THE LABOUR MARKET
THE DEMAND FOR LABOUR, MARGINAL, MARGINAL PRODUCTIVITY THEORY
Introduction to the Labour market
Firms and employers demand labour
Individuals supply labour
Where the demand for labour=the supply for labour we get an equilibrium wage rate
and quantity of workers
The demand for labour is a derived demand
The Labour market is a factor market. The supply of labour is determined by those
who want to be employed (employees) whilst the demand for labour is from
employers
The demand for labour is derived from the demand for goods and services in an
economy.
In competitive markets, firms are assumed to be profit-maximizing, i.e. they seek at a
least a normal economic profit (AR=AC)
At a micro (firm) level, demand for
labour will change according to
demand for the firm’s goods.
At a macro level, aggregate demand for
labour will reflect the economic cycle
and be reflected inversely by the extent
of cyclical unemployment.
Demand is related to how productive labour is
and how much the product is demanded. The
elasticity of demand for labour is linked to how price elastic the demand for the product is
The wage rate will lead to movements along the supply and demand curves for
labour. All other factors will shift the curves
The demand curve for labour shows how many workers will be hired at any given
wage rate over a given period of time
o At a given wage rate, how many workers will a firm employ?
The marginal product of labour
The marginal product of labour (also known as the marginal physical product of
labour) is the additional amount of output for every additional worker that is
employed by a firm
In the short-run, it is common for units of labour (and land, i.e. materials) to be
added in the production process, whereas it is more difficult to add units of capital
As additional units of labour (i.e. workers) are added to fixed capital, the law of
diminishing returns will apply from the point where the marginal product of labour
begins to fall.- short run
We assume that the firm is in perfect competition and therefore is a wage taking
firm
o Price=MR=AR
, o Firms will determine their demand decisions for labour on the marginal
product of labour
o This explains why the curve slopes downwards after a certain point
o Additional units of labour will increase output up to a certain point, soon the
marginal product will decrease (due to one factor being fixed) however
because firms will still be experiencing an increase in output they will
continue hiring workers until the marginal revenue product= the wage rate
o If the firm hired 6 workers the revenue gained would be less than the cost
and so the 6th worker has greater costs than benefits
o I.e. when the example reaches 5 workers
o Firm= price taker= £60 in the picture
Diagram shows MRP
Marginal revenue product of labour (MRPL)
The marginal revenue product of labour is the additional revenue that is received by
the firm as a result of employing an additional worker.
MRP=MP x MR
The marginal revenue is the additional revenue earned by selling one more unit of
output. We assume also the firm operates in a perfectly competitive market, so
therefore the marginal revenue will equal the price (average revenue).
In the short run, the marginal output of workers is determined by the law of
diminishing returns
It increases at first due to specialisation and the division of labour but then it
decreases
A profit-maximising firm will produce output at a level where MC=MR. The same
principle applies in labour markets and determines how many workers a firm should
employ to maximise profits.
Given that the wage rate, i.e. the marginal cost of labour (MC L) is constant, a firm
will employ the number of workers where MRPL = MCL
o this is the point where profit max occurs
Evaluation/ criticism of MRPL
MRP tells a firm at a given wage rate how many workers they should employ and for
workers, if their MRP is at least equal to the wage rate they will get a job
In the real world this can break down because knowledge of MRP is assumed
The assumption that the MPPL (and MRP) will comply with the law of diminishing
returns is flawed because:
, o Productivity is hard or impossible to measure across different jobs in
different industries, especially in the service sector.
Working out the MRP is
very tough
E.g. teaching
o Workers often don’t work alone
but in teams where it is the output
and productivity of an individual is
hard or impossible to measure
o The self-employed pay
themselves as they please and
don’t apply the theory that they should only work when MRP=MCL
o Many labour markets are not perfectly competitive
Trade unions
Deriving an industry’s labour market demand
There is an inverse relationship between wages and quantity of workers
WHY
1. SR-> law of diminishing returns
2. LR-> Substitutability of labour and capital
The demand for labour is affected by:
o The wage rate- causes movements along the curve
o When wages go up there will be a contraction
(fall) of labour demand
o When wages decrease there will be an extension
(increase) of labour demand
Lower wage rate= more workers because
workers who have a lower MRP can easily
justify being hired at a lower wage rate
All other factors cause shifts
o Demand for products
o Productivity of labour
o Substitutes for labour
THE DEMAND FOR LABOUR, MARGINAL, MARGINAL PRODUCTIVITY THEORY
Introduction to the Labour market
Firms and employers demand labour
Individuals supply labour
Where the demand for labour=the supply for labour we get an equilibrium wage rate
and quantity of workers
The demand for labour is a derived demand
The Labour market is a factor market. The supply of labour is determined by those
who want to be employed (employees) whilst the demand for labour is from
employers
The demand for labour is derived from the demand for goods and services in an
economy.
