Labour Market I: Features of the Labour Market, Demand for and Supply of Labour, Types of Labour Market, and Economic Systems and the Labour Market

• Labour is inseparable from the labourer: the worker must deliver his labour in person, so working conditions, hours and treatment matter to the seller as much as the price.
• Labour is perishable: a day's work not sold is lost for ever and cannot be stored, which weakens the worker's ability to hold out for a better price.
• The individual worker usually has weaker bargaining power than the employer, having few reserves and many competitors — the economic case for unions and minimum-wage law.
• Labour is relatively immobile, geographically (family, language, housing, cost of moving) and occupationally (skills, training, social barriers).
• Labour is heterogeneous: workers differ in skill, education, experience, effort and reliability, so there is not one price but a structure of wages.
• Supply adjusts slowly: population, education and training take years to change the supply of labour.
• The labour market is shaped by institutions — law, unions, custom, caste and gender norms — and not by price alone.

The demand for labour is a derived demand: employers want workers not for themselves but for the goods and services they produce, so the demand for labour depends on the demand for the product. A profit-maximising firm in competitive markets hires workers up to the point where the wage equals the value of the marginal product of labour (the marginal physical product multiplied by the price of the product), or, more generally, the marginal revenue product; because the marginal product falls as more workers are added to fixed capital (the law of diminishing returns), the firm's demand curve for labour slopes downward. Alfred Marshall, later refined by John Hicks, set out the conditions under which the demand for labour is more elastic — so that a wage rise causes a larger fall in employment: the more elastic the demand for the final product; the easier it is to substitute other factors (such as machines) for labour; the more elastic the supply of those other factors; and the larger the share of labour costs in total costs. The last is known as "the importance of being unimportant": a group of workers whose wages are a small part of total cost can win a rise with little loss of jobs.

The supply of labour to the economy depends on the size and age structure of the population, the labour force participation rate (itself shaped by education, income, social norms and, especially for women, the care of children and the household), the hours people are willing to work, their skills, and migration. The individual worker chooses between income and leisure. A rise in the wage has two effects that pull in opposite directions: the substitution effect (each hour of leisure now costs more income, so the worker works more) and the income effect (he is richer and can afford more leisure, so he works less). At low wages the substitution effect usually dominates and hours rise with the wage; beyond some point the income effect may dominate and hours fall, giving the backward-bending supply curve of labour. Under perfect competition wages and employment settle where the market demand and supply curves cross. Under monopsony — a single or dominant buyer of labour, such as a mill in a one-company town or a plantation — the employer faces the upward-sloping market supply curve and, to hire more, must raise the wage for all, so its marginal cost of labour exceeds the wage; it hires fewer workers and pays less than a competitive market would, and a minimum wage set within the right range can raise both pay and employment. When a union faces a monopsonist (bilateral monopoly), the wage is indeterminate within a range and is settled by bargaining power.

Two development models explain the labour markets of countries like India. W. Arthur Lewis's "Economic Development with Unlimited Supplies of Labour" (1954) divided the economy into a traditional subsistence sector, with surplus labour whose marginal product is close to zero, and a modern capitalist sector that can draw labour from it at a constant wage slightly above subsistence; development proceeds as the capitalist sector reinvests its profits and absorbs the surplus, until the surplus is exhausted (the "Lewis turning point") and wages begin to rise. John Harris and Michael Todaro (1970) explained why rural–urban migration continues despite urban unemployment: migrants respond not to the urban wage but to the expected urban wage — the wage multiplied by the probability of finding a job — so that migration continues until the expected urban wage equals the rural wage, leaving a pool of urban unemployed and informal workers. Gustav Ranis and John Fei (1961) extended Lewis's model to the agricultural sector.

Under capitalism, labour is a commodity bought and sold in a free market: workers choose their employers and employers their workers, wages are set by supply and demand modified by bargaining and law, unions are voluntary associations that bargain with employers, and the risks of unemployment fall largely on workers, cushioned by social insurance. Under socialism of the Soviet type, the state owned the means of production and planned the allocation of labour: employment was guaranteed and open unemployment officially absent, wages were set centrally by grades, unions were state-linked bodies concerned with welfare and plan fulfilment rather than bargaining, and labour mobility was often restricted. A mixed economy such as India's combines the two: the market allocates most labour, but the state acts as a large employer (and as a "model employer" in the public sector), regulates wages, hours, safety, dismissal and social security, and promotes employment through public works — the Mahatma Gandhi National Rural Employment Guarantee Act 2005, which guarantees a hundred days of wage employment a year to every rural household whose adult members volunteer for unskilled manual work, is the largest example. Since the 1980s the debate everywhere has turned on labour market flexibility: John Atkinson's "flexible firm" (1984) distinguished numerical flexibility (varying the number of workers, through temporary and contract labour), functional flexibility (multi-skilled core workers deployed across tasks) and financial or wage flexibility, with a secure core and an insecure periphery; critics answer that flexibility for employers is insecurity for workers, and the Indian codes' fixed-term employment and higher thresholds are part of that debate.