5.1: Demand for Labour
Derived demand
The demand for factor inputs, like labour, is derived from the demand for the product they are used to
make
E.g. if demand for foreign holidays increases, the derived demand for airline pilots is likely to increase
During a recession/slowdown, the AD for labour will decline as businesses scale back on production to
reduce costs
Business failures and closures are likely to lead to short-term redundancies reducing the derived demand
for labour
In comparison, fast-growing markets often see a strong rise in the demand for labour
Marginal productivity theory
Demand for labour is also known as theory of marginal revenue productivity (MRP)
MRP refers to the addition to a firm’s revenue from employing an additional unit of labour
Productivity of additional labour units affects the resulting addition to output; marginal physical product
(MPP)
Demand curve for labour
The demand curve for labour, or MRP curve, shows relationship between wage rate and number of
workers employed
Equal to MPP in labour market multiplied by marginal revenue obtained in market for firm’s product -
MRP = MPP x MR
In a perfectly competitive market, the MR is constant and so the gradient of the MPP and MRP curves will
be the same
Determinants of labour demand
Wage rate
As wages are the price of labour, higher wages will lead to a
contractionary movement along demand curve for labour
This is because if the wage rate is high, it becomes more costly for a
business to hire extra employees
However, when wages are lower, labour becomes relatively cheaper than
capital -> increases demand for labour
Increased demand
A rise in consumer demand for a product may mean a firm needs to take on more workers (derived
demand)
This is likely to lead to an outward shift of the labour demand curve
Alternatively, in a recession there is likely to be an inward shift of labour demand, due to likely demand
deficiency
Labour productivity
As output per worker (per hr) increases, workers are more valuable to employer, causing an increase in
labour demand
This is because an increase in labour productivity makes labour more cost efficient than using capital
equipment
This lower cost of production may incentivise employers to take on more workers, thus increasing labour
demand
Price of substitute factors
Capital equipment (e.g. robotic technologies) are a substitute for labour
, If capital equipment becomes cheaper, this may lead to a reduction in the demand for labour
This effect can be seen in the market for supermarket assistant, where ‘self-checkout’ technology has
replaced workers
Similarly, an increase in the cost of capital equipment may lead to an increase in the demand for labour,
as a substitute
Shifts vs movement
A change in wage rate is likely to lead to a movement along the demand curve for labour (as wage =
price of labour)
A change in the other factors (demand, productivity, substitutes) are likely to lead to a shift in demand
curve for labour
Determinants of elasticity of labour demand
Elasticity of demand for labour measures responsiveness of quantity of labour demanded following
change in wage rate
Calculated by the percentage change in quantity of labour demanded ÷ percentage change in the wage
rate
Ease of substitution
The easier it is to substitute labour for other factors of production, e.g. capital, the more elastic the
demand for labour
However, when specialised labour/capital is needed, then demand for labour is likely to be more inelastic
E.g. may be easy to replace security guards with cameras, but may be difficult to replace cleaning staff
with machinery
Time
The longer the time period, the easier it becomes to substitute labour with other factors, like capital
machinery
This means demand for labour may be more elastic in the long-run
Elasticity of demand for product
As labour is a derived demand, the elasticity of demand for good/service influences the elasticity of
demand for labour
If demand for good/service (brain surgery) is inelastic, as substitution for service is difficult, labour
demand is inelastic
For goods of elastic demand, firms have little market power to pass higher wage costs onto consumer;
labour is elastic
Derived demand
The demand for factor inputs, like labour, is derived from the demand for the product they are used to
make
E.g. if demand for foreign holidays increases, the derived demand for airline pilots is likely to increase
During a recession/slowdown, the AD for labour will decline as businesses scale back on production to
reduce costs
Business failures and closures are likely to lead to short-term redundancies reducing the derived demand
for labour
In comparison, fast-growing markets often see a strong rise in the demand for labour
Marginal productivity theory
Demand for labour is also known as theory of marginal revenue productivity (MRP)
MRP refers to the addition to a firm’s revenue from employing an additional unit of labour
Productivity of additional labour units affects the resulting addition to output; marginal physical product
(MPP)
Demand curve for labour
The demand curve for labour, or MRP curve, shows relationship between wage rate and number of
workers employed
Equal to MPP in labour market multiplied by marginal revenue obtained in market for firm’s product -
MRP = MPP x MR
In a perfectly competitive market, the MR is constant and so the gradient of the MPP and MRP curves will
be the same
Determinants of labour demand
Wage rate
As wages are the price of labour, higher wages will lead to a
contractionary movement along demand curve for labour
This is because if the wage rate is high, it becomes more costly for a
business to hire extra employees
However, when wages are lower, labour becomes relatively cheaper than
capital -> increases demand for labour
Increased demand
A rise in consumer demand for a product may mean a firm needs to take on more workers (derived
demand)
This is likely to lead to an outward shift of the labour demand curve
Alternatively, in a recession there is likely to be an inward shift of labour demand, due to likely demand
deficiency
Labour productivity
As output per worker (per hr) increases, workers are more valuable to employer, causing an increase in
labour demand
This is because an increase in labour productivity makes labour more cost efficient than using capital
equipment
This lower cost of production may incentivise employers to take on more workers, thus increasing labour
demand
Price of substitute factors
Capital equipment (e.g. robotic technologies) are a substitute for labour
, If capital equipment becomes cheaper, this may lead to a reduction in the demand for labour
This effect can be seen in the market for supermarket assistant, where ‘self-checkout’ technology has
replaced workers
Similarly, an increase in the cost of capital equipment may lead to an increase in the demand for labour,
as a substitute
Shifts vs movement
A change in wage rate is likely to lead to a movement along the demand curve for labour (as wage =
price of labour)
A change in the other factors (demand, productivity, substitutes) are likely to lead to a shift in demand
curve for labour
Determinants of elasticity of labour demand
Elasticity of demand for labour measures responsiveness of quantity of labour demanded following
change in wage rate
Calculated by the percentage change in quantity of labour demanded ÷ percentage change in the wage
rate
Ease of substitution
The easier it is to substitute labour for other factors of production, e.g. capital, the more elastic the
demand for labour
However, when specialised labour/capital is needed, then demand for labour is likely to be more inelastic
E.g. may be easy to replace security guards with cameras, but may be difficult to replace cleaning staff
with machinery
Time
The longer the time period, the easier it becomes to substitute labour with other factors, like capital
machinery
This means demand for labour may be more elastic in the long-run
Elasticity of demand for product
As labour is a derived demand, the elasticity of demand for good/service influences the elasticity of
demand for labour
If demand for good/service (brain surgery) is inelastic, as substitution for service is difficult, labour
demand is inelastic
For goods of elastic demand, firms have little market power to pass higher wage costs onto consumer;
labour is elastic
