Using the labor market to understand employment and wage trends

Demand and supply analysis of the labor market is useful for understanding long-run trends in employment and wages. Firms demand labor in order to produce goods and services, while men and women supply labor in return for wages. Together, the demand for and supply of labor determine the equilibrium wage and employment level in the labor market. Changes in demand and supply lead to changes in wages and employment over time. Understanding the causes of these changes in the demand for and supply of labor helps us better understand long-term trends in employment and wages.

Exploration: What causes changes in employment and wages over time

The applet above illustrates the market for labor. Equilibrium in this market is determined by the intersection of the labor demand and labor supply curves. To use the graph, use the mouse to drag the SN or DN labels to the right or left and click on the New Equilibrium button to observe the movement to the new equilibrium. Click the Reset button to restore the curves to their original positions.

1. Before working with the applet, think about how an increase in productivity will affect the demand for and supply of labor in the labor market. Will a change in productivity affect labor demand? Will it affect labor supply? In what way? Why?
   
   
2. What will be the effect of an increase in labor productivity on the level of employment and the real wage in the labor market? What happens to the real wage? What happens to the level of employment? Why?
   
   
3. According to the labor market model, what types of shifts in labor demand or labor supply can explain the long-term increase in real wages? What do these shifts imply about employment trends? Which shifts are plausible and which are not? Why?
   
   
4. What will be the effect of an increase in immigration on the level of employment and the real wage in the labor market? What happens to the real wage and level of employment at the new equilibrium? Why?
   
   Based on your analysis, do you conclude that increasing the level of immigration into the U.S. would be beneficial or harmful for the U.S.? Explain, using economic arguments to frame your answer.

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