The Demand for Labour
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The demand for labour is influenced by its function as a factor of production.
Firms will demand more labour if demand for the products they produce rises.
Marginal Productivity Theory seeks to explain what determines the number of
workers a firm employs.
A change in the wage rate will have an impact on the demand for labour.
Elasticity of demand for labour measures the extent to which demand for workers
responds to a change in the wage rate.
Demand for labour is a derived demand – that is, it is not wanted for its own
sake, but for what it can produce.
The aggregate (total) demand for labour depends mainly on the level of economic activity
(stage of the economic cycle). If the economy is growing (a boom, where real GDP rises
from year to year) and firms are optimistic that the economy will continue to grow in the
future, then employment is likely to rise and more workers will be taken on by firms.
However, if output is declining (a recession) and firms are pessimistic about future
levels of A.D, then employment is likely to fall.
How many workers a firm seeks to employ is influenced by a number of factors :
1)
2)
3)
4)
5)
Marginal Productivity Theory
This theory suggests that demand for any factor of production depends on its
marginal revenue product (MRP) and that THE QUANTITY OF ANY FACTOR
EMPLOYED WILL BE DETERMINED BY WHERE THE MARGINAL COST OF
EMPLOYING ONE MORE UNIT OF THE FACTOR EQUALS THE MARGINAL
REVENUE PRODUCT OF THAT FACTOR.
The marginal cost of labour – the cost of employing one more worker (ie the wage
rate).
The marginal product of labour – this is the change in total output which results from
employing one more worker.
The marginal revenue product of labour – this is the change in a firm’s revenue
resulting from employing one more worker. It is found by multiplying marginal product by
marginal revenue (price).
Consider the table below :
Number of
workers
1
2
3
4
5
6
Total output
(units)
20
80
160
220
260
280
Marginal
product
20
60
80
60
40
20
Marginal
revenue (price)
£10
£10
£10
£10
£10
£10
Marginal
revenue product
£200
£600
£800
£600
£400
£200
Total
revenue
£200
£800
£1600
£2200
£2600
£2800
Let us assume that the wage rate is constant at £400 per worker. This table predicts
that the firm will employ
workers, since this is where the marginal cost of labour =
MRP. At this level of employment, the total cost of workers will be
This level of employment is the one where the gap between total revenue and total cost
of labour is the greatest. In other words,
The marginal revenue product of labour curve is basically the demand curve for
labour and it shows the quantity of labour demanded at each wage rate, as shown
below :
The MRP (and hence the demand curve) for labour will shift out to the right if the
marginal product of labour and/or the marginal revenue increase, as shown below :
In practice it can be difficult to measure MRP because :
a)
b)
The elasticity of demand for labour
While a change in marginal productivity or marginal revenue will shift the demand curve
for labour, a change in the wage rate will cause a movement along the demand curve
for labour. The extent to which demand will contract or extend as a result of a change
in the wage rate is measured by the elasticity of demand for labour. The formula is :
For example : if the wage rate in a particular industry rises from £5 per hour to £6 per
hour and the demand for labour falls from 80,000 workers to 70,000 workers, what is
the elasticity of demand for labour ?
There are a number of factors which influence the elasticity of demand for labour.
These include :
1) The price elasticity of demand for the product produced.
2) The proportion of wage costs in total costs.
3) The ease with which labour can be substituted by other factors.
4) The elasticity of supply of complementary factors.
5) The time period.