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Chapter Five

Demand for Labour in Competitive Labour Markets. Chapter Five. Chapter Focus. Labour demand curve Short and long run Demand for Labor Elasticity. Demand for Labour. Factors of production inputs into the production of final goods Linked to the firms demand for goods/services

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Chapter Five

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  1. Demand for Labour in Competitive Labour Markets Chapter Five

  2. Chapter Focus • Labour demand curve • Short and long run Demand for Labor • Elasticity

  3. Demand for Labour • Factors of production • inputs into the production of final goods • Linked to the firms demand for goods/services • Derived demand

  4. Employment Decisions • Short-run – one or more factors of production cannot be varied (e.g., k) • Long-run – firm can adjust all of its inputs (N and K) • State of technical knowledge is assumed to be fixed

  5. Demand for Labour • The quantity of labour services the firm would employ at each wage: N=N(w) • Depends on the firms objectives and constraints • Objective is to maximize profits

  6. Firm’s Constraints • Demand for product (output) • Supply of labour (and other factors of production) • Production function ( the maximum output given the various combinations of inputs) • Fixed quantity of one or more factors of production (short run only)

  7. Theory of Labour Demand • Examines the quantity of labour the firm desires • given the market-determined wage rate Assume: The firm is a perfect competitor in the labour market.

  8. Market Behaviour • A firm’s behaviour in the product market affects • demand for labour • wage rate • employment decisions • The structure of the labour market affects supply curve - amount of labour available to the firm at various wage rates

  9. Categorizing the Structure of Product Markets • Industry Structures • perfect competition • monopolistic • oligopoly • monopoly decreasing degree of competition

  10. Categorizing the Structure of Labour Markets • Industry Structures • perfect competition • monopsonistic competition • oligopsony • monopsony decreasing degree of competition

  11. Characteristics of Industry Structures • Categories are independent of each other • 16 possible combinations that affect wage and employment outcomes

  12. Demand for Labour in the Short Run Perfect Competition Case

  13. Production Function • Firms use factors of production (labour- N, capital -K) to produce Q (quantity of a single output) • Q=F(K,N) • In the short-run K is fixed so the production function is simply a function of N

  14. Profit-Maximization Situation • Costs fall into two categories: • fixed • variable Decision Rule #1 • Operate as long as variable costs are covered • Total revenue exceeds total variable costs

  15. Profit-Maximization Decision Rule #2 • Increase output until the additional cost associated with the last unit produced equals the additional revenue associated with that unit • Marginal Costs equal Marginal Revenue, I.e., MC=MR

  16. Profit-Maximizing in Terms of Labour Demand • Terminology is modified: • Total Revenue Product (TRP) - the total revenue associated with the amount of an input employed • Marginal Revenue Product (MRP) - the change in total revenue associated with a change in the amount of input employed

  17. Profit-Maximizing Decisions in terms of Labour • Firm should: • produce as long as the total revenue product generated by the variable input exceeds the total costs associated with employing that input • expand employment of labour to the point at which its marginal revenue product equals marginal cost

  18. A Firm’s Short-Run Demand for Labour In competitive markets: • price taker • can hire labour without affecting market wage • marginal (and average) cost is market wage • hire labour until the MRP equals the W • short-run labour demand curve is it’s marginal revenue product curve (for labour)

  19. Wages higher than W1 the firm would shut down W1 N*1 Figure 5.1 Short-Run Demand for Labour Wage Rate W0 ARPN MRPN N*0 Labour Services

  20. Short-Run Demand for Labour • Firm will shut down • if average cost of labour (wage rate) exceeds the average revenue product of labour • Short-run labour demand curve • MRPN curve • below the point at which the average and marginal product curves intersect

  21. Short-Run Labour Demand Curve • Downward sloping because of diminishing marginal returns to labour •  in wage rate will cause  in demand for labour (movement along the curve) •  in K will cause  in demand for labour (shift in demand curve) •  in p will cause  in demand for labour (shift in demand curve)

  22. Perfectly Competitive Company price taker can sell output without affecting market price MRQ=product price employs labour services until the value of MP of labour just equals the wage Monopoly firm is so large it influences price when the monopolist hires more labour to produce more output, both the marginal physical product of labour and the marginal revenue falls Industry Structure

