Demand for labour (3.5.1)

Define the term ‘Labour Demand’.

The quantity of labour that firms are willing and able to to pay for workers at a given wage rate, in a particular period of time

What is meant by Labour being a ‘derived demand’

It depends on the demand for goods/services

Explain the relationship between the demand for labour and wage rate

If the wage rate is high, it is more expensive for firms to hire more workers so the demand for labour contracts.

If the wage rate is low, labour becomes cheaper than capital which creates a substitution effect between labour and capital, so the demand for labour increases.

Explain the term ‘Marginal Revenue Product of Labour (MRP)’

The extra revenue generated when an additional worker is employed.

MRP = Marginal output × Price

Explain the term ‘Diminishing marginal productivity of labour (MRP)’

As more workers are added, each additional worker contributes less to total output. As marginal productivity declines, the marginal cost of labour increases, making it inefficient to retain extra staff . Since other factors are fixed in the short run, hiring more labour leads to diminishing returns, reducing efficiency

How does derived demand influence the demand for labour?

Derived demand: When the demand for labour is dependent on the demand for the goods/service that they produce. If there is there is an increase in the demand for goods and services, the demand for labour will increase. This is because in order to meet the increase in demand for goods/services, firms must increase their output. However, if they’re already operating at full capacity they will have to employ their factors of production, the main one being labour.

How does productivity influence the demand for labour?

The demand for labour is influenced by the worker’s marginal revenue product (MRP) which is the extra revenue generated when an additional worker is employed. Therefore, if there is an increase in worker productivity, then demand for labour will increase. This is because an increase in MRP can make it more efficient for firms to use workers to produce their good/services than it is to use capital as the average cost of labour is spread along more units of output, increasing a firms profit.

However, if workers become more productive and each can produce more goods and services, firms may reduce the demand for labour because they need fewer extra workers to produce the goods/services they need and it would be an effective way to reduce the marginal cost of labour.

How do capital costs influence the demand for labour?

If the cost of capital decreases, it is now cheaper for firms to buy capital. This creates a substitution and so firms demand for labour decreases because it is less cost effective to hire extra workers.