The Labour Market, Wage Determination and Gross/Net Pay
A wage is a price, and a pay difference between two jobs is what happens when the same two forces act on different markets. Then the gap between what an employer pays and what lands in a bank account, and why it is not the employer keeping it.
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A wage is a price
You already know how a price is settled in a market: what buyers want meets what sellers will supply, and the price ends up where the two agree. A wage is that same idea applied to work. The buyers are employers, who want a certain amount of labour of a certain kind. The sellers are workers, who are willing and able to do it. The wage settles where those two meet. That one sentence explains almost everything in this section, including the part people find uncomfortable. When one job pays more than another, it is tempting to read that as a statement about which job matters more, and economics does not say that. It says that in one market few people can or will do the work while many are wanted, and in the other the reverse. A pay difference between two occupations is a consequence of two markets, not a verdict on two jobs. Keep that distinction and the whole topic, including the difference between what an employer pays and what you actually receive, stays straight.
Words for the labour market
Five terms. The first two are the forces; the last two are the numbers that get confused.
Supply, demand, or neither
- A job requires a qualification that takes years to obtain
- Employers open several new sites and need more staff of that kind
- The work becomes possible from home, so more people are willing to do it
- A machine can now do part of the work
- Supply is limited, because few people can do it
- Demand rises, because more of that labour is wanted
- Supply rises, because more people are willing to do it
- Demand falls, because less of that labour is wanted
Why scarcity pays
Two jobs are both useful and both needed. One requires training that few people complete; the other can be done by almost anyone. Why does the first tend to pay more?
- Because fewer people are able to supply that labour, so employers must offer more to attract them
- Because the work is more valuable to society
- Because the work is physically harder
- Because employers choose to be generous to trained staff
Two sides of one market
The labour market has the same two sides as any other market. What changes is who is on each side.
Work out the gross weekly pay
A worker is paid 12 pounds an hour and works 35 hours in a week. Work out the gross pay for that week, in pounds.
Work out the deductions
From that same gross weekly pay of 420 pounds, deductions come to one fifth of the total. Work out the deductions, in pounds.
Work out the take-home pay
The same worker had gross pay of 420 pounds and deductions of 84 pounds. Work out the net pay, in pounds.
The gap is not the employer keeping it
Somebody looking at those two figures for the first time usually asks where the difference went, and the honest answer matters. The employer agreed to pay 420 pounds and paid 420 pounds; the worker received 336. The 84 in between was not retained by the employer. Deductions are amounts taken from pay and passed on elsewhere, so the employer is handing over the whole of the gross figure, just not all of it to the worker. Two consequences worth carrying into an exam. First, when a question gives you a rate of pay it is almost always the gross figure, so any question about what somebody actually takes home has a step you must not skip. Second, when comparing what two jobs pay, compare like with like: a gross figure against a net figure is not a comparison at all, and answers that mix them lose marks even when the arithmetic is right. If a question mentions deductions, expect gross and net both to matter, and label which is which as you go.
Which two would push a wage up
Select the TWO changes that would tend to raise the wage in a particular labour market.
- Employers want considerably more of that kind of labour than before
- The training needed becomes longer, so fewer people can do the work
- Many more people become willing and able to do the work
- Deductions from pay increase
The wage in a sentence
A wage is a _____. Demand for labour comes from _____ and supply comes from workers, and the wage settles where the two meet. A wage _____ between two occupations therefore reflects the state of two markets rather than a judgement about which job matters more. And the amount an employer agrees to pay is the _____ figure, while what the worker actually receives after deductions is the _____ figure.
The claim that reads a wage as worth
Three of these explain a pay difference in economic terms. Select the ONE that treats a wage as a judgement about how valuable a job is.
- Few people complete the training, so the supply of that labour is limited.
- Employers in that area want more of this kind of labour than before.
- That job pays more because it is simply a more important job than the other one.
- The work became possible to do from home, so more people are now willing to do it.
A differential, explained
A question gives two occupations, says one pays considerably more, and asks you to explain why. Here is an answer that would score full marks. The wage in each occupation is settled where the demand for that labour meets the supply of it. In the higher-paying occupation the work requires a qualification that takes several years, so the supply of people able to do it is limited, and employers must offer more to attract the workers they need. In the lower-paying one many people are able and willing to do the work, so supply is much greater and the wage settles lower even though employers may want a similar amount of labour. It should be added that this explains the difference in the wage rather than justifying it: economics accounts for the pay gap by the state of the two markets, and does not claim that one job matters more than the other. And if the question asks what either worker actually receives, remember that the figure quoted is gross pay, so deductions have to come off before you have the take-home figure. Notice three things. Each side of the market is named. The explanation is about supply and demand rather than about effort or importance. And the gross-to-net step is flagged rather than assumed.
Advising on a pay question
A question describes a labour market and asks what will happen to the wage. Take the decisions in order.
- Employers in the area suddenly want far more workers of one kind. What happens to the wage, and why?
- A year later, a new college course means many more people can do the work. What now?
- Somebody says the higher-paid job is simply more important. How should that be handled in an answer?
- The question ends by asking what one of these workers takes home. What must you do?
Explain how a wage is set
Explain how wages are determined in a labour market and why two occupations may pay differently. Then explain the difference between gross and net pay.
- Explain where the demand for labour comes from and what makes it rise or fall
- Explain where the supply of labour comes from and what makes it rise or fall
- Explain where the wage settles, and why
- Explain one reason two occupations might pay differently, in terms of supply
- Explain one reason in terms of demand
- Explain why a wage differential is not the same as a judgement about which job matters more
- Explain the difference between gross and net pay, and why the gap is not money the employer keeps