Chapter 5-1 Chapter Five Demand for Labour in Competitive Labour Markets

Chapter 5-2 Chapter Focus  Labour demand curve  Short and long run Demand for Labor  Elasticity

Chapter 5-3 Demand for Labour  Factors of production  inputs into the production of final goods  Linked to the firms demand for goods/services  Derived demand

Chapter 5-4 Employment Decisions  Short-run – one or more factors of production cannot be varied (e.g., k)  Long-run – firm can adjust all of its inputs (N and K)  State of technical knowledge is assumed to be fixed

Chapter 5-5 Demand for Labour  The quantity of labour services the firm would employ at each wage: N=N(w)  Depends on the firms objectives and constraints  Objective is to maximize profits

Chapter 5-6 Firm’s Constraints  Demand for product (output)  Supply of labour (and other factors of production)  Production function ( the maximum output given the various combinations of inputs)  Fixed quantity of one or more factors of production (short run only)

Chapter 5-7 Theory of Labour Demand  Examines the quantity of labour the firm desires  given the market-determined wage rate Assume: The firm is a perfect competitor in the labour market.

Chapter 5-8 Market Behaviour  A firm’s behaviour in the product market affects  demand for labour  wage rate  employment decisions  The structure of the labour market affects supply curve - amount of labour available to the firm at various wage rates

Chapter 5-9 Categorizing the Structure of Product Markets  Industry Structures  perfect competition  monopolistic  oligopoly  monopoly decreasing degree of competition

Chapter 5-10 Categorizing the Structure of Labour Markets  Industry Structures  perfect competition  monopsonistic competition  oligopsony  monopsony decreasing degree of competition

Chapter 5-11 Characteristics of Industry Structures  Categories are independent of each other  16 possible combinations that affect wage and employment outcomes

Chapter 5-12 Demand for Labour in the Short Run Perfect Competition Case

Chapter 5-13 Production Function  Firms use factors of production (labour- N, capital -K) to produce Q (quantity of a single output)  Q=F(K,N)  In the short-run K is fixed so the production function is simply a function of N

Chapter 5-14 Profit-Maximization Situation  Costs fall into two categories:  fixed  variable Decision Rule #1  Operate as long as variable costs are covered  Total revenue exceeds total variable costs

Chapter 5-15 Profit-Maximization Decision Rule #2  Increase output until the additional cost associated with the last unit produced equals the additional revenue associated with that unit  Marginal Costs equal Marginal Revenue, I.e., MC=MR

Chapter 5-16 Profit-Maximizing in Terms of Labour Demand  Terminology is modified:  Total Revenue Product (TRP) - the total revenue associated with the amount of an input employed  Marginal Revenue Product (MRP) - the change in total revenue associated with a change in the amount of input employed

Chapter 5-17 Profit-Maximizing Decisions in terms of Labour  Firm should:  produce as long as the total revenue product generated by the variable input exceeds the total costs associated with employing that input  expand employment of labour to the point at which its marginal revenue product equals marginal cost

Chapter 5-18 A Firm’s Short-Run Demand for Labour In competitive markets:  price taker  can hire labour without affecting market wage  marginal (and average) cost is market wage  hire labour until the MRP equals the W  short-run labour demand curve is it’s marginal revenue product curve (for labour)

Chapter 5-19 Figure 5.1 Short-Run Demand for Labour Labour Services N* 0 Wage Rate ARP N MRP N N* 1 W 1 Wages higher than W 1 the firm would shut down W0W0

Chapter 5-20 Short-Run Demand for Labour  Firm will shut down  if average cost of labour (wage rate) exceeds the average revenue product of labour  Short-run labour demand curve  MRP N curve  below the point at which the average and marginal product curves intersect

Chapter 5-21 Short-Run Labour Demand Curve  Downward sloping because of diminishing marginal returns to labour   in wage rate will cause  in demand for labour (movement along the curve)   in K will cause  in demand for labour (shift in demand curve)   in p will cause  in demand for labour (shift in demand curve)

Chapter 5-22 Industry Structure  Perfectly Competitive Company  price taker  can sell output without affecting market price  MR Q =product price  employs labour services until the value of MP of labour just equals the wage  Monopoly  firm is so large it influences price  when the monopolist hires more labour to produce more output, both the marginal physical product of labour and the marginal revenue falls

Chapter 5-23 Perfectly Competitive Firm  Perfectly Competitive Company  price taker  sells output without affecting market price  MR Q =product price  Employs labour services until the value of MP of labour just equals the wage

