Download Change in Quantity of Labor Demanded = Substitution Effect + Scale

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
Production isoquants describe
the relation between inputs and
outputs
Ko
K2
Q1
K1
Qo
Lo
L2
L1
L
Two Key Propositions
K
Ko
K2
Q1
K1
Qo
Lo
L2
L1
L
• Labor has a
positive
marginal
product.
• Labor has a
diminishing
marginal
physical product
MPP and VMP Curves
Q
Q*
MPP
L
L*
MPP and VMP Curves
Q
$
VMP = MPP x P
MPP
L
L
The Short Run Demand
For Labor
• The VMP curve is
the short run
labor demand
curve.
$
VMP = MPP x P
L
The Short Run Demand
For Labor
• The VMP curve is
the short run
labor demand
curve.
• When the wage
rate is wo, Lo
workers are
demanded
$
VMP = MPP x P
wo
L
Lo
The Short Run Demand
For Labor
$
• The VMP curve is
the short run labor
demand curve.
• When the wage rate wo
is wo, Lo workers are w
1
demanded
• When the wage rate
is w1, L1 workers are
demanded
VMP = MPP x P
L
Lo L1
Long Run Labor Demand
K
Ko
Qo
L
Lo
Long Run Labor Demand
K
K1
Q1
Ko
Qo
L
L1
Lo
Long Run Labor Demand
K
Expansion Line
K1
Q1
Ko
Qo
L
L1
Lo
Long Run Labor Demand
K
Expansion Line
K1
Q1
Ko
•While we would
normally expect an
increase in output to
lead to a increased
demand for both
factors, that need not
be the case.
Qo
L
L1
Lo
K
The Effect of a Change in Wage
Rate
Let’s see what happens
when wages change.
Initially the firm is
employing L* workers.
w
L*
L
K
The Effect of a Change in Wage
Rate
w
L*
Now, the wage rate
falls to w’. If the
firm kept producing
the same amount of
output, we would
substitute labor for
capital.
w’
L**
L
K
The Effect of a Change in Wage
Rate
MC
But there is
more to the
story. What
happens to MC?
w
L*
w’
L**
L
Q*
K
The Effect of a Change in Wage
Rate
MC
MC
It probably
moves to the
right. (Note
that this is a
fall in MC).
w
L*
w’
L**
L
Q*
Q**
K
The Effect of a Change in Wage
Rate
MC
MC
•Substitution Effect
•Scale Effect
w
L*
w’
L**
L
Q*
Q**
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
wo
D1
q1
Q
From Firm Demand to
Market Demand
w
wo
D1
q1
q2
D2
Q
From Firm Demand to
Market Demand
w
wo
D1
q1
q2
D2
qm=q1+q2
Dm = D1 +D2
Q
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 wo, Lo
workers are
demanded.
$
VMP = MPP x P
wo
L
Lo
A Change in the Wage Rate-Short
Run Labor Demand
• When the wage
rate is wo, Lo
workers are
demanded.
• When the wage
rate is w1, L1
workers are
demanded.
$
VMP = MPP x P
wo
w1
L
Lo L1
A Change in the Wage Rate-Short
Run Labor Demand
$
• When the wage rate
is wo, Lo workers are
demanded
• When the wage rate w
o
is w1, L1 workers are
w1
demanded.
• In short, the lower
the wage rate the
greater the quantity
of labor demanded.
VMP = MPP x P
L
Lo L1
A Change in the Product PriceShort Run Labor Demand
• When the wage
rate is w1, L1
workers are
demanded.
$
VMP = MPP x P
w1
L
L1
A Change in the Product PriceShort Run Labor Demand
• When the wage
rate is w1, L1
workers are
demanded.
• If the price rises
to P*, the VMP
curve shifts up
and to the right.
$
VMP = MPP x P
VMP= MPP x P*
w1
L
L1
A Change in the Product PriceShort Run Labor Demand
$
• When the wage rate
is w1, L1 workers are
demanded.
• If the price rises to
P*, the VMP curve
w1
shifts to the right.
• The quantity of
labor demanded
increases to L1*
VMP = MPP x P
VMP= MPP x P*
L
L1
L1*
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.
K
A Change in the Product PriceLong Run Labor Demand
L*
L
K
A Change in the Product PriceLong Run Labor Demand
MC
P
L*
L
Q
K
A Change in the Product PriceLong Run Labor Demand
MC
P*
P
L*
L
Q
Q*
K
A Change in the Product PriceLong Run Labor Demand
MC
•There is no substitution
effect, but the scale effect
is probably positive, so
that the higher price
probably leads to an
increased demand.
L*
L
P*
P
Q
Q*
End
©2003 Charles
W. Upton