Markets for labor have supply and demand curves. So do the markets for goods. The Law of Supply states that the supply of products goes up in a direct relationship. The Law of Demand instructs us that as the price goes up, the demand for that product goes down in an inverse relationship. The same laws apply when the product or commodity is labor.


As far as economists are concerned, labor functions just like any other commodity in the marketplace. Supply and demand for labor is affected by changes in prevailing wages in the same way goods are affected by changes in price.

Supply vs. Demand

The laws of supply and demand – possibly the most important laws in economic theory – explain how these economic forces interact. Supply refers to the amount of a good, service or labor the market can provide. Demand tells you how much of a good, service or labor buyers (or companies) want.

By the laws of supply and demand, the quantity of a good or service supplied (such as labor) rises as the market price rises and falls as the price falls.

On the demand side, the quantity of a good or service demanded falls as the price rises. The trick is setting prices (or wages) at just the right level such that supply and demand are equal. When that happens, economists say the market has reached a state of equilibrium.

The Goldilocks Principal

Put simply, a state of equilibrium exists when the quantity supplied and the quantity demanded are equal.

The laws of supply and demand in the labor (or any) market, though, might better be called the Goldilocks principle, an idea based on the popular children's story where the lead character finds porridge that is not too hot, and not too cold, but just right.

When the price (salary) a business pays for labor attracts just the right amount of labor to satisfy demand, you've reached a state of equilibrium.

As wages rise in the labor market, employers may find themselves less willing or less able, financially, to hire additional employees. Hence, the demand for labor may drop even as the number of people wanting to work – the supply of labor – increases due to the lure of higher wages.

Wages that are too low, on the other hand, will produce just the opposite effect.

The Right Number of Nurses

Consider a study involving 34,000 registered nurses who worked in the Minneapolis-St. Paul-Bloomington, Minnesota-Wisconsin metropolitan area. The nurses worked for a variety of employers: hospitals, doctors’ offices, schools, health clinics and nursing homes.

The results are posted in this table:

Annual Salary Quantity Demanded Quantity Supplied
$55,000 45,000 20,000
$60,000 40,000 27,000
$65,000 37,000 31,000
$70,000 34,000 34,000
$75,000 33,000 38,000
$80,000 32,000 41,000

At $55,000 – that is, when companies were offering annual salaries of $55,000 – these firms needed 45,000 nurses (the demand) but only 20,0000 (the supply) were interested and available to work. At the other extreme, when the employers offered salaries of $80,000, they needed only 32,000 nurses (likely because they could afford no more nurses at these salaries), but there were double that number, 41,000, willing to work.

Finding the correct price, then, is the key to ensuring that the right amount of labor is available to meet the specific demand of employers for that labor.

At $70,000 in annual salary, employers needed 34,000 nurses, and 34,000 nurses applied and were ready to work. Thus, a state of equilibrium had been reached, because the price (salary) was just right: The supply of nurses exactly equaled the demand for them.

Put another way, when the price (salary) was just right, the supply of labor equaled the demand for labor.