Labor Supply

This article focuses on the theory of labor supply. The relationship between labor markets, labor supply and demand, labor force, and wage rate are discussed. The article explores why and how the United States government measures labor supply and unemployment rates. The issues associated with child labor and labor policies are addressed.

Keywords Budget Constraint; Child Labor; Current Population Survey; Economic Growth; Income Effect; Labor Demand; Labor Force; Labor Market; Labor Supply; Occupation; Opportunity Cost; Productivity; Rate of Substitution; Reservation Wage; Unemployment Rate; Utility; Wage Rate

Economics > Labor Supply

Overview

The health and demographics of a nation's labor force effects the nation's productivity and potential for economic growth. National economies rely on steady and, in most instances, growing labor supply and demand. Economic growth is often created by increased productivity from a larger labor supply. Individual and aggregate labor supply is determined by individual and aggregate appetite for leisure and consumption as well as wage rates. The public sector can manipulate wage rates and institute labor policies that control work related issues such as child labor and work visas, to raise or lower the labor supply. Labor supply policies are often developed to address the public problem of intractable poverty. Labor supply policies, such as welfare reform, job training, and the Earned Income Tax Credit (EITC), are developed to increase the labor supply, job skills, or wages of the poor (Bartik, 2001).

Labor Economics

Labor economics considers labor supply and demand to be a central factor in the health of the labor market and the economy as a whole. Labor economics is concerned with the relationship between markets and labor. Labor markets are the markets that form from the interaction of employers and workers. Labor markets differ from the market for other public goods in the finite nature of human labor, energy, and productivity; human workers can work a finite number of hours. In addition, reproduction rates and global resources limit the growth in the overall population of workers. The scope of labor economics extends to the following areas: Labor supply, labor demand, income, wages, and employment patterns and trends.

Labor Supply

The concept of labor supply is a fundamental building block in both microeconomic and macroeconomic theory. In microeconomics, labor supply is directly linked to the theory of income-leisure choice. In microeconomic theory, the labor supply increases or decreases in response to changes in real wages (Morris, 2001). The overall labor supply includes employment and unemployment rates. Employment and unemployment, in microeconomic theory, are viewed as alternative uses of time. People are believed to choose the type and duration of their work based on their preferences for leisure and wage requirements. This perspective does not explain or account for involuntary unemployment (Spencer, 2005).

Labor Supply & Economic Fluctuations

In macroeconomics, labor supply is studied as a means of understanding large cyclical fluctuations in the economy. Economists debate the role of labor supply and demand in causing economic booms and slumps. Economists agree that workers expend greater work effort during times of economic boom than in times of economic slumps but cannot fully explain and predict individual labor supply decisions. Individual and aggregate labor supply decisions are affected by variables and factors such as wages, availability of work, and preference for leisure over consumption. In the United States, households make individual decisions about labor market participation. In most instances, economists find that wage amounts affect labor market participation more than a laborer's preference for leisure (Change & Kim, 2005). Labor supply is managed in most industrialized nations through labor supply and wage policies that promote full employment and labor market equilibrium.

The following section provides an overview of the neoclassical theory of labor supply. This section serves as the foundation for later discussions of how and why the U.S. government measures labor supply and unemployment rates in the United States. The issues associated with labor supply and child labor are addressed.

The Theory of Labor Supply

Neoclassical Theory of Labor Supply

The neoclassical labor supply theory conveys the largest amount of hours a worker will be willing to contribute to the economy over the course of a certain span of time at each wage rate. The neoclassical theory of labor supply is used to analyze employment and unemployment patterns in labor markets. Neoclassical economic theory argues that employment and unemployment are two alternate ways to spend time. Individuals are believed to choose whether or not to work based upon their preference for work or leisure and the wage rate available to them. Unemployment, in this theory, can be interpreted as a form of voluntary leisure. Economist John Keynes developed the idea of involuntary unemployment in his book, “The General Theory of Employment, Interest, and Money” (1936). Involuntary unemployment is believed to exist due to an insufficiency in aggregate, or total, labor demand. Involuntary unemployment is generally addressed by government intervention and labor policies.

