3.5.1 Demand for Labour
Edexcel A-Level Economics (9EC0) | Theme 3.5.1
Demand for Labour as Derived Demand
The demand for labour is not wanted for its own sake, but for what labour can produce.
This means that demand for labour is derived from the demand for the goods and services that labour helps to produce.
For example, demand for builders is derived from demand for new houses.
The Marginal Revenue Product Theory
Firms base their demand for labour on the marginal revenue product (MRP) of workers.
\[ MRP = MPP \times MR \]
Marginal Physical Product (MPP): The extra output produced by one more worker.
Marginal Revenue (MR): The extra revenue gained from selling that extra output.
The MRP curve is the demand curve for labour, labelled D(L), and it slopes downward because of the law of diminishing returns.
Profit-Maximising Employment
A profit-maximising firm hires workers up to the point where:
\[ MRP = MCL \]
In a competitive labour market, the marginal cost of labour is simply the wage rate.
Therefore, the firm hires workers where:
\[ MRP = W \]
Factors That Shift the Demand for Labour Curve
Any factor that changes the MRP of labour shifts the demand curve for labour.
| Factor | Effect on Demand for Labour | Reason |
|---|---|---|
| Increase in demand for the final product | Increase, so demand shifts right | Higher product demand raises price and marginal revenue, so worker MRP rises. |
| Increase in labour productivity | Increase, so demand shifts right | Better training, technology, or management raises MPP. |
| Increase in the price of capital | Increase, so demand shifts right | Labour becomes relatively cheaper than capital, so firms substitute labour for capital. |
| Decrease in the price of capital | Decrease, so demand shifts left | Capital becomes relatively cheaper, so firms may substitute capital for labour. |
| Decrease in wages | Movement along the labour demand curve | This changes quantity demanded rather than shifting the curve itself. |
Elasticity of Demand for Labour
The elasticity of demand for labour measures how responsive the quantity of labour demanded is to a change in the wage rate.
It is influenced by several factors:
- PED of the final product: The more elastic product demand is, the more elastic labour demand will be.
- Ease of substituting labour: If capital can easily replace labour, demand is more elastic.
- Labour's share of total costs: If labour is a high proportion of total cost, demand is more elastic.
- Time period: Labour demand is more elastic in the long run because firms have more time to reorganise production.
Exam Preparation
- Define derived demand and explain marginal revenue product theory.
- Draw the downward-sloping demand for labour curve.
- Explain the profit-maximising employment condition \( MRP = W \).
- Analyse factors that shift the demand for labour curve.
- Explain the factors that affect the elasticity of demand for labour.