Demand and Supply Factors Behind Widening Income Inequality

Question

In the second decade of the 21st century, the divergence between low-skilled and high-skilled labour has never been more stark, despite an increase in demand for both types of labour. The difference in years of schooling between the upper and lower echelons of income is widening, and technological advances are making low-skilled labour less relevant by the day.

(a) Explain how possible demand and supply factors might contribute to widening income inequality in Singapore. [10]

Answer

Income inequality is the dispersion in how income is distributed across the population; here it is driven by the gap between the wages of high-skilled and low-skilled workers. The labour market is a factor market in which households are the suppliers of labour and firms are the demanders, and the wage is the price of labour set by the demand for and supply of labour. To explain a widening gap, the analysis must contrast how demand and supply act on the two groups differently. Both a demand-side and a supply-side mechanism pull the two wages apart.

Demand factor: divergent shifts in derived demand. The demand for labour is derived from the demand for the goods and services it produces. Globalisation and technological advance have raised the demand for high-value-added output — for example, the semiconductors in which Singapore has a comparative advantage — lifting the demand for high-skilled labour and shifting its demand curve rightward from $D_1$ to $D_2$. At the prevailing wage a shortage emerges; firms compete for scarce high-skilled workers and bid wages up, while the higher wage draws out more labour, until a new equilibrium is reached at a higher wage $W_2$. For low-skilled labour the demand shift is far weaker: automation and machinery increasingly substitute for routine tasks, so demand rises only slightly, from $D_3$ to $D_4$, and the equilibrium wage rises only modestly to $W_4$. The much larger upward shift in high-skilled demand than in low-skilled demand widens the wage gap.

The contrast can be sharpened by the price elasticity of demand for labour. High-skilled labour, such as surgeons, has few substitutes — it cannot easily be replaced by other workers or by machines — so its demand is inelastic, and a rise in demand requires a large wage rise to clear the shortage. Low-skilled labour is readily substitutable by machinery, so its demand is more elastic and the same rise in demand clears with only a small wage rise. The faster wage growth at the top than the bottom widens inequality.

Supply factor: divergent price elasticity of supply. The wage gap is also widened by differences in the price elasticity of supply of the two types of labour — the responsiveness of the quantity of labour supplied to a change in the wage. High-skilled labour has an inelastic supply (PES < 1): training a surgeon or researcher takes years of specialised education and experience, so the quantity supplied cannot expand quickly when wages rise. As applying PES to a demand shift shows, when supply is inelastic a rise in demand raises wages more than proportionately to the rise in quantity, so wages climb sharply from $W_1$ to $W_2$. Low-skilled labour has a more elastic supply (PES > 1): the skills and education required are low, so untrained workers can enter quickly, and a rise in demand is absorbed largely by a rise in quantity rather than wage, leaving wages rising only modestly from $W_3$ to $W_4$. The different elasticities of supply therefore amplify the wage divergence created on the demand side.

Conclusion. Both blades of the scissors widen the gap: high-skilled labour faces a larger rightward demand shift and a more inelastic supply than low-skilled labour, so its wages rise far faster. The combination of divergent derived demand and divergent elasticity of supply between the two groups is what drives the widening income inequality in Singapore.