The neoclassical model of labor supply and demand, often represented as a curve, is based on the idea that participating in the labor market is a voluntary choice more than an economic necessity. Unemployment in the neoclassical theory of labor supply is considered to be a labor-leisure choice (Spencer, 2005). The following factors and variables affect labor supply and demand: Utility function, budget constraint, rate of substitution, income effect, and opportunity cost. The neoclassical theory of labor supply is directly connected to the neoclassical theory of labor demand. While the labor supply theory, often represented as a curve, conveys the largest amount of hours a worker will be willing to contribute to the economy over the course of a certain span of time at each wage rate; the theory of labor demand illustrates the most hours an employer will demand at each wage rate.

Labor Market Equilibrium

When labor demand and labor supply are balanced, labor market equilibrium occurs. The neoclassical theory of labor equilibrium argues that when labor supply and demand are equal, the economy is in equilibrium. Neoclassical economists argue that the supply and demand for labor will be equal to one another in the absence of fixed or static wages. In labor equilibrium, the labor supply is balanced. Workers give their time to work in a manner that balances the utility of their wages with the utility of leisure time. In labor equilibrium, the labor demand is also stable and balanced. Businesses hire workers based on business productivity needs and estimations. Businesses can entice workers to forgo leisure by offering wages above the worker’s reservation wage. A reservation wage refers to the minimum real wage that causes workers to become indifferent when faced with consumption and leisure choices.

Understanding & Predicting Labor Patterns

Ultimately, the theory of labor supply is one half of the labor supply and demand model used to understand and predict employment and unemployment patterns. The theory of labor supply is often equated with a labor-leisure tradeoff or choice. In practice, economic factors such as wages and income needs, possibly more than leisure preferences, affect individual labor supply choices. Labor supply and labor force participation rates are tracked by the government as part of the overall project of promoting and facilitating economic growth for the nation. The following section describes how and why the federal government measures the U.S. labor supply and the unemployment rate.

Applications

Measuring the U.S. Labor Supply & the Unemployment Rate

Measuring Labor Supply

In the United States, the labor supply is measured through the national unemployment rate. The labor supply and demand rates control local labor markets. As wages increase, businesses seek lower cost alternatives to increasingly more expensive labor. For example, businesses may invest in productivity enhancing technology and ultimately reduce the number of workers required to do the work. At the same time, as wages increase, workers are drawn into the labor force. The overall quantity or supply of labor is increased. Ultimately, the demand for labor is a decreasing function of wages while the supply of labor is an increasing function of wages.

In a balanced labor system, labor equilibrium and full employment will exist at the intersection of labor supply and demand. For example, all those workers wishing to work at a certain wage will be employed and labor demand will be met. In most labor markets, labor equilibrium and full employment are rarely achieved. In most local and national labor markets, there are more persons willing to work at the prevailing wage than there are businesses willing or able to hire at the prevailing wage. The unemployment rate refers to the number unemployed as a percentage of the total labor force. The total labor force is the number of unemployed persons in addition to the number of employed persons. 

Unemployment

Economists debate whether or not all labor markets have an inherent or natural rate of unemployment. Unemployed people are generally grouped into three unemployment categories: Frictional, cyclical and structural unemployment.

• Structural Unemployment: Unemployment caused by changes in technology or structure of the economy.
• Cyclical Unemployment: Unemployment caused by down turns in the aggregate economy.
• Frictional Unemployment: Unemployment caused changing jobs, reentering the job market, or searching for their first job.

Additionally, there is a "shadow" labor supply that the U.S. government refers to as "discouraged" workers because they have stopped actively looking for jobs but claim to want employment. The shadow labor supply increased greatly in the aftermath of the 2008 financial crisis and continued to grow even after the recession ended in 2009. By early 2013, there were approximately 6.7 million discouraged workers — 7.5 percent of the non-employed (Davig & Mustre-del-Río, 2013).