Chapter 5-24 Application: Proposals by Carter and Bentsen (1979)  Cartel: subsidize firms by x dollars per worker hired.  Bentsen: subsidy is given only if firms hire more workers than they did previously.  Conclusion: Bentsen’s proposal is better in terms of job creation (I.e., Nb>Nc)

Chapter 5-25 Figure: Cartel vs Bentsen w Labour w1 w1-x N1N1 Nc D W1-y, where y>x Nb

Chapter 5-26 Labour Demand in Long-Run

Chapter 5-27 Isoquants  “Equal quantity”  Combinations of labour and capital used to produce a given amount of a product (output)  Slope exhibits a diminishing marginal rate of technical substitution  MRTS

Chapter 5-28 Figure 5.2 Isoquants K N 0 Q0Q0 Q1Q1

Chapter 5-29 Isocost Line  All combinations of capital and labour that can be bought for a given total cost  C M =rK+wN  Total Cost =(price of capital * K)+(wage rate*employees)

Chapter 5-30 Figure 5.2 b Isocost N K K H =C H r 0 K M =C M r 0 Slope=-w 0 /r 0 0 N H =C H W 0 N M =C M W 0

Chapter 5-31 Figure 5.2 c Cost-Minimizing N K 0 K0K0 N1N1 N0N0 NMNM KMKM K1K1 Q0Q0 E0E0

Chapter 5-32 A Firm’s Labour Demand Obtained by varying the wage rate and tracing out the new equilibrium, profit maximizing amounts of labour employed

Chapter 5-33 Figure 5.3 a Isocost Rotation from a Wage Increase N K K P =C 1 r 0 K M =C 0 r 0 0 N M =C 0 w 0 N P =C 1 w 1 Slope=-w 0 /r 0 Slope=-w 1 /r 0 E0E0 Q0Q0 K0K0 N0N0

Chapter 5-34 Figure 5.3 b Profit Maximizing Output and Derived Labour Demand N K 0N0N0 NMNM KMKM Q0Q0 E0E0 N KNKN N1N1 E1E1 Q1Q1

Chapter 5-35 Figure 5.3 c Derived Labour Demand Schedule K N 0 D w1w1 w0w0 N1N1 N0N0

Chapter 5-36 Perfect Competition   wage rotates isocost line downwards with a greater slope  The firm will maximize profit by moving to a lower level of output   wage also shifts up the firms’s marginal and average cost curves  In a perfect competitive industry each firm reduces output raising the price of the product

Chapter 5-37 Figure 5.4 a Perfect Competition Price Output P1P1 P0P0 MC 1 MC 0 Q1Q1 Q0Q0

Chapter 5-38 Figure 5.4 a Industry Price Output P1P1 P0P0 S1S1 S0S0 q1q1 q0q0 D

Chapter 5-39 Figure 5.4 a Monopoly Price Output P1P1 P0P0 MC 1 MC 0 q1q1 q0q0 DMR

Chapter 5-40 Figure 5.5 Substitution and Scale Effects of a Wage Change N K 0NSNS N0N0 NMNM KMKM KNKN Q0Q0 E0E0 N1N1 E1E1 Q1Q1 ESES

Chapter 5-41 In Theory  Demand schedule is downward sloping  firm would substitute cheaper inputs for the more expensive labour  SUBSITUTION EFFECT  Firm would reduce its scale of operations because of the cost increase associated with the increase in wage  SCALE EFFECT

Chapter 5-42 Relationship Between the Short and Long Run  Short-Run  amount of capital is fixed  no substitution effect  Long-Run  firm has flexibility by varying its capital stock  response to a wage change will be larger in the long run

Chapter 5-43 Elasticity of Demand for Labour  Demand for labour decreases as wages increase (negative function)  Wage increases have an adverse effect on employment  The magnitude of the effect can be seen by the elasticity of the derived demand for labour

Chapter 5-44 Elasticity of Demand  Measures the responsiveness of the quantity of labour demanded to the wage rate  Equals the % change in the quantity of labour demanded divided by the % change in the wage rate

Chapter 5-45 Figure 5.7 a Inelastic W N 0 D

Chapter 5-46 Figure 5.7 b Elastic W N 0 D

Chapter 5-47 Elasticity of Demand for Labour  Basic determinants of the elasticity of demand for labour:  availability of substitute inputs  supply of substitute inputs  demand for output  ratio of labour cost to total cost

Chapter 5-48 Elasticity of Demand  If inputs can not be easily substituted  elasticity of labour demand  If demand for output is not effected by a price increase (due to cost of wage increase) demand for labour will be inelastic  Demand for labour will be inelastic if labour cost is small portion of total cost

Chapter 5-49 End of Chapter Five