Demand for labour

• Demand curve for labor for an individual firm


  Shows how many workers firms will hire at any given wage rate over a given period of time
• The demand for labor is a derived demand
• Firms hire workers because there is a need for them to produce goods and services, not because they get a thrill out of it
• Marginal revenue product (MRP)


  The extra revenue generated when an additional worker is hired
• Calculating MRP


  Marginal physical product x Marginal revenue
• MRP curve


  The demand curve for labor for an individual firm
• MRP curve shape


  Due to the law of diminishing marginal returns
• Firms operate in a perfectly competitive labor market, so they are wage takers
• Wage rate


  Equal to the marginal cost of labor
• Firms will hire workers up until the marginal revenue product is equal to the wage (marginal cost of labor)
• MRP Theory


  • Tells a firm the number of workers it should employ at a given wage rate
  • Workers will get a job if their MRP is at least equal to the wage
• Productivity is difficult to measure


  In certain industries like teaching where the output is not marketed and has no price
• For schools, it is very difficult to know the number of workers to employ at a given wage rate if they don't know the MRP
• In the real world, it is difficult to measure the productivity of individuals who work in teams and produce output as a team
• It is difficult for firms to know the MRP of a worker looking for a new job at a given wage rate
• The self-employed don't pay themselves according to their marginal revenue product
• The assumption of perfectly competitive labor markets in MRP Theory breaks down when there are trade unions bargaining for higher wages that are not based on MRP
• conclusions of MRP Theory -

  1. that workers are paid according to their MRP and firms make employment decisions based on MRP - break down in the real world
• Factors affecting demand for labor


  Other than the wage
• Factors that shift the labor demand curve


  1. Price of the final product

  2. Demand for the final product

  3. Productivity of labor

  4. Price of capital
• Increase in price of final product


  Increases marginal revenue product (MRP) of labor, shifts labor demand curve right
• Increase in demand for final product


  Increases demand for labor, shifts labor demand curve right
• Increase in labor productivity


  Increases marginal product of labor, increases MRP, shifts labor demand curve right
• Decrease in price of capital


  Decreases demand for labor, shifts labor demand curve left
• Increase in price of capital


  Increases demand for labor, shifts labor demand curve right
• Labor is a derived demand
• In the long run, capital and labor are substitutable factors of production
• Non-wage factors shift the labor demand curve
• Elasticity of Labor demand


  Measures the responsiveness of Labor demanded given a change in the wage rate
• Wage elastic labor demand


  • The proportionate change in labor demand is greater than the change in the wage
• Wage inelastic labor demand


  • The proportionate change in labor demand is less than the change in the wage
• Factors determining elasticity of Labor demand

  1. Substitutability of capital for labor

  2. Elasticity of demand for the final product

  3. Labor cost as a percentage of total cost

  4. Time period
• Substitutability of capital for labor


  The more substitutable capital is for labor, the more wage elastic labor demand is going to be
• If capital is very substitutable for labor

  The proportional decrease in labor demand will be much greater than the increase in wage
• If capital is not very substitutable for labor


  Firms will not be able to reduce workers by very much, so demand for labor will be very wage inelastic
• Elasticity of demand for the final product

  If the elasticity of demand for the final product is inelastic, firms are not going to respond by cutting their Workforce significantly by reducing their labor demand significantly
• Labor cost as a percentage of total cost

  The greater that labor costs are as a percentage of total cost, the more wage elastic demand is going to be
• As wages go up and labor costs are a large percentage of total costs


  Firms need to cut their Workforce significantly, so labor demand reduces proportionately more than the rise in wages
• The more insignificant labor costs are as a percentage of total costs


  Labor demand is more wage inelastic
• Time period


  In the long run, all factors of production become variable so labor demand becomes more wage elastic, whereas in the short run it is more wage inelastic