Unemployment of all kinds is affected by wages. If the wage rate falls below the much-debated full employment wage rate, the labor supply will diminish. If the wage rate rises above the full employment wage rate, the labor demand will increase. The public and private sectors adjust wages in response to labor supply and demand (Deller, 1999). Unemployment generally impacts the economy negatively by diminishing rates of national productivity and consumption.

A rise in unemployment almost inevitably accompanies economic recession. During the Great Recession of 2007-2009, the United States experienced extensive job losses as even very large companies, such as General Motors, closed or contracted and reduced their workforces. As with the earlier 1980 recession, economic recovery was slow and unemployment remained high. By the end of 2012, the official employment level was 3.6 million below the pre-recession level. Because the labor supply grew during this same period, owing largely to younger adults entering the job market and others returning to it, the U.S. economy needed to add an additional 5.2 million jobs in order to achieve full employment (Kochan, 2013).

The Bureau of Labor Statistics

The Bureau of Labor Statistics (BLS) of the U.S. Department of Labor collects statistics on the unemployed in the United States. The Bureau of Labor Statistics is the main federal agency in charge of labor economics and statistics. The Bureau of Labor Statistics gathers data relevant to the social and economic conditions of U.S. workers and their families. The Bureau announces, on a monthly basis, the total number of employed and unemployed persons in the United States for the preceding month along with the demographic characteristics of all those counted. Unemployment rates are considered vital information to business and industry and, as a result, are generally widely reported in the media.

The Current Population Survey

The government gathers monthly unemployment statistics from a monthly sample survey called the Current Population Survey (CPS). The Current Population Survey, which began in 1940 as a Work Projects Administration project, generally samples 60,000 households each month from a total of 3,141 counties and 1,973 geographic areas in the United States. Fifteen hundred Census Bureau employees interview persons by telephone and in person in the 60,000 sample households to gather data on labor force happenings and the non-labor force designation of the members of these households.

Classifications Used in the Current Population Survey

The Census Bureau, as part of the Current Population Survey, has clear criteria for classifying a person as employed or unemployed. Employed persons are those people who performed any work at all for either pay or profit over the course of the survey week or persons who performed a minimum of 15 hours of unpaid work at a family-operated enterprise. Work includes part-time work, temporary work, and full-time year-round employment. People who are absent from work for any of the following reasons are still considered, by the U.S. Census Bureau, to be employed: On vacation; ill; experiencing child-care problems; taking care of some other family or personal obligation; on maternity or paternity leave; involved in an industrial dispute; or prevented from working by bad weather. Unemployed persons are all persons who do not have a job; who have not proactively searched for work during the last four weeks; and who are presently available for employment. Employment and unemployment figures include only those persons currently in the labor force. The labor force, as a whole, includes the civilian, non-institutional population aged 16 years and up.

Data Gathered by the U.S. Census Bureau

The employment data gathered by the U.S. Census Bureau, for use by the Bureau of Statistics, include the following: Employment status of the civilian non-institutional population 16 years and over by age, sex, race, Hispanic origin, marital status, family relationship, and Vietnam-era veteran status; employed persons by occupation, industry, class of worker, hours of work, full- or part-time status, and reasons for working part time; employed multiple jobholders by occupation, industry, numbers of jobs held, and full- or part-time status of multiple jobs; unemployed persons by occupation, industry, class of worker of last job, duration of unemployment, reason for unemployment, and methods used to find employment; the labor force status of particular subgroups of the population such as women maintaining families, working women with children, displaced workers, and disabled veterans; work experience, occupational mobility, job tenure, educational attainment, and school enrollment of workers; and weekly and hourly earnings by demographic group, occupation, education, union affiliation, and employment status (How the government measures unemployment, 2001, “Where do the statistics come from?”)

