How Wages and Employment Are Determined?

The demand for workers is at an all-time high. During the COVID-19 pandemic, many companies fired employees or made them redundant. Soon, however, they realized the need for manual labor. Despite many industries going digital, companies still need employees to operate. Usually, these companies cannot exist or survive without their workers. But there are many issues these companies face.

Despite the growing supply of high-skilled labor, companies have not succeeded in hiring those employees. Apart from the many issues in this process, salaries and wages play a significant role. For most companies, the focus is to keep costs low. On the other hand, employees always want higher pay. The difference between the requirements for both parties has become a global issue.

Wages and employment are an issue in economics. Most countries want to solve this issue as soon as possible to move toward a more stable economy. However, several factors contribute to the process. Many people wonder how wages and employment are determined. Before discussing that, it is crucial to understand the topics at a lower level.

What is Employment?

Employment refers to a contract between two parties where one party promises to provide services. This party, known as the employee, is an individual who possesses skills or knowledge in a specific area. On the other hand, the other party promises to compensate them for those services. This party is known as the employer. It can be an individual, business, organization, or any entity.

The relationship between employers and employees has existed over many centuries. In this relationship, both parties agree to set their roles and duties. They also define what each party must contribute to the contract. Both parties can negotiate the terms included within this contract. Usually, the employer has leverage during these negotiations due to their position.

The employee is an individual who promises to provide services through an employment contract. They receive compensation, which usually includes their salaries or wages. Sometimes, they will also get other benefits. In exchange, employees perform work that the employer expects from them. The contract also dictates the roles and responsibilities employees must undertake.

The employer is an entity that hires the employee to perform specific tasks. In the contract between them, the employer provides a job encompassing responsibilities. Furthermore, the employer also offers compensation in exchange. Apart from that, they also have other statutory duties. For example, the employer must deduct taxes and conform to employment laws and regulations.

Overall, employment is a relationship between an employer and an employee based on a contract. This contract defines the roles and responsibilities of each party to the other. One of the terms incorporated within this contract is wages. Usually, these wages depend on various factors, for example, experience, knowledge, rank, etc. Employment can include any employer-employee relationship.

How wages and employment are determined?

Wages and employment are determined through economic factors. These factors apply to a country, nation, or region. Usually, they depend on the type of the underlying labor market. In any country, two types of these markets can exist. These include perfect and imperfect labor markets. While the first is a theoretical scenario, it helps define how wages and employment are determined.

Perfectly competitive labour market

In a perfectly competitive labor market, the factors affecting wages and employment are supply and demand. However, these markets make various assumptions. They include the following.

  • There are no barriers to entry for labour.
  • Perfect knowledge of jobs is available to all participants.
  • Employers can hire labour as they need, depending on demand.
  • The supply curve for labour is perfectly elastic.
  • Each labour unit is identical to every other unit.

In practical scenarios, the above assumptions rarely hold. However, they help understand how the supply and demand for labor works. This market also helps define the equilibrium wage and employment rate. In this case, wages and employment depend on the intersection of two factors. These include the horizontal labor supply curve and the downward slopping MRP (D) curve.

In a perfect market, the wage is determined by the whole market. This rate applies to all entities or employers within the perfect market. In this case, the employer determines the demand for the labor. Combined with supply, this demand can also help determine the competitive market wage rate. The equilibrium wage rate represents the rate where both the supply and demand are equal.

Imperfect labour market

The perfectly competitive labor market is theoretical and does not exist practically. The assumptions made for the former rarely hold in existing scenarios. As stated above, employers lean toward saving costs rather than employee benefits. In these cases, the wages and employment don’t come from the whole market. Employers can impact this factor on their own.

On top of that, monopsonist employers can also impact these factors. These employers lower the wage rates from the perfect labor market. In these cases, the equilibrium wage rate for employment deviates from the optimal point. Furthermore, each assumption in the perfectly competitive labor market impacts this point. In these cases, the wages and employment may differ from the theoretical scenarios.

What are the factors affecting Wages and Employment?

Besides supply and demand, several other factors also impact wages and employment. These factors contribute to the wage rates that employees receive. Consequently, they also impact employment. Some of those factors include the following.

Market wage rates

One of the most crucial factors contributing to wages and employment is market wage rates. No employer can ignore how much other employers are paying their employees. Usually, these rates come from within an industry. Employees within a specific sector receive similar wage rates like other companies.

Cost of living

The cost of living in a country also impacts the wages and employment prevalent there. In many industries, salaries depend on the enterprise cost of living. This cost ensures fair wages to employees. As the cost of living in a country increases, workers demand higher pay. However, the wage rates in countries with a lower cost of living will also be below.

Ability to pay

Employers must also be able to afford and pay their employees. If an employer is going through an economic downturn, they won’t offer high salaries. Likewise, when an industry suffers as a whole, the wages and employment rates will decrease. Workers are also likely to prefer sectors that offer higher wage rates than those below average.

Power of employees

In some cases, employees may have leverage when negotiating contracts. For example, workers who are a part of trade unions are more likely to demand better terms. Consequently, the wages are determined by the employee’s bargaining power. The more influence they have over the contract, the higher wage rates they demand.

Government regulations

The government also intervenes in matters related to wages and employment. Usually, it comes through their policies, such as minimum wages.

The government seeks to improve the working conditions of workers. Consequently, they make rules that can increase wages and employment rates. On top of that, it can also impact those rates indirectly. For example, they can affect the cost of living, which links to wages and employment.


Wages and employment have become an issue in the global economy due to the ongoing pandemic. One of the crucial factors that impact them is supply and demand. In a perfectly competitive labor market, it is not a significant issue. However, achieving the assumptions made by that market is rarely possible. On top of that, other factors can also impact wages and employment.