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Labor economics seeks to understand the functioning and dynamics of the market for labor. Labor markets function through the interaction of workers and employers. Labor economics looks at the suppliers of labor services (workers), the demands of labor services (employers), and attempts to understand the resulting pattern of wages, employment, and income.

In economics, labor is a measure of the work done by human beings. It is conventionally contrasted with such other factors of production as land and capital. There are theories which have developed a concept called human capital (referring to the skills that workers possess, not necessarily their actual work), although there are also counter posing macro-economic system theories that think human capital is a contradiction in terms.

Compensation and measurement

Wage is a basic compensation for paid labor, and the compensation for labor per period of time is referred to as the wage rate.

Other frequently used terms include:

• wage = payment per unit of time (typically an hour)
• earnings = payment accrued over a period (typically a week, a month, or a year)
• total compensation = earnings + other benefits for labor
• income = total compensation + unearned income
• economic rent = total compensation - opportunity cost

Economists measure labor in terms of hours worked, total wages, or efficiency.

• total cost = fixed cost + variable cost

Demand for labor and wage determination

Labor demand is a derived demand, in other words the employer's cost of production is the wage, in which the business or firm benefits from an increased output or revenue. The determinants of employing the addition to labor depend on the Marginal Revenue Product (MRP) of the worker. The MRP is calculated by multiplying the price of the end product or service by the Marginal Physical Product of the worker. If the MRP is greater than a firm's Marginal Cost, then the firm will employ the worker. The firm only employs however up to the point where MRP=MC, not lower, in economic theory.

Wage differences exist, particularly in mixed and fully/partly flexible labor markets. For example, the wages of a doctor and a port cleaner, both employed by the NHS, differ greatly. But why? There are many factors concerning this issue. This includes the MRP (see above) of the worker. A doctor's MRP is far greater than that of the port cleaner. In addition, the barriers to becoming a doctor are far greater than that of becoming a port cleaner. For example to become a doctor takes a lot of education and training which is costly, and only those who are socially and intellectually advantaged can succeed in such a demanding profession. The port cleaner however requires minimal training. The supply of doctors therefore would be much more inelastic than the supply of port cleaners. The demand would also be inelastic as there is a high demand for doctors, so the NHS will pay higher wage rates to attract the profession.

The MRP of the worker is affected by other inputs to production with which the worker can work (e.g. machinery), often aggregated under the term "capital". It is typical in economic models for greater availability of capital for a firm to increase the MRP of the worker, all else equal. The education and training noted in the last paragraph are counted as "human capital". Since the amount of physical capital affects MRP, and since financial capital flows can affect the amount of physical capital available, MRP and thus wages can be affected by financial capital flows within and between countries, and the degree of capital mobility within and between countries. [1]

Two ways of analysing labor markets

There are two sides to labor economics. Labor economics can generally be seen as the application of microeconomic or macroeconomic techniques to the labor market. Microeconomic techniques study the role of individuals and individual firms in the labor market. Macroeconomic techniques look at the interrelations between the labor market, the goods market, the money market, and the foreign trade market. It looks at how these interactions influence macro variables such as employment levels, participation rates, aggregate income and Gross Domestic Product. (Morendy Octora)

The macroeconomics of labor markets

The labor force is defined as the number of individuals age 16 and over, excluding those in the military, who are either employed or actively looking for work. The participation rate is the number of people in the labor force divided by the size of the adult civilian noninstitutional population (or by the population of working age that is not institutionalised). The nonlabor force includes those who are not looking for work, those who are institutionalised such as in prisons or psychiatric wards, stay-at home spouses, children, and those serving in the military. The unemployment level is defined as the labour force minus the number of people currently employed. The unemployment rate is defined as the level of unemployment divided by the labor force. The employment rate is defined as the number of people currently employed divided by the adult population (or by the population of working age). In these statistics, self-employed people are counted as employed.

Variables like employment level, unemployment level, labor force, and unfilled vacancies are called stock variables because they measure a quantity at a point in time. They can be contrasted with flow variables which measure a quantity over a duration of time. Changes in the labor force are due to flow variables such as natural population growth, net immigration, new entrants, and retirements from the labor force. Changes in unemployment depend on: inflows made up of non-employed people starting to look for jobs and of employed people who lose their jobs and look for new ones; and outflows of people who find new employment and of people who stop looking for employment. When looking at the overall macroeconomy, several types of unemployment have been identified, including:

• Frictional unemployment — This reflects the fact that it takes time for people to find and settle into new jobs. If 12 individuals each take one month before they start a new job, the aggregate unemployment statistics will record this as a single unemployed worker. Technological change often reduces frictional unemployment, for example: the internet made job searches cheaper and more comprehensive.
• Structural unemployment — This reflects a mismatch between the skills and other attributes of the labor force and those demanded by employers. If 4 workers each take six months off to re-train before they start a new job, the aggregate unemployment statistics will record this as two unemployed workers. Technological change often increases structural unemployment, for example: technological change might require workers to re-train.
• Natural rate of unemployment — This is the summation of frictional and structural unemployment. It is the lowest rate of unemployment that a stable economy can expect to achieve, seeing as some frictional and structural unemployment is inevitable. Economists do not agree on the natural rate, with estimates ranging from 1% to 5%, or on its meaning — some associate it with "non-accelerating inflation". The estimated rate varies from country to country and from time to time.
• Demand deficient unemployment — In Keynesian economics, any level of unemployment beyond the natural rate is most likely due to insufficient demand in the overall economy. During a recession, aggregate expenditure is deficient causing the underutilisation of inputs (including labor). Aggregate expenditure (AE) can be increased, according to Keynes, by increasing consumption spending (C), increasing investment spending (I), increasing government spending (G), or increasing the net of exports minus imports (X−M).
  {AE = C + I + G + (X−M)}

(Morendy Octoras)

Neoclassical microeconomics of labor markets

Neo-classical economists view the labor market as similar to other markets in that the forces of supply and demand jointly determine price (in this case the wage rate) and quantity (in this case the number of people employed).

However, the labor market differs from other markets (like the markets for goods or the money market) in several ways. Perhaps the most important of these differences is the function of supply and demand in setting price and quantity. In markets for goods, if the price is high there is a tendency in the long run for more goods to be produced until the demand is satisfied. With labor, overall supply cannot effectively be manufactured because people have a limited amount of time in the day, and people are not manufactured. The income effect suggests a rise in overall wages will, in many situations, not result in more supply of labor: it may result in less supply of labor as workers take more time off to spend their increased wages. The substitution effect of a higher wage might cause people to work more, as the opportunity cost to work less is greater than it was prior to the increase. While available empirical evidence is mixed, some analysts suggest the income and substitution effects cancel each other out, resulting in no supply increase. Within the overall labor market, particular segments are thought to be subject to more normal rules of supply and demand as workers are likely to change job types in response to differing wage rates.