Lecture Labour market economics: Chapter 5 - Dwayne Benjamin, Morley Gunderson, Craig Riddell

Labour demand is derived demand, that is, labour is hired in order to produce goods which are sold in the product market. For this reason, labour demand is always connected to the product market, especially in terms of the degree of competition, whether from foreign or domestic producers. In this chapter, we will address the following contents: Labour demand curve, short and long run, elasticity, competitiveness of Canadian labour, globalization.

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Chapter Five

Demand for Labour

in Competitive Labour Markets

Created by: Erica Morrill, M.Ed

Fanshawe College

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Chapter Focus

 Labour demand curve

 Short and long run

 Elasticity

 Competitiveness of Canadian labour

 Globalization

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Demand for Labour

 Factors of production

 inputs into the production of final goods

 Linked to the firms demand for

goods/services

 Derived demand

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Employment Decisions

 Short-run – one or more factors of

production cannot be varied

 Long-run – firm can adjust all of its

inputs

 State of technical knowledge is

assumed to be fixed

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Demand for Labour

 The quantity of labour services the firm would employ at each wage

 Depends on the firms objectives and

constraints

 Objective is to maximize profits

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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)

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Theory of Labour Demand

 Examines the quantity of labour the firm desires

 given the market-determined wage rate

 given the labour supply function the firm faces

Assume:

The firm is a perfect competitor in

the labour market.

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 The structure of the labour market affects

 supply curve - amount of labour available to the firm at various wage rates

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 16 possible combinations that affect

wage and employment outcomes

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Demand for Labour in the

Short Run

Perfect Competition Case

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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

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associated with that unit

 Marginal Costs equal Marginal Revenue

 MC=MR

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 Marginal Revenue Product (MRP) - the change in total revenue associated with a change in the amount of input employed

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 expand employment of labour to the point

at which its marginal revenue product

equals marginal cost

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 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)

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W0

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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

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Short-Run Labour Demand

Curve

 Downward sloping because of

diminishing marginal returns to labour

 in wage rate entice in demand for

labour

 in wage rate will cause in demand for labour

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 can sell output without

affecting market price

 when the monopolist hires more labour to produce more output, both the marginal

physical product of labour and the

marginal revenue falls

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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

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Labour Demand in Long-Run

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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

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Figure 5.2 Isoquants

K

N 0

Q 0

Q 1

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K 1

Q 0

E 0

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A Firm’s Labour Demand

Obtained by varying the wage rate and

tracing out the new equilibrium, profit

maximizing amounts of labour

employed

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E 0

Q 0

K 0

N 0

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Figure 5.3 b Profit Maximizing Output

and Derived Labour Demand

E 1

Q 1

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w 1

w 0

N 1 N 0

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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

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K N

Q 0

E 0

N 1

E 1

Q 1

E S

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In Theory

 Demand schedule is downward sloping

 firm would substitute cheaper inputs for the more expensive labour

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Relationship Between the

Short and Long Run

 response to a wage change will be larger

in the long run

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 The magnitude of the effect can be

seen by the elasticity of the derived

demand for labour

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Elasticity of Demand

 Measures the responsiveness of the

quantity of labour demanded to the

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Figure 5.7 a Inelastic

W

N 0

D

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Figure 5.7 b Elastic

W

N 0

D

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 availability of substitute inputs

 supply of substitute inputs

 demand for output

 ratio of labour cost to total cost

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 Demand for labour will be inelastic if

labour cost is small portion of total cost

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End of Chapter Five

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