5.1 Demand for Labour

• Derived Demand


  Where the demand for a factor of production or good derives not from the factor or good itself, but from the goods or services that it provides
• Demand for labour is a derived demand
• Labour is not demanded for the workers themselves


  But for what they can produce and what that output can be sold for
• Factors determining the number of workers a firm wishes to employ

  • The revenue (and therefore profit) that can be earned from what the workers produce
• If demand rises or the price of the products made increases


  A firm will usually seek to employ more workers
• Labour markets

  There is not a single market for labour in the economy but a multitude of sub-markets reflecting individual workers' characteristics and skills, different markets for different types of labour, different geographic submarkets, labour markets for a particular industry, labour markets for a particular skill
• Demand curve for labour


  Based on the output the labour produces
• The additional output produced by labour as more labour is deployed is expected to diminish, other things remaining equal, due to the law of diminishing returns
• Marginal physical product of labour (MPPL)


  The amount of additional output produced if the firm increases its labour input by one unit (e.g. adding one more person-hour) holding capital constant
• Marginal revenue product of labour (MRPL)


  The change in a firm's revenue that results from employing one more worker, found by: MRPL = MPPL x MR
• The demand curve for labour is the MRPL curve
• The demand curve for labour is the same in any market structure - perfect or imperfect
• In a perfectly competitive market, the MRPL fell because of the law of diminishing returns
• In an imperfectly competitive market, the MRP curve falls because price falls as quantity increases AND because of the law of diminishing returns
• Factors affecting the demand for labour in an industry

  • Change in the price of labour (wage rate), increase in the productivity of workers, increase in the price of the product, decrease in the price of the product
• Factors influencing the demand for labour in an industry

  • Demand and expected future demand for the products produced and the revenue (MR) that can be earned from the output (key influence)
  • Productivity of workers (Marginal physical product of Labour) (MPPL) the additional quantity of output produced by an additional unit of labour
  • Factors affecting the cost of labour (wage rate, complementary labour costs, price of other factors of production)
• A change will cause the demand curve for labour (MRPL) to shift - increase or decrease in demand
• A change will cause a movement up or down the demand curve for labour (MRPL) - contraction or expansion
• Problems of the marginal productivity model

  • Assumptions: labour is homogenous, firms have no buying power when demanding labour, productivity of each worker can be clearly measured, the supply of labour is perfectly elastic, there is a perfectly competitive labour market
• Elasticity of demand for labour

  A measure of the responsiveness/sensitivity of the quantity demanded of labour to a change in the wage rate (price)
• Factors affecting the elasticity of demand for labour


  The ease of factor substitution (if labour can be easily substituted for another factor, the demand for labour would be relatively elastic; if labour cannot be easily substituted, the demand for labour would be relatively inelastic), the time period (capital tends to be inflexible in the short-run)
• Elasticity of demand for labour


  A change in wages will result in a greater proportional change in the quantity of labour demanded
• Factors affecting the elasticity of demand for labour


  • The ease of factor substitution
  • The share of labour costs to total costs
  • The price elasticity of demand for the product
• If in a particular industry labour cannot be easily substituted for another factor of production (for example capital)


  The demand for labour would be relatively inelastic - a change in wages will result in a smaller proportional change in the quantity of labour demanded
• The ease of factor substitution therefore varies between economic activities and industries and depends upon the technology used in production
• Ease of factor substitution

  • In some industries it is relatively easy - food packaging
  • In other it is more difficult - lawyers
• Time period


  Another important aspect affecting the elasticity of demand for labour
• In the short-run, capital tends to be inflexible


  Therefore in the short run if wages increase firms will have little flexibility in replacing workers with capital. The demand for labour will therefore be relatively inelastic
• In the long-run, firms will be able to adjust all factors of production (including capital to a different overall balance)


  The demand for labour will therefore be more relatively elastic
• Share of labour costs to total costs


  In many activities (service industries for example) labour is a highly significant share of total costs. Therefore firms are very sensitive to changes in the cost of labour. Demand for labour will tend to be wage elastic. However in capital intensive manufacturing activity, labour may comprise a much smaller proportion of total costs. The demand for labour will therefore be relatively inelastic
• Derived demand


  The demand for labour is a derived demand - the price elasticity of demand for the product the labour is producing must be taken into account
• If the product has elastic PED (for example foreign holidays)


  The demand for labour in the industry is likely to be relatively wage elastic. Why? If the product is price elastic (e.g. holidays) this limits the extent the firm can pass on any increased costs through wage increases onto customers in the form of higher prices. Any wage (or labour cost) increase is therefore likely to result in a greater proportional fall in the quantity demanded of labour
• Degrees of elasticity of demand for labour


  • The more flexible the workforce, the more elastic the demand for labour will be
  • Demand for labour in capital-intensive industries tends to be inelastic
  • Demand for labour in labour-intensive industries tends to be elastic
  • More elastic for young and unskilled workers
• Significance of demand for labour

  • Inelastic demand increases a union's bargaining strength
  • Elasticity of demand for labour must be taken into account by a government considering a change to the minimum wage
  • Elasticity of demand for labour must be taken into account by a government considering which industries to target with subsidies for taking on workers
• Why are labour costs so important for firms?

  Labour costs often account for a high proportion of the total costs of a product. Reducing labour costs can therefore positively affect price competitiveness and profitability. However if relative labour costs increase this can negatively affect price competitiveness and profitability. Unit labour cost is therefore an important measurement
• Unit labour costs

  The average cost of labour needed to create one unit of output. The unit labour cost will depend on the wage paid, other costs associated with labour, and the productivity of labour
• Labour costs


  Include the complete range of costs employers incur when they employ workers: wages (over 80%), recruitment costs, training costs, NI contributions, redundancy payments, benefits in kind
• Labour productivity


  A measure of output per worker per hour worked. Average labour productivity is measured by dividing the output produced by the amount of labour input (i.e. output produced per unit of labour)
• Main influences on labour productivity

  • The skills and training of the workforce
  • The availability of complementary factor inputs (capital and technology)
  • The organisation of the production process
• Skills and training of the workforce

  Workers are not all equally productive. Some are more skilled or highly trained, have higher innate ability or talents, and are better motivated. The combination of these characteristics determines how productive the individual worker is. When workers come together some are more suited to working in a team, which then influences the productivity of the whole workforce. Positive externality effects may also be evident such as educated workers cooperate better with each other, so raising the overall efficiency of the workforce