Shifts in Factor Supply & Wage Differentials

You’ll be able to

Identify what shifts the supply of labor to an occupation or region
Explain wage differentials in terms of supply, demand and compensating differentials
Explain how unions and licensing affect the labor market graph

What shifts labor supply

Supply to a particular occupation shifts with the number of qualified workers, the wage in alternative occupations, the non-wage attractiveness of the work, migration, and training or licensing requirements. Note that supply to an occupation can shift substantially while the total labor force is unchanged — workers move between occupations, and that reallocation is what most wage questions are actually about.

Explaining a wage gap

high wage = high MRP (productivity or output price) and/or restricted supply (skill, licensing, unpleasantness)

Any wage differential is a supply story, a demand story, or both. Naming which is what a free response wants.

Compensating differentials

Some jobs pay more because they are unpleasant, dangerous or inconvenient — night shifts, offshore work, remote postings. The extra pay is a compensating differential: it must be large enough to persuade workers to accept the conditions, so it works by shifting labor supply left for that job. This explains wage gaps between jobs requiring identical skill, which pure productivity arguments cannot.

Unions and licensing

Both work by restricting supply or raising demand. A union can bargain a wage above equilibrium — which raises pay for members and reduces employment, exactly like a minimum wage in a competitive market — or restrict entry to the trade, shifting supply left. Occupational licensing shifts supply left by requiring credentials, raising wages for the licensed. The efficiency question in both cases is whether the restriction protects the public or protects incumbents, and honest answers acknowledge that the same mechanism serves both purposes.

Worked example

Wages for commercial truck drivers rise sharply while wages for retail cashiers stagnate. Give a supply-side and a demand-side explanation for the gap.

1.Demand side: growth in e-commerce raised demand for freight, raising the value of driver output and shifting driver MRP right.
2.Supply side: driving requires a license and long periods away from home, so supply to the occupation is restricted and slow to expand.
3.For cashiers: demand is flat or falling as self-checkout substitutes, shifting MRP left.
4.And cashier work requires little training, so supply is large and easily replenished.

Answer: Driver wages rose from rightward demand shift combined with restricted supply, part of which is a compensating differential for time away from home. Cashier wages stagnated from leftward demand pressure with abundant, easily replaced supply. Both gaps are supply-and-demand stories rather than statements about the workers.

Watch out

A high wage is not evidence that a job is more valuable in any moral sense. It reflects MRP and supply conditions. The exam asks for the mechanism, and normative language about which jobs deserve more usually earns nothing.

Checkpoint

A compensating differential is extra pay that:

Checkpoint

Occupational licensing raises wages in the licensed occupation primarily by:

Checkpoint

A union negotiates a wage above the competitive equilibrium in a competitive labor market. The result is:

On the exam

When explaining a wage differential, give one demand-side and one supply-side reason. Rubrics frequently award one point for each, and answers that offer two versions of the same story earn only one.

Answer the 3 checkpoints as you read.