LABOR DEMAND PROBLEM – How does an employer decide how many people to hire?

 Basic Market Assumptions:  Firms want to maximize profits  Firms use (only) Labor and capital.  The only cost of hiring labor is the hourly wage  Labor and product markets are competitive  The firm is a price taker in both the Labor and Output Markets  Additional Assumption: Capital is Fixed  We are in the Short-RUN

How does an Employer Decide on the Number of Employees to Hire?  Marginal Analysis -  (Recall from Principles of Micro) MR=MC where MR – Marginal Revenue and MC – Marginal Cost  A Stepwise Manner  Hiring the First worker, second, etc, until MR=MC

How does an Employer Decide on the Number of Employees to Hire?  Another Equivalent Method:  Hire as long as MRP >=Wage  Where MRP is the marginal value of additional workers  MRP = P*MPL where P is the output’s price  So What Determines MPL:  Not Personal Characteristics  MPL depends on Capital (K) and Technology  Diminishing Marginal Returns (Diminishing Marginal Productivity)

How does an Employer Decide on the Number of Employees to Hire? NOTICE:  is defined as profits = TR - TC Watch Repairs LTPMPLMRPTRTC π MRMC

How does an Employer Decide on the Number of Employees to Hire? Now Assume market wage is $60 per day and the (average) cost of a watch repair is $25 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC MRP = MPL * P

How does an Employer Decide on the Number of Employees to Hire? Now Assume market wage is $60 per day and the (average) cost of a watch repair is $25 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC TR = TP * P

How does an Employer Decide on the Number of Employees to Hire? Now Assume market wage is $60 per day and the (average) cost of a watch repair is $25 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC TC = TFC + TVC Where TVC = L * w TFC TVC

How does an Employer Decide on the Number of Employees to Hire? Now Assume market wage is $60 per day and the (average) cost of a watch repair is $25 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC π = TR – TC Note that π is maximized when MRP = w or MR = MC

How does an Employer Decide on the Number of Employees to Hire? Now Assume market wage is $60 per day and the (average) cost of a watch repair is $25 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC

How does an Employer Decide on the Number of Employees to Hire? Assume market wage is $60 per day and the (average) cost of a watch repair is $25 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC Maximum Profit at Hiring 4 workers

What does an Employer do when the price of Labor Decreases? Now Assume market wage is $40 per day and the (average) cost of a watch repair is $25 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC Maximum Profit at Hiring 5 workers

What does an Employer do when the price of Labor Increases? Now Assume market wage is $80 per day and the (average) cost of a watch repair is $25 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC Maximum Profit at Hiring 3 workers

How does an Employer Decide on the Number of Employees to Hire? Conclusion: As Wages Decrease the Number of Workers Hired __________. As Wages Increase the Number of Workers Hired __________. increases decreases

How does an Employer Decide on the Number of Employees to Hire? Assume market wage is $60 per day and the (average) cost of a watch repair is $25 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC Maximum Profit at Hiring 4 workers

What does an Employer do when the price of the Output Increases? Now Assume market wage is $60 per day and the (average) cost of a watch repair is $33 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC Maximum Profit at Hiring 5 workers

What does an Employer do when the price of the Output Decreases? Now Assume market wage is $60 per day and the (average) cost of a watch repair is $19 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC Maximum Profit at Hiring 3 workers

How does an Employer Decide on the Number of Employees to Hire? Conclusion: As Price of Output Decrease the Number of Workers Hired __Decreases__. As Price of Output Increase the Number of Workers Hired __Increases__.

How does an Employer Decide on the Number of Employees to Hire? Assume market wage is $60 per day and the (average) cost of a watch repair is $25 and total fixed cost is $100. Watch Repairs LTPMPLMRPTRTC π MRMC Maximum Profit at Hiring 4 workers

What does an Employer do when the Fixed Cost Decreases? Now Assume market wage is $60 per day and the (average) cost of a watch repair is $25 and total fixed cost is $80. Watch Repairs LTPMPLMRPTRTC π MRMC Maximum Profit at Hiring 4 workers

What does an Employer do when the Fixed Cost Increases? Now Assume market wage is $60 per day and the (average) cost of a watch repair is $25 and total fixed cost is $120. Watch Repairs LTPMPLMRPTRTC π MRMC Maximum Profit at Hiring 4 workers

How does an Employer Decide on the Number of Employees to Hire? Conclusion: As Fixed Cost Decreases the Number of Workers Hired __Remains Unchanged__. As Fixed Cost Increases the Number of Workers Hired __Remains Unchanged__.