6.1 The demand for labour, marginal productivity theory

the demand for labour is

derived from the demand for the product

who demands labour and who supplies it

firms demand

individuals supply

the demand curve of labour for an individual firm shows

how many workers the firm is willing to hire at a given wage rate decided by the MRP

marginal productivity theory states that

the factor payment for each factor of production is equal to the value of extra output the factor produces

what does the marginal productivity theory of labour state

firms will hire workers up to the point where marginal revenue product is equal to the wage rate

MRP =

price x Marginal Physical Product

Marginal Physical Product

the extra output ptoduced by employing one more worker

Marginal Revenue product

the value of the extra output that one more worker produces

Assumptions of marginal productivity theory

labour is homogenous

firms aim to maximise profits

there is perfect information

perfect competition in the product market → price remains constant

in the short run → one FoP is fixed → diminishing marginal returns

the causes of a shift in demand for labour

change in the price of the product → price increases → MRP increases

change in the productivity of labour → MPP increases → MRP increases

Change in demand for the final product → Labour is derived demand → a higher output is required and at a higher price

government policies → eg increasing national insurance

determinants of the elasiticity of demand for labour

capital substitutes

time (short or long run)

PED of product

labour cost share

Explain capital as a determinant of the PED of labour

the price, availability, or productivity of capital substitutes → if there are close capital substitutes and they are more productive, firms are more likely to substitute capital for workers if there is a change in wage rate → as capital becomes relatively cheaper → increased elasticity

explain time (short or long run) as a determinant of PED

if in the long run → all factors of production are variable → firms have more time to adapt → eg investing in automation or relocating production → more reponsive to changes in wage costs → more elastic

explain elasticity of demand for the final product as a fator influencing the PED of labour

if final product is inelastic → increase in price will not cause a significal reduction in demand → firms can pass on higher prices to customers to cover rising costs of labour → labour is also inelastic

explain labour cost share as a factor influencing the PED of

if labour takes up a large portion of total cost → a rise in the price of labour will cause a similar rise in price of average costs → firms are more sensitive to changes in wage rate as they have a bigger impact → more elastic

example for labour cost share as a factor influencing PED of labour

In education → teachers(labour) → make up 65% of total costs

In manufacturing → capital intensive → labour takes up a lower portion of total costs

Evaluate MRP theory

firms may be unable to calculate MRP due to imperfect info

it is difficult to measure the MPP and MRP of certain jobs eg a manager or in the service sector

effect of teamwork vs individual

perceptions can influence MRP

In the short run

How do firms decide how many workers to hire

Profit maximising firms use the concept of the margin

The will hire workers while MRP > wage

As the additionally cost of hiring another worker is less than the revenue they generate

Why is MRP downward sloping

The law of diminishing returns suggests that as successive units of labour are employed against a fixed factor, the addition to total product will rise at first but then decline.

What can be said if there is an increase in MRP

Productivity has increased → output per worker increases

Workers can demand higher wages