Economic Analysis of Labor: Supply, Demand, and Market Dynamics

Posted on Nov 4, 2024 in Economy

Economic Analysis of Labor Reality

1. Neoclassical Microeconomic Theory (Conventional Approach)

a) The labor market is analyzed like goods markets: the interaction of labor supply (workers: LS) and labor demand (companies: LD) determines the market wage (W) and the level of employment (L).

  • If W > LD, then W ↓ LD ↑
  • If W < LS, then W ↑ LS ↓

b) The behavior of individual workers and companies is guided strictly by economic rationality (Cost-Benefit Analysis).

c) The labor market clears (supply and demand equal) under conditions of perfect competition and flexibility (jobs and wages):

  1. If there is excess labor supply, wage competition between workers lowers wages → labor supply decreases, labor demand increases.
  2. If there is excess labor demand, wage competition between firms raises wages → labor demand decreases, labor supply increases.
  3. The market automatically reaches an equilibrium wage (where supply and demand for labor match), with a corresponding level of (full) employment.

Graphical Representation of Labor Market Equilibrium

LS LD W* L*

W1 LD1 LS1 W1 > W* → Excess labor supply → Reduction of salary → Equilibrium: W*, L* (reduced supply, increased demand)

LS LD W* L*

W2 LS2 LD2 W2 < W* → Excess labor demand → Increased wage → Equilibrium: W*, L* (increased supply, decreased demand)

d) The institutional framework (legislation, industrial action, collective bargaining, etc.) is seen as a flaw that interferes in the market because it departs from the model of perfect competition.

2. Keynesian Macroeconomic Theory

a) Labor market dynamics depend on the overall situation of the markets for goods and services (aggregate demand, GDP) and the complex relationships between various macroeconomic agents: households (consumption, savings), businesses (investment, production), the State (public expenditure, taxes), and the foreign sector (imports, exports) → overcomes the microeconomic view of the labor market.

b) Individual decisions (consumption, investment, production) are affected by uncertainty and expectations → workers and businesses try to secure their revenues by limiting competition and the flexibility of wages and prices → adjustments in the labor market occur through the quantity of employment.

c) The market does not sufficiently ensure the coordination of individual decisions consistently with steady growth → imbalances are cyclical (periodic crises with unemployment) that require state intervention.

3. Marxist Perspective

a) The relations of production in the capitalist system are marked by inequality between social classes (capitalists and workers) in the ownership of the means of production → dominance of the owners of capital in the organization of work, decisions on employment, and the ownership of the generated income.

b) There is a conflict over the distribution of income between wages and profits; wages are determined by power relations between capital and labor.

c) The distinction between the labor force (the working potential that the capitalist can buy) and actual work (a factor incorporated into the production process) → indeterminacy of the employment contract regarding the full utilization of manpower in the company → development of forms of corporate control of the labor force (making work effective: simple and coercive control, incentives, employee involvement, identification with the company’s goals).

4. The Institutional Approach (Institutional Labor Economics)

a) Institutions are social norms, more or less formalized, governing relations among individuals and groups, with permanence in time and penalties to ensure compliance. They influence individual economic performance while enabling the development of this activity.

b) Institutional peculiarities of the labor force:

  1. Employees and employers are part of a society with certain institutional values that determine their actions beyond economic rationality.
  2. Workers and employers can organize collectively to defend their interests in the field of industrial relations.
  3. Non-market institutions (family, school, etc.) are involved in the (re)production of the workforce.

c) Institutions and social norms regulating the workplace:

  1. Market: employment contract (individual voluntary agreement).
  2. Organization: unions, employers’ associations, collective agreements, professional associations (norms arising from the collective action of organized players in the field of labor relations).
  3. Public intervention: political regulation of the conflict between capital and labor; regulation of labor market conditions and business management of labor (labor law).

d) Different configurations of the working reality, multiple labor markets differentiated by their social norms of regulation:

  1. The perfectly competitive labor market is characterized more by the absence of market institutions → operation according to the logic of supply and demand.
  2. There are labor markets that have little to do with the perfectly competitive market, as there are institutional rules derived from legal regulation and collective organization that limit the logic of supply and demand. Examples:
    • Internal labor markets: internal promotion of staff to fill higher vacancies (limitation of external competition), regulation through company regulations and collective bargaining (wages, hierarchy, promotion standards, etc.).
    • Professional markets: the professional organization governs market access (through training and accreditation processes), operating rules, and wages → no external competition, limited internal competition.

