Wage determination in perfectly competitive labour markets

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.
  1. Supply is inelastic because of the qualifications required
  2. MRP of lawyers is high. If they are successful they can make firms a lot of revenue.

McDonalds workers however get lower pay because:

  1. 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