Use of Data Gathered by the U.S. Census Bureau

The Bureau of Labor Statistics data are used in the following ways: Economic indicators; measures of national employment and unemployment; sources of information on employment status and labor force characteristics, developing patterns, and changes; quantifying the possible labor supply; and establishing factors that impact the labor force participation of various demographics. In additional to the labor supply indicator of the monthly unemployment rate, the Bureau of Labor Statistics also releases a labor demand indicator. The Bureau of Labor Statistics, in 1999, developed the Job Openings and Labor Turnover Survey to evaluate surplus labor demand in the U.S. labor market. The unemployment rate, released every month by the Bureau of Labor Statistics, along with the Job Openings and Labor Turnover Survey are intended to serve as a marker of labor market activity, overall economic conditions, and labor market supply and demand (Clark & Hyson, 2000).

Issues

Labor Supply & Child Labor

The work force or labor force in most industrialized countries refers to all persons designated as employed or unemployed in the civilian, non-institutional population aged 16 years and up. In many nations, particularly developing nations, the work force includes extensive child labor. How do nations and global governing organizations solve the problem of child labor? Governments can work to control the labor supply of and labor demand for child workers through the manipulation of wages, regulations, and labor policies. Child labor is an economic problem with an economic solution. Economic problems refer to factors that hinder the functioning and growth of an economy. Economic problems of all kind, including structural, fiscal, and cultural, impact economic development efforts by national governments, corporations, and international development organizations. Economic development encompasses a wide range of programs and strategies aimed at promoting growth in a part or whole of an economy. Developing countries with limited economies or economies in transition are particularly sensitive to the economic problem of child labor.

ILO Statistics on Worldwide Child Labor

Exploitative child labor, which refers to any economic activity done by a person under the age of fifteen, is a major economic and social problem in developing countries. The International Labor Organization (ILO) estimates that there are roughly 250 million children, between the ages of five and fourteen, involved in at least part time labor. The International Labor Organization (ILO) approximates that there are 120 million involved in hazardous and exploitative full-time work. Child labor by region suggests that child labor is a global problem: Asia has 152.5 million child laborers, Africa has 80 million child laborers, and Latin America has 17.5 million child laborers (Palley, 2002). The International Labor Organization reports that child labor is used in multiple industries and sectors including agriculture, fishing, forestry, hunting, manufacturing, retail, trade, community and personal services, transport, storage, communications, construction, mining, and quarrying (Tierney, 2000).

Addressing Child Labor in Developing Countries

Child labor is deeply connected to the economic life and prosperity of many developing countries. Child labor in developing countries cannot be eradicated without resolving problems that plague developing labor markets. Dysfunctional labor markets and under-development are believed to be key factors that result in the exploitation of child labor in developing regions of the world. The eradication of exploitative child labor practices needs the development and implementation of economic development programs that strengthen the economies of developing countries. International development organizations, national governments and corporations debate whether voluntary practices or required labor rules should be used to solve the problem of child labor in developing countries. Corporations are increasingly adopting voluntary practices, such as private labeling schemes, as part of corporate social responsibility (CSR) efforts, which let global consumers know that a product has been created without the used of child labor. While voluntary efforts by corporations to use adult labor rather than child labor is a positive step, voluntary practices alone are not believed to be sufficient to eradicate child labor in developing countries. International labor standards, which address the underlying causes of child labor such as labor market dysfunction and under-development, will likely succeed better than voluntary practices alone.

ILO Standards for Reducing Child Labor

The International Labor Organization (ILO), as described in the 1998 Declaration of Fundamental Principles and Rights at Work, promotes five main international labor standards which, if adopted by developed and developing countries alike, would likely significantly impact the problem of child labor (Palley, 2002):

• Freedom of Association: The ILO Freedom of Association and Protection of the Right to Organize Convention (No. 87) establishes the right of workers to form and join organizations, including unions, of their own choosing.
• Effective Recognition of the Right to Collective Bargaining: The Right to Organize and Collective Bargaining Convention (No. 98) protects unions from outside interference.
• The Elimination of All Forms of Forced or Compulsory Labor: The Forced Labor Convention (No. 29) and the Abolition of Forced Labor Convention (No. 105) require governments to suppress all forms of forced and compulsory labor in their territories.
• The Effective Abolition of Child Labor: The Minimum Age Convention (No. 138) sets a baseline minimum working age of fifteen.
• The Elimination of Discrimination in Respect of Employment and Occupation: The Discrimination Convention (No. 111) requires governments to establish national policies that eliminate discrimination on the basis of race, color, sex, religion, political opinion, and national origin (Palley, 2002, p.5-6)

