitative prediction: an increase in the minimum wage will decrease employment and increase unemployment. At the same time, the wage increase will ensure that those with jobs will earn a higher wage. So we can see that there may be both advantages and disadvantages of increasing the minimum wage. To go further, we have to know how big an effect such a change would have on employment and unemployment—that is, we need the quantitative effects of a higher minimum wage.

To understand the quantitative effects, we want to know when to expect big or small changes in employment or unemployment—which depends on the wage elasticity of labor demand The percentage change in the quantity of labor demanded divided by the percentage change in the wage. Shifts in equilibrium create either a labor surplus or labor shortage. When the market wage rate increases, the theoretical demand for labor decreases and a labor surplus more workers than jobs occurs.

As market wages decrease below the equilibrium rate, the demand for labor is greater than the supply, creating a shortage of workers. Several different forces can affect both the demand for labor and the supply of labor, affecting wages, employment levels and thus equilibrium. For example, changes in firms' demand for labor could result from consumer demand for products or a change in government regulations that affect labor costs. Changes in the supply of labor can result from the population, such as a growth that expands the size of the labor force or a change in the age composition of workers, such as more elderly or younger workers.

Labor supply can also change because of workers' preferences and attitudes toward the labor market. Matthew Schieltz has been a freelance web writer since August , and has experience writing a variety of informational articles, how-to guides, website and e-book content for organizations such as Demand Studios. He plans to pursue graduate school in clinical psychology. Share It. Board of Governors of the Federal Reserve System.

Economy Can Sustain? Corporate Finance Institute. Use precise geolocation data. Select personalised content.

Create a personalised content profile. Measure ad performance. Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. When producing goods and services, businesses require labor and capital as inputs to their production process.

The demand for labor is an economics principle derived from the demand for a firm's output. That is, if demand for a firm's output increases, the firm will demand more labor, thus hiring more staff. And if demand for the firm's output of goods and services decreases, in turn, it will require less labor and its demand for labor will fall, and less staff will be retained. Labor market factors drive the supply and demand for labor. Those seeking employment will supply their labor in exchange for wages.

Businesses demanding labor from workers will pay for their time and skills. Demand for labor is a concept that describes the amount of demand for labor that an economy or firm is willing to employ at a given point in time.