Excess supply and excess demand for labour

Let's see what happens in the labour market if the wage is higher or lower than the equilibrium wage rate.

Excess supply of labour

If the wage rate is R200, which is higher than the equilibrium wage rate of R100, will this cause an excess demand for labour or an excess supply of labour?

A wage rate higher than the equilibrium wage causes a decrease in the quantity of labour demanded, an upward movement along the demand for labour takes place, and an increase in the quantity of labour supplied, an upward movement along the supply curve of labour takes place. The reason for the decrease in the quantity of labour demanded is because firms compare the marginal revenue product of labour with the wage rate and a higher wage rate requires a higher marginal revenue product, which can only be achieved by decreasing the quantity of labour. The quantity of labour supplied increases as the wage rate increases since people are willing to supply more labour in return for a higher income, which allows them to purchase more goods and services. Note that in this case the substitution effect dominates.

Since the quantity of labour demanded is less than the quantity of labour supplied, an excess supply of labour exists. In a competitive labour market, this will cause a decline in the wage until equilibrium is reached where the quantity of labour demanded is equal to the quantity of labour supplied. In our diagram, this occurs as point E.

Excess demand for labour

If the wage rate is R50, which is lower than the equilibrium wage rate of R100, will it cause an excess demand for labour of an excess supply of labour?

A wage rate lower than the equilibrium wage causes an increase in the quantity of labour demanded and a decrease in the quantity of labour supplied. Since the quantity of labour demanded is less than the quantity of labour supplied, an excess demand for labour exists. In a competitive labour market, this will cause an increase in the wage until a point is reached where the quantity of labour demanded is equal to the quantity of labour supplied. This occurs at point E in the diagram.


Activity

Use the following diagram to indicate the following positions in this labour market:

1. If the wage rate is higher than the equilibrium wage.
2. If the wage rate is lower than the equilibrium wage.

1. If the wage rate is higher than the equilibrium wage, an excess  supply of labour exists.

2. If the wage rate is lower than the equilibrium wage, an excess demand for labour exists.