The Demand for Labor

1. Neoclassical Microeconomic Perspective: Wages and Productivity

1.1. The Short-Term Approach:

a) Capital (machinery) and the production technique are fixed → production can only increase by using more labor (decreasing marginal productivity of labor; each additional worker allows for a smaller increase in product than the previous one).

b) Rational firm’s decision for maximum profit → labor is demanded by comparing the market wage (labor cost) with the product value derived from the worker (value of marginal productivity of labor: VMP) → the demand for labor that maximizes the firm’s profit is that at a wage W = VMP.

c) The demand for labor (LD) is greater the lower the wage rate (W) and vice versa → labor demand curve with a negative slope.

1.2. The Long-Term Approach:

a) The company can vary the capital, the production technique, and the workload used (different combinations of labor and capital for the same production).

b) Companies will choose the technique that enables them to maximize profits: with higher salaries, they choose more capital-intensive techniques, which use less labor (and have higher productivity).

2. Keynesian Macroeconomic Perspective: Aggregate Demand and Jobs

a) Principle of effective aggregate demand (AD = Consumption by families + Investment by firms + Government Expenditure + Exports – Imports): The level of spending by these agents determines the level of macroeconomic production (GDP) and employment (labor demand) within a country.

b) The demand for labor depends on various determinants of aggregate demand (business expectations, income, interest rates, fiscal policy, competitiveness, etc.), and labor demand depends on the economic cycle.

c) The wage is not just a labor cost for businesses but also a source of income (consumption, aggregate demand), and the wage has a complex influence on labor demand (positive and negative effects of a wage increase).

d) Increases in aggregate demand not only increase employment but can also generate inflation: the lack of competition and innovation in specific productive sectors can cause an increase in demand to put upward pressure on prices without increasing real GDP and employment.

3. Structural Determinants of Labor Demand

a) Demand for goods: the situation in each market (expansion, crisis) influences production planning and labor demand, quantitatively (volume and dynamism of employment) and qualitatively (job stability, working conditions).

b) Technology: impact on job requirements (in number and qualifications).

  1. Labor-intensive technology: increased demand for labor, less skilled jobs, lower productivity.
  2. Capital-intensive technology: lower demand for labor, more specialized jobs, increased productivity.

c) Strategies for business competitiveness: companies try to reduce the unit labor cost (ULC = total labor cost divided by the value of production) → the objective is to reduce the ULC to improve profitability and competitiveness:

  1. Determinants of unit labor cost (ULC):
    • ULC = (W / Y) = (W / L) * (L / Q) * (Q / Y) = ω / π
    • W: total labor cost (wages and other labor costs paid).
    • Y: value of production of the company (Y = P * Q, where P is the product price and Q is the quantity produced).
    • L: employment size of the enterprise.
    • W / L = ω: average wage paid per employee → if ω ↓ then ULC ↓
    • Q / L = π: value of labor productivity (value of the product per worker) → if π ↑ then ULC ↓
  2. Competitive business strategies based on improving productivity (technological and organizational innovations) or increasing product value (through quality, market differentiation, and control) can reduce the ULC without reducing wages or working conditions.
  3. Competitive strategies not based on productivity and innovation reduce the ULC by reducing the cost of wages and working conditions.

d) Business structure: size and place of each company in the production hierarchy, degree of competition/monopoly → existing restrictions for various labor demands (the greater the subordination of the company and the less control over its market, the slower the growth and job quality).

e) Business practices in labor force management: companies manage the labor force (through hiring, training, promotion, salaries, etc.) to achieve their goals of flexibility and control.

