This article focuses on the theory of labor supply. The relationship between labor markets, labor supply and demand, labor force, and wage rate are discussed. The article explores why and how the United States government measures labor supply and unemployment rates. The issues associated with child labor and labor policies are addressed.
Keywords Budget Constraint; Child Labor; Current Population Survey; Economic Growth; Income Effect; Labor Demand; Labor Force; Labor Market; Labor Supply; Occupation; Opportunity Cost; Productivity; Rate of Substitution; Reservation Wage; Unemployment Rate; Utility; Wage Rate
Economics: Labor Supply
The health and demographics of a nation's labor force effects the nation's productivity and potential for economic growth. National economies rely on steady and, in most instances, growing labor supply and demand. Economic growth is often created by increased productivity from a larger labor supply. Individual and aggregate labor supply is determined by individual and aggregate appetite for leisure and consumption as well as wage rates. The public sector can manipulate wage rates and institute labor policies that control work related issues such as child labor and work visas, to raise or lower the labor supply. Labor supply policies are often developed to address the public problem of intractable poverty. Labor supply policies, such as welfare reform, job training, and the Earned Income Tax Credit (EITC), are developed to increase the labor supply, job skills, or wages of the poor (Bartik, 2001).
Labor economics considers labor supply and demand to be a central factor in the health of the labor market and the economy as a whole. Labor economics is concerned with the relationship between markets and labor. Labor markets are the markets that form from the interaction of employers and workers. Labor markets differ from the market for other public goods in the finite nature of human labor, energy, and productivity; human workers can work a finite number of hours. In addition, reproduction rates and global resources limit the growth in the overall population of workers. The scope of labor economics extends to the following areas: Labor supply, labor demand, income, wages, and employment patterns and trends.
The concept of labor supply is a fundamental building block in both microeconomic and macroeconomic theory. In microeconomics, labor supply is directly linked to the theory of income-leisure choice. In microeconomic theory, the labor supply increases or decreases in response to changes in real wages (Morris, 2001). The overall labor supply includes employment and unemployment rates. Employment and unemployment, in microeconomic theory, are viewed as alternative uses of time. People are believed to choose the type and duration of their work based on their preferences for leisure and wage requirements. This perspective does not explain or account for involuntary unemployment (Spencer, 2005).
In macroeconomics, labor supply is studied as a means of understanding large cyclical fluctuations in the economy. Economists debate the role of labor supply and demand in causing economic booms and slumps. Economists agree that workers expend greater work effort during times of economic boom than in times of economic slumps but cannot fully explain and predict individual labor supply decisions. Individual and aggregate labor supply decisions are affected by variables and factors such as wages, availability of work, and preference for leisure over consumption. In the United States, households make individual decisions about labor market participation. In most instances, economists find that wage amounts affect labor market participation more than a laborer's preference for leisure (Change & Kim, 2005). Labor supply is managed in most industrialized nations through labor supply and wage policies that promote full employment and labor market equilibrium.
The following section provides an overview of the neoclassical theory of labor supply. This section serves as the foundation for later discussions of how and why the U.S. government measures labor supply and unemployment rates in the United States. The issues associated with labor supply and child labor are addressed.
The Theory of Labor Supply
Neoclassical Theory of Labor Supply
The neoclassical labor supply theory conveys the largest amount of hours a worker will be willing to contribute to the economy over the course of a certain span of time at each wage rate. The neoclassical theory of labor supply is used to analyze employment and unemployment patterns in labor markets. Neoclassical economic theory argues that employment and unemployment are two alternate ways to spend time. Individuals are believed to choose whether or not to work based upon their preference for work or leisure and the wage rate available to them. Unemployment, in this theory, can be interpreted as a form of voluntary leisure. Economist John Keynes developed the idea of involuntary unemployment in his book, “The General Theory of Employment, Interest, and Money” (1936). Involuntary unemployment is believed to exist due to an insufficiency in aggregate, or total, labor demand. Involuntary unemployment is generally addressed by government intervention and labor policies.
The neoclassical model of labor supply and demand, often represented as a curve, is based on the idea that participating in the labor market is a voluntary choice more than an economic necessity. Unemployment in the neoclassical theory of labor supply is considered to be a labor-leisure choice (Spencer, 2005). The following factors and variables affect labor supply and demand: Utility function, budget constraint, rate of substitution, income effect, and opportunity cost. The neoclassical theory of labor supply is directly connected to the neoclassical theory of labor demand. While the labor supply theory, often represented as a curve, conveys the largest amount of hours a worker will be willing to contribute to the economy over the course of a certain span of time at each wage rate; the theory of labor demand illustrates the most hours an employer will demand at each wage rate.
Labor Market Equilibrium
When labor demand and labor supply are balanced, labor market equilibrium occurs. The neoclassical theory of labor equilibrium argues that when labor supply and demand are equal, the economy is in equilibrium. Neoclassical economists argue that the supply and demand for labor will be equal to one another in the absence of fixed or static wages. In labor equilibrium, the labor supply is balanced. Workers give their time to work in a manner that balances the utility of their wages with the utility of leisure time. In labor equilibrium, the labor demand is also stable and balanced. Businesses hire workers based on business productivity needs and estimations. Businesses can entice workers to forgo leisure by offering wages above the worker’s reservation wage. A reservation wage refers to the minimum real wage that causes workers to become indifferent when faced with consumption and leisure choices.
Ultimately, the theory of labor supply is one half of the labor supply and demand model used to understand and predict employment and unemployment patterns. The theory of labor supply is often equated with a labor-leisure tradeoff or choice. In practice, economic factors such as wages and income needs, possibly more than leisure preferences, affect individual labor supply choices. Labor supply and labor force participation rates are tracked by the government as part of the overall project of promoting and facilitating economic growth for the nation. The following section describes how and why the federal government measures the U.S. labor supply and the unemployment rate.
Measuring the U.S. Labor Supply
Measuring Labor Supply
In the United States, the labor supply is measured through the national unemployment rate. The labor supply and demand rates control local labor markets. As wages increase, businesses seek lower cost alternatives to increasingly more expensive labor. For example, businesses may invest in productivity enhancing technology and ultimately reduce the number of workers required to do the work. At the same time, as wages increase, workers are drawn into the labor force. The overall quantity or supply of labor is increased. Ultimately, the demand for labor is a decreasing function of wages while the supply of labor is an increasing function of wages.
In a balanced labor system, labor equilibrium and full employment will exist at the intersection of labor supply and demand. For example, all those workers wishing to work at a certain wage will be employed and labor demand will be met. In most labor markets, labor equilibrium and full employment are rarely achieved. In most local and national labor markets, there are more persons willing to work at the prevailing wage than there are businesses willing or able to hire at the prevailing wage. The unemployment rate refers to the number unemployed as a percentage of the total labor force. The total labor force is the number of unemployed persons in addition to the number of employed persons.
Economists debate whether or not all labor markets have an inherent or natural rate of unemployment. Unemployed people are generally grouped into three unemployment categories: Frictional, cyclical and structural unemployment.
- Structural Unemployment: Unemployment caused by changes in technology or structure of the economy.
- Cyclical Unemployment: Unemployment caused by down turns in the aggregate economy.
(The entire section is 4341 words.)