Demand for Labour

Specification Coverage: Edexcel unit 3.5.1 - Demand for Labour. Students should be able to explain why demand for labour is derived demand, use marginal revenue product theory to explain the demand curve for labour, identify the profit-maximising employment condition, analyse shifts in labour demand, and explain the elasticity of demand for labour.

Demand for Labour

Demand for labour refers to the quantity of workers that firms are willing and able to employ at a given wage rate.

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.

Labour demand curve derived from marginal revenue product, sloping down as extra workers add less revenue
Figure 1: The demand for labour curve (D(L)) is derived from the marginal revenue product of labour. As more workers are hired, MPP typically falls, leading to a downward-sloping demand curve for labour.

Worked Example: Calculating Marginal Revenue Product

A firm sells its output at a constant £5 per unit, so MR is £5. Adding workers changes total output as follows:

Workers Total Output MPP MRP = MPP × MR
1 20 20 £100
2 46 26 £130
3 66 20 £100
4 78 12 £60

MPP rises to the second worker and falls after it - this is the law of diminishing returns setting in, and it is what makes the MRP curve slope downward. A firm hires an extra worker only while MRP is at least the wage, so at a wage of £80 it employs three workers: the fourth would add £60 of revenue but £80 of cost.

Factors That Shift the Demand for Labour Curve

Any factor that changes the MRP of labour shifts the demand curve for labour.

Factor Explanation
Demand for the final product An increase in demand for the final product raises the MRP of labour, shifting the demand curve to the right. This is called derived demand because labour demand is derived from the demand for the goods and services that labour helps to produce.
Price of the final product An increase in the price of the final product raises the MRP of labour, shifting the demand curve to the right.
Labour productivity An increase in labour productivity raises the MPP and therefore the MRP of labour, shifting the demand curve to the right.
Changes to the substitutability of labour If capital becomes a better substitute for labour, the demand for labour will fall, shifting the demand curve to the left.

Wage Elasticity of Demand for Labour

The wage 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.

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Six original multiple-choice questions on marginal revenue product, what shifts the demand for labour, and the wage elasticity of that demand.

Practice Questions: 3.5.1 Demand for Labour

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Two questions on Demand for Labour from the Edexcel A-Level papers, 2020–2021, 5 to 25 marks. Each one links straight to the page of the official mark scheme where its answer begins.

Past Paper Questions: 3.5.1 Demand for Labour