Worksheet on Pay (Tutor Version)

This worksheet is intended for economics and business students and considers the factors that affect the level of wages. The initial steps consider the factors affecting the demand and supply curves for labour and the worksheet then goes on to look at the equilibrium level of wages and why if differs between different jobs.

Step 1 - Who is demanding?

You may well be able to answer this question very easily (the answer may even be your economics and business teacher / lecturer!), but in this context we mean who demands labour? Labour is demanded as a factor of production to help produce goods and services.

The demand for labour is therefore considered a 'derived demand'. The demand for labour is derived from the demand for the goods and services that the labour can produce. The amount that labour can produce is therefore a critical determinant of demand.

Use your textbook or library to find out definitions for the following:

Marginal physical product

The increase in output resulting from employing an extra unit of the variable factor.

Marginal revenue product

The value of the increase in output from employing one more unit of the variable factor. It is calculated by multiplying the Marginal Physical Product by the Marginal Revenue (equal to the price in perfect competition).

Use these definitions to fill in the table and answer the questions below:

N.B. We are assuming perfectly competitive markets and all figures are daily ones.

Use the table to plot the Marginal Revenue Product Curve. (Students could be encouraged to put the figures above in the table into Excel or a similar spreadsheet package. They could then input a formula to calculate the MRP and use the graphing function to plot it).

1. How many people will the firm employ at a wage rate of £30 per day? 6 people
   
   
2. If the wage rate was to rise to £60 per day, how many people would the firm employ? 5 people
   
   
3. Show these points on your diagram.
   
   
4. If the price of the product was to rise to £10 what would happen to the MRP curve?
   
   It would shift to the right
   
   
5. What would happen to the MRP curve if the productivity of labour (the MPP) fell?
   
   It would shift to the left
   

We can see from all this that the MRP curve shows the number of people employed at each wage rate. This means that the MRP curve represents the demand curve for labour. Any change in the productivity of labour or the price of the product will shift the demand curve. Any change in the wage rate and the firm will simply move along the MRP curve and alter the amount of labour they employ.

Step 2 - Who sells themselves?

The supply of labour can be looked at on 3 different levels:

• the supply of hours by an individual
• the supply of workers to an individual employer
• the supply of workers to an individual market

Individual supply

The number of hours the individual supplies depends on a number of factors. One of the key determinants will be the individual's attitude to work.

How would you react if your wage went up? Would you (circle your response):

1. Work harder to earn more money?
2. Work the same amount? Or
3. Work less because you can still earn the same amount as before?

This decision is made up of two components; the income effect and the substitution effect. Use your textbook or library to find out the definition of each and write them below:

Income effect

The effect on supply from a change in the level of real income alone. The income effect measures how people's work effort or supply reacts to this income change.

Substitution effect

The effect on supply resulting from a change in the wage rate (the price of labour). Because the opportunity cost of leisure has changed, people would normally substitute from the one that has become relatively more expensive to the one that has become cheaper. i.e. when the wage rate increases, leisure becomes more expensive and so people may work harder.

For each of the above reactions to a wage rise work out which effect is greater - the income effect (IE) or the substitution effect (SE) or neither. Circle your answers below:

1. Work harder to earn more money? SE > IE
2. Work the same amount? Or Neither
3. Work less because you can still earn the same amount as before? SE < IE

These answers could be used to generate a discussion of the effectiveness of tax cutting as a supply-side policy. Will people react by working harder?

Market supply

The shape of the market supply curve depends on a number of factors including:

• the wage
• the length of training required for the job
• the skills required
• the status of the job
• the amount of experience required
• the ease with which other factors can be substituted

Bearing in mind these determinants, what shape would you expect the supply curve to be in each of the following jobs - elastic or inelastic:

Consultant surgeon? INELASTIC?

Why? Long training period and high level of experience required mean that the supply will tend to be very inflexible and unable to respond rapidly to price (wage) changes.

Supermarket shelf-stacking? ELASTIC?

Why? Short training period and high availability of suitable candidates mean that supply is much more flexible to wage changes. Staff can quickly be attracted from elsewhere by a small wage increase.

BBC Video-editor? INELASTIC?

Why? Need for creative ability together with a high level of experience limits the flexibility of supply. Perhaps not as inelastic as surgeons though?

Step 3 - Who demands what and who supplies what?

If we put demand and supply of labour together we get the equilibrium in any particular labour market. To examine this equilibrium in practice go to one of the employment agency sites on the Internet and use them to find two contrasting jobs - one earning a fairly high salary, and one a lower salary. Some sites you could use are given below:

• Reed Employment (http://www.reed.co.uk/)
• Jobsite (http://jobsite.co.uk/)

Hint: Don't be too specific with the jobs and places you search for or you may not find many jobs available - use general search terms or leave boxes blank where possible.

Put the details of each job in the table below:

For each of these jobs, try to think of factors that will affect the demand and supply of labour for them. Fill in as many as you can in the table below:

Students should be encouraged to choose contrasting jobs, and to apply all the above to each job. How long a training period is required? What will the level of MRP be? What skills are required? Are the jobs very specific to an individual location? And so on.

Step 4 - Demand and supply in balance?

Where demand and supply are equal will be the equilibrium. This equilibrium may change when demand or supply change. The table below considers the market for Internet programmers - people who can write and design web sites. Consider whether you would expect demand or supply to shift, and therefore whether wages would rise or fall:

Show each of these changes on the diagrams below:

No.1	No.2
No.3	No.4

Step 5 - Where will you work?

The equilibrium level of wages will vary considerably between areas of the country. Go to the Reed Employment Agency (http://www.reed.co.uk/) and find their 'regional salary calculator' (under career tools). Choose a salary of £20,000 per annum in Bristol, and see what the equivalent salaries would be in the following places:

Why do these differences occur? (Refer to the level of supply and demand wherever possible in your answers)

• Differences in the cost of living
• Geographical and occupational immobility - limiting supply in some jobs and areas
• Industrial inertia - limiting supply of skills in some areas
• Structure of industry - generating different levels of demand for different skills
• Different availability of land for development - may limit demand in some areas for some skills