In competitive markets, firms are assumed to be profit-maximizing, i.e. they seek at a
least a normal economic profit (AR=AC)
At a micro (firm) level, demand for
labour will change according to
demand for the firm’s goods.
At a macro level, aggregate demand for
labour will reflect the economic cycle
and be reflected inversely by the extent
of cyclical unemployment.
Demand is related to how productive labour is
and how much the product is demanded. The
elasticity of demand for labour is linked to how price elastic the demand for the product is
The wage rate will lead to movements along the supply and demand curves for
labour. All other factors will shift the curves
The demand curve for labour shows how many workers will be hired at any given
wage rate over a given period of time
o At a given wage rate, how many workers will a firm employ?
The marginal product of labour
The marginal product of labour (also known as the marginal physical product of
labour) is the additional amount of output for every additional worker that is
employed by a firm
In the short-run, it is common for units of labour (and land, i.e. materials) to be
added in the production process, whereas it is more difficult to add units of capital
As additional units of labour (i.e. workers) are added to fixed capital, the law of
diminishing returns will apply from the point where the marginal product of labour
begins to fall.- short run
We assume that the firm is in perfect competition and therefore is a wage taking
firm
o Price=MR=AR
, o Firms will determine their demand decisions for labour on the marginal
product of labour
o This explains why the curve slopes downwards after a certain point
o Additional units of labour will increase output up to a certain point, soon the
marginal product will decrease (due to one factor being fixed) however
because firms will still be experiencing an increase in output they will
continue hiring workers until the marginal revenue product= the wage rate
o If the firm hired 6 workers the revenue gained would be less than the cost
and so the 6th worker has greater costs than benefits
o I.e. when the example reaches 5 workers
o Firm= price taker= £60 in the picture
Diagram shows MRP
Marginal revenue product of labour (MRPL)
The marginal revenue product of labour is the additional revenue that is received by
the firm as a result of employing an additional worker.
MRP=MP x MR
The marginal revenue is the additional revenue earned by selling one more unit of
output. We assume also the firm operates in a perfectly competitive market, so
therefore the marginal revenue will equal the price (average revenue).
In the short run, the marginal output of workers is determined by the law of
diminishing returns
It increases at first due to specialisation and the division of labour but then it
decreases
A profit-maximising firm will produce output at a level where MC=MR. The same
principle applies in labour markets and determines how many workers a firm should
employ to maximise profits.
Given that the wage rate, i.e. the marginal cost of labour (MC L) is constant, a firm
will employ the number of workers where MRPL = MCL
o this is the point where profit max occurs
Evaluation/ criticism of MRPL
MRP tells a firm at a given wage rate how many workers they should employ and for
workers, if their MRP is at least equal to the wage rate they will get a job
In the real world this can break down because knowledge of MRP is assumed
The assumption that the MPPL (and MRP) will comply with the law of diminishing
returns is flawed because:
, o Productivity is hard or impossible to measure across different jobs in
different industries, especially in the service sector.
Working out the MRP is
very tough
E.g. teaching
o Workers often don’t work alone
but in teams where it is the output
and productivity of an individual is
hard or impossible to measure
o The self-employed pay
themselves as they please and
don’t apply the theory that they should only work when MRP=MCL
o Many labour markets are not perfectly competitive
Trade unions
Deriving an industry’s labour market demand
There is an inverse relationship between wages and quantity of workers
WHY
1. SR-> law of diminishing returns
2. LR-> Substitutability of labour and capital
The demand for labour is affected by:
o The wage rate- causes movements along the curve
o When wages go up there will be a contraction
(fall) of labour demand
o When wages decrease there will be an extension
(increase) of labour demand
Lower wage rate= more workers because
workers who have a lower MRP can easily
justify being hired at a lower wage rate
All other factors cause shifts
o Demand for products
o Productivity of labour
o Substitutes for labour