  1. Flexibility of employment: adjustment (cheaply) of workforce use (number of employees, job functions performed: quantitative and/or qualitative flexibility) to changing demand and production circumstances.
  2. Control over the workforce: ensuring appropriate labor behavior for the enhancement of productivity (through coercive forms of control, negotiated or discretionary incentives, employee involvement, identification with the company, etc.).
  3. Entrepreneurial management of labor is determined by the company’s market position and production structure, by institutional policies (industrial action, legislation), and by the labor-management culture, thus defining working conditions and wage differentials for different jobs (segmentation of labor demand: within the firm, between firms in the same sector, between sectors).

The Labor Supply

1. The Neoclassical Approach: Rational Choice Between Income and Leisure

1.1. Optimal Decision:

The rational worker seeks maximum welfare, and each person offers more or less work depending on worker preferences between consumption (income earned through work) and leisure (not working), valuing the opportunity cost of leisure by the forgone wages.

1.2. Labor Supply Curve:

Labor supply (LS) is greater the higher the wage (W) and lower the less → labor supply curve with a positive slope.

1.3. Clarification:

A rise in wages above a certain level can reduce the labor supply of each worker (because they can achieve the same income by working less), but it increases the total supply (new workers entering the labor market).

1.4. Criticism:

If the employee wishes to maintain a certain level of income and has no income alternative to wage labor, the labor supply would increase if wages decrease (not vice versa).

Graphical Representation of Labor Supply Curve

W L LS

2. The Theory of Human Capital

2.1. Training Decisions as Human Capital Theory

a) Training resembles an investment process (human capital) that responds to individual rational decisions (CBA).

  1. Training represents an opportunity cost in time and resources.
  2. Qualifications and training increase worker productivity and therefore allow for a higher salary in the future (compensation by the company for the greater contribution to production value).
  3. Each employee decides rationally (comparing costs and benefits) whether to invest in training: different individual efforts in training lead to different qualifications, different productivity, and wage differentials.

b) Criticism of human capital theory:

  1. Information problems limit the rationality of training decisions.
  2. Difficulties in assessing the human capital that each worker incorporates and their productivity; the theory cannot properly compare them.
  3. Credentials/signal theory: training does not necessarily increase productivity, but educational qualifications are used by companies as indicators of positive attitudes and skills to develop work effectively, so they become filters for recruitment that must be overcome to access better-paid jobs.

2.2. Generic and Specific Training

a) Generic Training: increases worker productivity in any job (useful for many companies), and its cost is not borne by the company but by the worker or the education system.

b) Specific Training: increases worker productivity only in certain jobs (only useful for the company where the skills are acquired) → its cost is borne by the company and promotes a stable employment relationship.

3. Structural Determinants of Labor Supply

3.1. Industrial Strategies of Families

a) The family allocates the capacity of its members to employment and reproductive work to meet family needs coherently, and family strategies condition labor supply decisions (activity rate).

b) Different strategies of mobilization/participation in the labor market:

  1. Strategies of specialization: one family member devoted only to market work, others to reproductive work → limited labor supply.
  2. Diversification: more than one member engaged in market work → expansion and differentiation of labor supply.

3.2. Differentiating Factors of Labor Supply

a) Gender differentiation: the position of men and women regarding the allocation of reproductive and market labor implies different patterns of behavior, expectations, and attitudes regarding access to employment and the training system.

b) Social differentiation (economic resources, culture) → differential access to education, expectations, and work behaviors; differences in employment opportunities and the acceptance of certain jobs.

3.3. Influence of the Education System on the Differentiation of Labor Supply

a) Meritocratic vision: the educational system promotes the empowerment of people with more skills (human capital theory).

b) Radical vision: the educational system reproduces social differences and legitimizes unequal occupational structures as if they were the result of merit.

c) Societal vision: the educational system is embedded in the social processes of differential recognition of qualifications, interacting with corporate policies for the management of labor, legislation, collective bargaining, etc. (e.g., job fairs).

3.4. Differentiation of the Workforce and Business Practices in Labor Management: The Logic of Segmentation

a) The social reproduction system generates different bargaining skills in the labor market for different groups → differences between individuals regarding the possibility of access to different jobs and the degree of acceptance of certain working conditions and pay.

b) These differences are used by companies to fill different jobs (segmentation) according to technical requirements, required standards of conduct, and management and corporate culture. They can deepen certain lines of differentiation of the labor force through corporate policies of recruitment, training, promotion, remuneration, etc.