What is Labor Market?
The labor market or the job market is a widely tracked market that functions through the supply and demand dynamics of people seeking employment (workers) and organizations/people rendering employment (employers).
- Microeconomics looks at the labor market at the individual (firm and worker) level of demand and supply. The supply of labor increases as the wages increase until a point when the marginal utility of each additional hour of wage starts decreasing. Once that happens people forego additional work for leisure activities and supply declines.
- Demand in microeconomics is determined by the marginal cost and marginal revenue of the product. If the marginal revenue from each additional unit of product is less than its marginal cost, the demand for labor will decline.
Components of Labor Market in Macroeconomics
In macroeconomics, the labor market is a function of the following components.
#1 – Labor Force
Part of the working-age population that is employed or actively looking for employment. The labor force is a function of population growth, net immigration, new entrants, and the number of retirees from the labor force.
#2 – Participation Rate
It is determined as the size of the labor force as a percentage of the size of the adult civilian non-institutional population.
#3 – Non-Labor Force
It is the difference between the size of the adult civilian noninstitutional population and the size of the labor force.
#4 – Unemployment Level
Difference between the labor force and the number of workers currently employed.
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#5 – Unemployment Rate
The number of unemployed workers as a percentage of the labor force.
#6 – Employment Rate
The number of employed workers as a percentage of the labor force.
Example of Labor Market
Let’s discuss an example of the labor market.
An economy has a total civilian non-institutional population of 100,000, out of which, 80,000 people are in their working age. Out of the working-age population, 75,000 are actively employed or are looking for employment (forming a part of the labor force) while 5,000 do not form a part of the labor force. Out of the labor force of 75,000 people, 4000 people are unemployed (an unemployment rate coming to be 5.3%). See the below illustration for more details.
Types of Unemployment in Macroeconomics
The following are types of unemployment in microeconomics.
#1 – Frictional Unemployment – It is due to the time taken for people to find jobs.
#2 – Structural Unemployment – It happens due to a mismatch between the skills required by firms and offered by workers in the job market. If the skills offered are not in demand and ones that are in demand cannot be supplied, it causes structural unemployment.
#3 – Natural Rate of Unemployment – It is an addition of frictional and structural unemployment and is the rate that prevails when the economy is in equilibrium.
#4 – Cyclical Unemployment – Any rate of unemployment higher than the natural rate is caused due to cyclical reasons. It generally happens when the economy is not in good shape and the demand for workers is generally low as the demand for final goods and services also gets reduced.
The natural rate of unemployment in the United States is 5%. It touched a high of 10% during the financial crisis of 2009 and came back to a normal 4.9% years later in 2016.
Advantages of Labor Market
Some of the advantages of the labor market are as follows:
- Labor market and analysis are useful in forming broader level economic policies for the benefit of citizens of the country. A wide range of government decisions is taken based on the shape of labor markets.
- The labor market is an important gauge of structural changes happening in the economy or industry. It helps policymakers draft and implements new policies if they are aware of the structural trends.
- Helpful in determining labor productivity if the same number of workers are helping produce the higher value of goods and services.
- Labor markets also help determine the prevailing average wage rates that are useful in making many economic decisions including inflation control by the central banks.
Limitations of Labor Market Analysis
Some of the limitations of the job market analysis are as follows:
- Labor market analysis does not factor in the emotional and psychological factors that go into employment or unemployment status of individuals.
- The analysis is majorly applicable in capitalist countries, where the job market is fairly developed. It is not applicable in a market dominated by a few employers or where the normal economic activity if distorted due to extraordinary reasons.
- Labor markets also do not factor in the role of unpaid labor like unpaid interns, who are employed, not paid but contributing to the economic activity.
- Labor markets change based on the level of economic activity (recessions and booms) and structural changes in the economy (technological changes, change of habits, etc.)
- The high rate of immigration can distort equilibrium in the market result in high unemployment rates.
- The labor market is an integral part of any economy. It is because of the efforts the workers put that brings about economic activity and growth. Analyzing the labor market is tough. Different theories have different approaches to the labor market. However, the most followed and effective is the macroeconomic theory talked about earlier in the article.
- Analysts and economists study the variables in macroeconomic theory to access the health of the labor market and determine the essential steps to be taken to bring the economy back to equilibrium if there has been a shift.
- The labor market is a must study for a student of economics to understand the nuances of the economy and business. It is also interesting to study how the market has changed over a long period of time.
This has been a guide to what is the labor market and its definition. Here we discuss the top 6 components of labor market in macroeconomics theory along with an example. We also discuss the advantages and limitations. You can learn more about finance from the following articles –