Labor and Financial Markets
Summary :Supply and Demand Beyond Goods and Services
The supply and demand model economists use to analyze markets for goods like bread or furniture applies just as well to markets that do not look like ordinary shopping at all, including markets for labor and markets for borrowed or saved money. In a labor market, individuals looking for work are the suppliers of labor, while firms and other organizations seeking to hire are the demanders. In a financial market, anyone who saves money, whether a household or a business, supplies financial capital, while anyone who borrows, whether a person financing a car, a company funding an expansion, or a government funding infrastructure, demands it. Recognizing that the same supply-and-demand framework applies to both markets lets economists analyze wages and interest rates using the same tools they use to analyze the price of any ordinary good.
Equilibrium in a Labor Market
Consider the market for experienced software quality-assurance testers in a mid-sized technology hub. Employers who need testers make up the demand side, and qualified individuals willing to take testing jobs make up the supply side. As with any market, the demand curve for testers slopes downward, since employers are willing to hire more testers at a lower salary, while the supply curve slopes upward, since more people are willing to train for and accept testing jobs as the salary rises. Suppose the equilibrium settles at a salary of ninety thousand dollars a year, where the number of testers employers want to hire exactly matches the number of qualified people willing to work at that salary. If the salary were pushed above equilibrium, say to one hundred thousand dollars, more people would want testing jobs than employers wish to fill, creating a surplus of applicants that would tend to push salaries back down; if the salary were pushed below equilibrium, employers would want to hire more testers than are willing to work at that lower pay, creating a shortage that would tend to push salaries back up.
What Shifts Labor Demand and Labor Supply
Several factors can shift the demand curve for a given type of labor rather than simply moving along it. A better-trained, more productive workforce increases employer demand for that labor, shifting demand to the right, while new technology can either substitute for workers, shifting demand left, as automated testing tools have reduced some routine manual-testing roles, or complement workers, shifting demand right, as growing software complexity has increased demand for testers skilled in writing automated test scripts. On the supply side, an increase in the number of people qualified and willing to do a job, whether from population growth, immigration, or more people entering that field, shifts labor supply to the right, while stricter licensing or certification requirements that make it harder to qualify for a job shift labor supply to the left. A change in salary alone moves the market along its existing demand and supply curves, but changes like these shift the curves themselves and move the market to a new equilibrium salary and quantity of workers hired.
Price Floors in the Labor Market: Minimum and Living Wages
A minimum wage is a price floor: a legal minimum below which employers may not pay workers, set with the goal of raising pay for the lowest-paid workers. Suppose a labor market for retail cashiers reaches equilibrium at eleven dollars an hour with twelve hundred workers employed, but a city government imposes a living wage law setting a floor of fourteen dollars an hour. At fourteen dollars, more people want cashier jobs than before, but employers want to hire fewer cashiers than they would at the lower equilibrium wage, creating an excess supply of willing workers relative to available positions. Whether a minimum or living wage law meaningfully reduces employment depends heavily on how far above the equilibrium wage it is set: a floor set close to or slightly below the market wage has little effect on hiring, since it rarely binds, while a floor set well above equilibrium creates a larger gap between the number of people wanting jobs at that wage and the number employers are willing to offer.
Financial Markets: Savers, Borrowers, and the Interest Rate
Financial markets connect those who wish to save money, the suppliers of financial capital, with those who wish to borrow it, the demanders of financial capital, and the price that balances the two is the interest rate. When a household deposits savings into a bank account, it supplies funds and expects to earn interest in return; when a business borrows to purchase new equipment, it demands funds and expects to pay interest in return. A higher interest rate typically draws in more savers, willing to supply more funds at a more attractive return, but discourages some borrowers, who find it more expensive to finance a purchase or an investment, so the interest rate adjusts to bring the quantity of funds people wish to save into balance with the quantity others wish to borrow, exactly as price does in the market for an ordinary good.
Quick Revision Summary
The supply and demand framework used for ordinary goods applies equally well to labor markets, where workers are suppliers and employers are demanders, and to financial markets, where savers are suppliers of funds and borrowers are demanders. A labor market reaches equilibrium where the salary employers are willing to pay matches the salary at which enough qualified workers are willing to work, and a wage set away from that equilibrium creates either a surplus of job seekers or a shortage of workers. Labor demand shifts with changes in worker productivity and technology, while labor supply shifts with changes in the number of qualified workers or the requirements needed to qualify for a job; either kind of shift moves the market to a new equilibrium salary and quantity. A minimum or living wage acts as a price floor in the labor market, and its effect on employment depends on how far above the equilibrium wage it is set. In financial markets, the interest rate performs the same balancing role that price performs in any other market, adjusting until the quantity of funds savers wish to supply matches the quantity borrowers wish to demand.