  23. Perfectly Competitive Firm • Perfectly Competitive Company • price taker • sells output without affecting market price • MRQ=product price • Employs labour services until the value of MP of labour just equals the wage

  24. Application: Proposals by Carter and Bentsen (1979) • Cartel: subsidize firms by x dollars per worker hired. • Bentsen: subsidy is given only if firms hire more workers than they did previously. • Conclusion: Bentsen’s proposal is better in terms of job creation (I.e., Nb>Nc)

  25. Figure: Cartel vs Bentsen w w1 w1-x W1-y, where y>x D N1 Nb Nc Labour

  26. Labour Demand in Long-Run

  27. Isoquants • “Equal quantity” • Combinations of labour and capital used to produce a given amount of a product (output) • Slope exhibits a diminishing marginal rate of technical substitution • MRTS

  28. Figure 5.2Isoquants K Q1 Q0 N 0

  29. Isocost Line • All combinations of capital and labour that can be bought for a given total cost • CM=rK+wN • Total Cost =(price of capital * K)+(wage rate*employees)

  30. KH=CH r0 KM=CM r0 NH=CH W0 NM=CM W0 Slope=-w0/r0 Figure 5.2 b Isocost K 0 N

  31. Figure 5.2 c Cost-Minimizing K K1 KM E0 K0 Q0 NM 0 N1 N0 N

  32. A Firm’s Labour Demand Obtained by varying the wage rate and tracing out the new equilibrium, profit maximizing amounts of labour employed

  33. KP=C1 r0 KM=C0 r0 NM=C0 w0 NP=C1 w1 Figure 5.3 a Isocost Rotation from a Wage Increase K Slope=-w1/r0 Slope=-w0/r0 E0 K0 Q0 0 N0 N

  34. KN E1 Q1 N1 NN Figure 5.3 b Profit Maximizing Output and Derived Labour Demand K KM E0 Q0 0 N0 N NM

  35. Figure 5.3 c Derived Labour Demand Schedule K w1 w0 D 0 N1 N0 N

  36. Perfect Competition •  wage rotates isocost line downwards with a greater slope • The firm will maximize profit by moving to a lower level of output •  wage also shifts up the firms’s marginal and average cost curves • In a perfect competitive industry each firm reduces output raising the price of the product

  37. Figure 5.4 a Perfect Competition Price MC1 MC0 P1 P0 Q1 Q0 Output

  38. Figure 5.4 a Industry Price S1 S0 P1 P0 D q1 q0 Output

  39. Figure 5.4 a Monopoly Price MC1 MC0 P1 P0 MR D q1 q0 Output

  40. Figure 5.5 Substitution and Scale Effects of a Wage Change K KN KM ES E0 E1 Q0 Q1 0 N1 NS N0 N NM

  41. In Theory • Demand schedule is downward sloping • firm would substitute cheaper inputs for the more expensive labour • SUBSITUTION EFFECT • Firm would reduce its scale of operations because of the cost increase associated with the increase in wage • SCALE EFFECT

  42. Short-Run amount of capital is fixed no substitution effect Long-Run firm has flexibility by varying its capital stock response to a wage change will be larger in the long run Relationship Between the Short and Long Run

  43. Elasticity of Demand for Labour • Demand for labour decreases as wages increase (negative function) • Wage increases have an adverse effect on employment • The magnitude of the effect can be seen by the elasticity of the derived demand for labour

  44. Elasticity of Demand • Measures the responsiveness of the quantity of labour demanded to the wage rate • Equals the % change in the quantity of labour demanded divided by the % change in the wage rate

  45. Figure 5.7 a Inelastic W D 0 N

  46. Figure 5.7 b Elastic W D 0 N

  47. Elasticity of Demand for Labour • Basic determinants of the elasticity of demand for labour: • availability of substitute inputs • supply of substitute inputs • demand for output • ratio of labour cost to total cost

  48. Elasticity of Demand • If inputs can not be easily substituted  elasticity of labour demand • If demand for output is not effected by a price increase (due to cost of wage increase) demand for labour will be inelastic • Demand for labour will be inelastic if labour cost is small portion of total cost

  49. End of Chapter Five

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