In the labour market, the equilibrium level of employment is attained where the demand for labour equals the supply of labour.

The demand for labour is a derived demand. The labour is demanded because it helps in the production of goods and services. The demand curve for labour is derived from the production function. The demand for labour depends upon its marginal productivity. Under competitive conditions, so long as the cost of hiring an additional unit of labour is less than the marginal revenue gained, firms will continue to employ addition units of labour. The cost of labour is expressed in terms of money wages (W) or real wages (W/P), i.e., wage derived by the general price level. Similarly, the revenue derived from labour can be expressed in terms of the marginal physical product of labour (i.e. MPP( ) ) multiplied by the general price level.

Symbolically, money wages can be expressed as follows:

W = P. MPP_N
Where W = money wage,
P = general price level , and
MPP_N =  marginal physical product of labour.

Equation (1) shown that the money wage is equal to MPP( ) multiplied by P.
The same idea can be expressed in terms of real wages by dividing bothe the sides fo equation (1) by general price level (P). We get,

W/P = P.MPP_N / P = MPP_N

Where W/P is the real wage, which is equal to marginal physical product of labour.

Since MPP_N = W/P, the demand for labour is also a function of real wages, i.e.,

D_N = f (W/P)

The demand for labour varies inversely with the real wage rates, therefore, the demand curve of labour will have a negative (downward) slope, as shown in.


In at real wage rate (W/P)₀ the level of employment is ON₀. As real wage rate falls to (W/P)₁, the firms will employ more workers, as a result, the level of employment rises to ON₁. Conversely, if the real wage rate rises to (W/P)₂, the level of employment will fall to ON₂.

The supply of labour is also a function of real wages. The supply of labour is positively associated with the real wages. Larger number of workers will be supplied at a higher real wage rate than at a lower real wage rate. As work involves exertion, strain and sacrifice of Leisure, workers would be willing to offer more of their services only at higher real wages, and vice versa, The supply curve of labour will have a positive (upward).




In the supply curve of labour is an increasing function of the real wage rate (W/P₀) the level of employment is ON₀. As the real wage rate rises to (W/P) ₁, the level of employment increases to ON₁.

Equilibrium level of employment in the labour market is determined at a point where the demand for labour equals its supply. The equilibrium in labour market is.

In D_N is the demand curve of labour and S_N is the supply curve of labour. Equilibrium level of employment is attained at point E. where at (W/P)₀ the real wage rate, the demand for labour is ON₀, i.e., the demand for labour equals the supply of labour.

In case, the real wage rate rises to (W/P)₁, the supply of labour increases to (W/P)₁ N₁. Since, the supply of labour exceeds its demand,t he unemployed workers would be willing to accept lower wage rate. As a result,the wage rate falls to (W/P)₀. Conversely, if the real wage rate decreases to (W/P)₂, the demand for labour raises to (W/P)₂ N₄, where as its suply falls to (W/P)₂ N₃. Excessive demand for labout buts pressure ont he wage rage, which rises to (W/P)0.

At the full employment equilibrium level, all the workers who are willing to offer their services at (W/P)₀ the real wage rate are absorbed by the economy.


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