# Labor Economics

Business I · Introduction to Economics · https://tryals.app/learn/business-i/labor-economics

## The Market for Work

The labor market is a market like any other, with households supplying labor and firms demanding it at a price called the **wage**.

**Labor demand** slopes downward because firms hire up to the point where a worker's contribution matches their pay. It is a **derived demand**: firms want workers only because customers want products.

**Labor supply** slopes upward: higher wages draw more people into work and more hours from them.

Where the curves cross, the **equilibrium wage** clears the market. When forecasting employment in a sector, look first at the demand for its products, not the workers.

| Curve | Source | Slope | Meaning |
| --- | --- | --- | --- |
| **Demand** | Firms | Downward | Derived from product demand |
| **Supply** | Households | Higher wages | Draws more workers and hours |

## Wages and Unemployment

Wages differ systematically due to scarce skills (surgeons), **compensating differentials** (extra pay for dangerous night shifts), and **human capital** from years of training.

A **minimum wage** set above equilibrium raises pay for some but can price the least experienced out of work. Supply rises, demand falls, and the gap is measured unemployment.

| Unemployment | Cause | Nature |
| --- | --- | --- |
| **Frictional** | Search time between jobs | Normal and healthy |
| **Structural** | Skill or location mismatch | Painful and persistent |
| **Cyclical** | Recession, demand collapses | Returns with recovery |

## Practice questions

4 of this lesson's 13 practice questions, with answers. The full set is in the app.

### 1. Labour demand is called a DERIVED demand. What follows for a union negotiating wages in a shrinking industry?

A. That the union should target the firm’s profit margin instead of the wage
B. That the ceiling is set by demand for the product
C. That derived demand makes labour demand more elastic than product demand always
D. That wages can be raised indefinitely because labour demand is fixed

**Answer:** B. That the ceiling is set by demand for the product

**Why:** Workers are wanted because customers want the product. When that demand falls the derived demand falls with it, which is why bargaining power tracks the health of the product market.

Page: https://tryals.app/practice/business-i/labor-economics/labour-demand-is-called-a-derived-demand-what-follows-for-a-union

### 2. Match each wage pattern to its economic explanation.

**Answer:**

- Surgeons earn multiples of the median → Scarce skills after years of human capital
- Night shifts pay a premium → Compensating differential for hard conditions
- Wages rise with experience → Productivity grows with accumulated skills
- Star athletes earn extremes → Tiny supply meeting global demand

**Why:** Wage differences are mostly supply and demand wearing biographies: scarcity, unpleasantness, and accumulated skill all get priced.

Page: https://tryals.app/practice/business-i/labor-economics/match-each-wage-pattern-to-its-economic-explanation

### 3. Two workers do the same job with the same skill and one earns 30% more. Standard labour theory predicts equal pay. What is the most common real explanation?

A. Search frictions, since matching is costly and slow
B. Discrimination, which is the only source of unexplained wage gaps
C. One worker must be more productive in a way the observer cannot see
D. The theory is wrong; wages are set arbitrarily by employers

**Answer:** A. Search frictions, since matching is costly and slow

**Why:** The frictionless model assumes costless search and instant mobility, and neither holds, so wage dispersion survives among identical workers. Search theory is what earned Diamond, Mortensen and Pissarides the 2010 Nobel, and it is why unemployment can coexist with vacancies.

Page: https://tryals.app/practice/business-i/labor-economics/two-workers-do-the-same-job-with-the-same-skill-and-one-earns-30

### 4. Order the chain by which a recession creates cyclical unemployment.

**Answer:**

1. Consumer demand for products collapses
2. Firms’ revenues fall across the economy
3. Derived demand for labor shifts left
4. Layoffs spread through many industries at once
5. Unemployment rises until demand recovers

**Why:** Cyclical unemployment travels from product demand to labor demand, which is why it lifts economy-wide with recovery, unlike its structural cousin.

Page: https://tryals.app/practice/business-i/labor-economics/order-the-chain-by-which-a-recession-creates-cyclical-unemployment