**5. Competitive labor market equilibrium**

One of the most important implications of the perfectly competitive assumptions is that buyers and sellers are price takers. In other words, all the firms (buyers of labor) and workers (sellers of labor) in a perfectly competitive labor market accept the market price (wage) as given. No firm and worker has any influence over the market wage.

However, if all the firms and workers cannot influence the wage, who sets the wage? In fact, in a perfectly competitive market, the demand and supply of labor

together determine the market wage and the trading quantity of labor (employment).

When a competitive labor market is in equilibrium, the quantity supplied for labor equals the quantity demanded for labor at the market wage. **Figure 9** combines the supply and demand for labor in a perfectly competitive labor market. In **Figure 9**, the competitive labor market equilibrium is where the labor supply and demand curves cross. The equilibrium wage is \$20 per hour, and the equilibrium employment level is 300 workers.

If the wage rate is above \$20, as shown in **Figure 10 (a)**, the quantity supplied for labor is greater than the quantity demanded. The excess supply is known as a surplus. It means some of the workers cannot find a job. In order to find a job, those workers would accept a lower wage rate. As wage falls, the quantity demanded for labor rises and the quantity supplied falls until the market reaches equilibrium at point E.

If the wage rate is below \$20, as shown in **Figure 10 (b)**, the quantity demanded for labor is greater than the quantity supplied. The excess demand is known as a shortage. It means some of the firms cannot find workers. In order to find workers,

**Figure 9.** *Competitive labor market equilibrium.*

**Figure 10.**

*Why the intersection of the labor supply and demand is the equilibrium. (a) the quantity supplied for labor is greater than the quantity demanded (b) the quantity supplied for labor is less than the quantity demanded.*

those firms would offer a higher wage rate. As wage rises, the quantity demanded for labor falls and the quantity supplied rises until the market reaches equilibrium at point E.

Notice that both the supply and the demand together bring the wage back to \$20 per hour. When the wage is at \$20 per hour, no worker has an incentive to accept a lower wage, and no firm has an incentive to offer a higher wage. Therefore, the equilibrium wage is \$20 per hour.