Ultimately, a labor market dependent on child labor is out of balance and, unfortunately, self-reinforcing. Labor market conditions in developing countries, characterized by low wages and a large labor pool, provide families with few options for subsistence and survival other than sending their children to work. Basu (1998) argues that to eliminate child labor supply, governments must raise adult wages. Wage changes in developing labor markets will decrease and possibly eliminate the need for child labor. Doran (2013), however, looked at data from a Mexican farm labor experiment and concluded that adult wages rise in response to demand as child labor is removed from the supply. National governments, and global governing organizations, can institute anti-child labor policies as part of an economic effort to restore equilibrium or balance in labor supply and demand. Government changes may include higher wages, new technologies, and active brainstorming and participation of employers, workers, and policymakers (Basu & Van, 2003).

Conclusion

In the final analysis, the concept of labor supply is central to microeconomic and macroeconomic theory. Labor supply, which is half of the labor supply and demand model, affects national productivity and economic growth. Economists are increasingly aware that labor supply, and the decision to enter the workforce, is more affected by external variables such as economic need and wage rates than on preference for leisure over consumption. Labor supply can be controlled by the manipulation of wages and the development of labor supply policies that address issues such as child labor and intractable poverty.

Terms & Concepts

Budget Constraint: The consumption options available to someone with a limited income to allocate among various goods.

Current Population Survey: A household survey conducted monthly by the Census Bureau to provide labor force data - including information regarding employment, unemployment, and non-labor force persons - to the Bureau of Labor Statistics.

Economic Growth: The quantitative change or expansion in a country's economy.

Income Effect: The influence that a change in income will have on consumption decisions.

Labor Demand: The aggregate need for labor in a given region.

Labor Force: All persons classified as employed or unemployed in the civilian, non-institutional population 16 years old and over.

Labor Supply: The number of workers available in the local or national work force.

Occupation: The set of activities that an employee is paid to complete.

Opportunity Cost: The cost of passing up the next best choice when making a decision.

Productivity: A measurement demonstrating the extent to which economic inputs are changed into outputs in an effective manner.

Rate of Substitution: TThe minimum rate where an agent will be willing to exchange units of one product for units of another.

Reservation Wage: The lowest possible real wage that makes workers indifferent between consumption and leisure.

Unemployment Rate: The number unemployed as a percentage of the total labor force.

Utility: The satisfaction gained from an activity.

Wage Rate: The rate per hour paid for a specific job.

Bibliography

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Bartik, T. (2001). Fighting poverty with labor demand policies. W.E. Upjohn Institute for Employment Research. Retrieved August 13, 2007, from http://www.upjohninst.org/publications/newsletter/tjb%5f701.pdf.

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Palley, T. (2002). The child labor problem and the need for international labor standards. Journal of Economic Issues, 36, 601-615. Retrieved August 13, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=7364159&site=ehost-live

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Spencer, D. (2006). Work for all those who want it? Why the neoclassical labour supply curve is an inappropriate foundation for the theory of employment and unemployment. Cambridge Journal of Economics, 30, 459.

Suggested Reading

Kogan, I. (2006). Labor markets and economic incorporation among recent immigrants in Europe. Social Forces, 85, 697-721. Retrieved August 13, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=23608208&site=ehost-live

Neumark, D., Powers, E., & Zimmermann, K. (2006). Supplemental security income, labor supply, and migration. Journal of Population Economics, 19, 447-479. Retrieved August 13, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=21436456&site=ehost-live

Noonan, K., Reichman, N., & Corman, H. (2005). New fathers' labor supply: Does child health matter? Social Science Quarterly (Blackwell Publishing Limited), 86, 1399-1417. Retrieved August 13, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=19493480&site=ehost-live