An explanation of how wages are determined in a perfectly competitive labour market.
A perfectly competitive labour market will have the following features
- Many firms
- Perfect information about wages and job conditions
- Firms are offering identical jobs
- Many workers with same skills
Diagram of wage determination
- The equilibrium wage rate in the industry is set by the meeting point of the industry supply and industry demand curves.
- In a competitive market firms are wage takers because if they set lower wages, workers would not accept the wage.
- Therefore they have to set the equilibrium wage We.
- Because firms are wages takers the supply curve of labour is perfectly elastic therefore AC = MC
- The firm will maximise profits by employing at Q1 where MRP of Labour = MC of Labour
Comparing wage of lawyers and McDonalds workers
- Lawyers get higher pay for two reasons.
- Supply is inelastic because of the qualifications required
- MRP of lawyers is high. If they are successful they can make firms a lot of revenue.
McDonalds workers however get lower pay because:
- Supply is elastic, because there are many 1000s of people who are suitable for working, qualifications are not really required
The MRP of a McDonalds worker is much lower because there is a limited profit to be made from selling Big Macs.
Diagram of wage determination for lawyers and McDonald’s workers