The Demand for Labor

The Demand For Labor This lecture develops the model of labor demand

The Demand For Labor This lecture develops the model of labor demand The next lecture develops labor supply

The Demand For Labor This lecture develops the model of labor demand The next lecture develops labor supply A third and fourth lecture apply the model to some specific issues.

Why study labor demand and supply? Factor markets are important in themselves.

Why study labor demand and supply? Factor markets are important in themselves. –We are all interested in labor markets –We are particularly interested in one aspect, human capital

Why study labor demand and supply? Factor markets are important in themselves. The theory says important things about the markets for particular commodities.

Why study labor demand and supply? Factor markets are important in themselves. The theory says important things about the markets for particular commodities. –We think of many commodities as factors of production. –An automobile is not a commodity per se, but a factor of production for transportation services.

Why study labor demand and supply? Factor markets are important in themselves. The theory says important things about the markets for particular commodities. Firms worry a great deal about this topic.

Why study labor demand and supply? Factor markets are important in themselves. The theory says important things about the markets for particular commodities. Firms worry a great deal about this topic. Many important political topics turn on an understanding of factor markets.

The Basics of Factor Demand K L Q1Q1 QoQo KoKo LoLo L2L2 L1L1 K2K2 K1K1 Production isoquants describe the relation between inputs and outputs

Two Key Propositions L abor has a positive marginal product. Labor has a diminishing marginal physical product

MPP and VMP Curves Q L MPP Q* L*

MPP and VMP Curves Q L MPP $ L VMP = MPP x P

The Short Run Demand For Labor The VMP curve is the short run labor demand curve.

The Short Run Demand For Labor The VMP curve is the short run labor demand curve. When the wage rate is w o, L o workers are demanded wowo LoLo

The Short Run Demand For Labor The VMP curve is the short run labor demand curve. When the wage rate is w o, L o workers are demanded When the wage rate is w 1, L 1 workers are demanded wowo w1w1 LoLo L1L1

Long Run Labor Demand K L QoQo LoLo KoKo

K L Q1Q1 QoQo L1L1 LoLo K1K1 KoKo

K L Q1Q1 QoQo L1L1 LoLo K1K1 KoKo Expansion Line

Long Run Labor Demand K L Q1Q1 QoQo L1L1 LoLo K1K1 KoKo Expansion Line While we would normally expect an increase in output to lead to a increased demand for both factors, that need not be the case.

The Effect of a Change in Wage Rate L K w L* Let’s see what happens when wages change. Initially the firm is employing L* workers.

The Effect of a Change in Wage Rate L K w w’ L*L** Now, the wage rate falls to w’. If the firm kept producing the same amount of output, we would substitute labor for capital.

The Effect of a Change in Wage Rate L K MC w w’ L*L** Q* But there is more to the story. What happens to MC?

The Effect of a Change in Wage Rate L K MC w w’ L*L** Q* Q** It probably moves to the right. (Note that this is a fall in MC).

The Effect of a Change in Wage Rate L K MC w w’ L*L** Q* Q** Substitution Effect Scale Effect

The Two Effects Change in Quantity of Labor Demanded = Substitution Effect + Scale Effect In general, we expect the substitution effect will dominate even if the scale effect is negative.

From Firm Demand to Market Demand w Q D1D1 wowo q1q1

w Q D1D1 wowo q1q1 q2q2 D2D2

w Q D2D2 D1D1 D m = D 1 +D 2 wowo q1q1 q2q2 q m =q 1 +q 2

Applications Short Run Labor Demand

Applications Short Run Labor Demand –A change in wage rates –A change in the price of the product

Applications Short Run Labor Demand –A change in wage rates –A change in the price of the product Long Run Labor Demand

Applications Short Run Labor Demand –A change in wage rates –A change in the price of the product Long Run Labor Demand –A change in wage rates –A change in the price of the product

A Change in the Wage Rate- Short Run Labor Demand When the wage rate is w o, L o workers are demanded. wowo LoLo

A Change in the Wage Rate- Short Run Labor Demand When the wage rate is w o, L o workers are demanded. When the wage rate is w 1, L 1 workers are demanded. wowo w1w1 LoLo L1L1

A Change in the Wage Rate- Short Run Labor Demand When the wage rate is w o, L o workers are demanded When the wage rate is w 1, L 1 workers are demanded. In short, the lower the wage rate the greater the quantity of labor demanded. wowo w1w1 LoLo L1L1

A Change in the Product Price- Short Run Labor Demand When the wage rate is w 1, L 1 workers are demanded. w1w1 L1L1

A Change in the Product Price- Short Run Labor Demand When the wage rate is w 1, L 1 workers are demanded. If the price rises to P*, the VMP curve shifts up and to the right. w1w1 L1L1 VMP= MPP x P*

A Change in the Product Price- Short Run Labor Demand When the wage rate is w 1, L 1 workers are demanded. If the price rises to P*, the VMP curve shifts to the right. The quantity of labor demanded increases to L 1 * w1w1 L1*L1* L1L1 VMP= MPP x P*

A change in the Wage Rate-Long Run Labor Demand Change in Quantity of Labor Demanded = Substitution Effect + Scale Effect

A change in the Wage Rate-Long Run Labor Demand Change in Quantity of Labor Demanded = Substitution Effect + Scale Effect A fall in the wage rate means increased quantity demand via the substitution effect.

A change in the Wage Rate-Long Run Labor Demand Change in Quantity of Labor Demanded = Substitution Effect + Scale Effect A fall in the wage rate means increased quantity demand via the substitution effect. While theoretically possible that the scale effect could reverse this, it is not likely.

A Change in the Product Price- Long Run Labor Demand L K L*

A Change in the Product Price- Long Run Labor Demand L K MC L* Q P

A Change in the Product Price- Long Run Labor Demand L K MC L* Q Q* P P*

A Change in the Product Price- Long Run Labor Demand L K MC L* Q Q* P P* There is no substitution effect, but the scale effect is probably positive, so that the higher price probably leads to an increased demand.

End ©2003 Charles W. Upton