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ECON 152 – PRINCIPLES OF MICROECONOMICS
Chapter 29: Labor
Demand and Supply
Materials include content from Pearson Addison-Wesley which has been modified
by the instructor and displayed with permission of the publisher. All rights reserved.

The principles we have used to explain the
output markets in which goods are sold will
also describe the labor and other input
markets where inputs are bought.

Profit-maximizing firms will hire labor up to
the point where the marginal benefit (MRP)
equals the marginal cost (MFC).
2
Competition in the Product Market

Assumptions
 Each
employer is one of a very large number
of employers
 Workers do not need special skills
 Workers are free to move from one employer
to another
 The firm is a price taker
3
Marginal Physical Product

Marginal Physical Product (MPP)
of Labor
 The
change in output resulting from the addition of
one more worker
 The change in total output accounted for by hiring the
worker, holding all other factors of production
constant

MPP eventually declines because of the law of
diminishing returns
4
Marginal Physical Product

Marginal Revenue Product (MRP)
 The
marginal physical product (MPP) times
the marginal revenue
 The additional revenue obtained from a oneunit change in labor input
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Marginal Revenue Product
Labor Input
Total
Physical
Product
(TPP)
6
882
7
1,000
8
1,111
9
1,215
10
1,312
11
1,402
12
1,485
13
1,561
Marginal
Physical Product
(MPP)
Marginal
Revenue Product
(MRP) (MR = $10)
118
$1,180
111
$1,110
104
$1,040
97
$970
90
$900
83
$830
76
$760
Observations
• MPP declines
• MRP = MP x MR
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Marginal Physical Product

Marginal Factor Cost (MFC)
 The
cost of using an additional unit of an input
change in total cost
Marginal factor cost =
change in amount of resources used
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Marginal Physical Product

In a perfectly competitive labor market:
 The
market determines the wage
 The individual employer is a wage taker
 All workers are hired for the same wage
 MFC = wage
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Marginal Revenue Product

The MRP curve: demand for labor
 The
MRP curve is the demand curve for labor
for the firm.
 This tells us how many workers will be hired
at various possible wage rates.
 The firm will hire any worker who can
contribute to revenues by more than they
contribute to costs.
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Marginal Physical Product

General rule for hiring
 The
firm hires workers up to the point at which
the additional cost associated with hiring the
last worker is equal to the additional revenue
generated by that worker.
MRP = MFC
10
Derived Demand

Derived Demand
 The
factors of production are needed to
manufacture a final good or to provide a final
service.
 Thus, the demand for labor is influenced by
demand for the final product.
11
Demand for Labor—
a Derived Demand
The firm produces CDs
• MRP0 when price of CDs is P0
• MRP1 when price of CDs is P1
• MRP2 when price of CDs is P2
• MRP0: MRP = MFC at 12 workers
• MRP1: MRP = MFC at 10 workers
• MRP2: MRP = MFC at 15 workers
P1 reflects the effect
of a lower product
price.
P2 reflects the effect
of a higher product
price.
Figure 29-2
12
The Market Demand for Labor
The quantity of labor demanded for a
particular type of labor in each industry will
vary as the wage rate changes.
 The market demand for labor will generally
be less elastic than the demand exhibited
by one firm.

13
Derivation of the Market Demand
for Labor with Drop in Wage Rate
Wage Rate per Hour ($)
Firm
20
Market (200 firms)
a
A
Increased supply
leads to reduced
market price, so
MRP shifts inward.
10
b
B
MRP0 = d0
D
MRP1 = d1
0
Figure 29-3
10
15
22
Quantity of Labor
per Time Period
0
2,000 3,000
Quantity of Labor
per Time Period
14
Determinants
of Demand Elasticity for Inputs

The price elasticity of demand for a variable
input will be greater




The greater the price elasticity of demand for the
final product
The easier it is for a particular variable input to be
substituted for by other inputs
The larger the proportion of total costs accounted
for by a particular variable input
The longer the time period being considered
15
Wage Determination
The demand for labor curve has been
determined.
 Now add an analysis of labor supply.
 We can derive the equilibrium wage rate
that workers earn in an industry.

16
The Equilibrium Wage
Rate and the CD Industry
Figure 29-4
17
Wage Determination

Shifts in the market demand for labor will
alter the equilibrium wage rate:
 Change
in demand for the final product
 Change in labor productivity
 Change in the price of related inputs
18
Wage Determination

Shifts in labor supply will alter the
equilibrium wage rate:
 Change
in wages in other industries
 Changes in working conditions
 Job flexibility
19
Labor Outsourcing,
Wages, and Employment

Outsourcing:
A
firm’s employment of labor outside the
country in which the firm is located.
 Some U.S.-based companies outsource labor
to other countries.
 Some firms based around the globe
outsource labor to the U.S.
20
Labor Outsourcing,
Wages, and Employment

How are U.S. workers affected?
 If
cheaper labor is available in other countries,
this will dampen the demand for U.S. labor.
 But as the volume of global commerce rises,
there may be more of a demand by foreign firms
to hire U.S. workers as well.
Instructor Note: Observe the timing of the chain of events.
21
Labor Outsourcing,
Wages, and Employment

The long-term effects:
 Labor
outsourcing enhances trade, which
allows for more specialization.
 If goods are produced and services are
performed in those countries where the
opportunity costs are lowest, then global
economic growth is enhanced.
22
Labor Outsourcing,
Wages, and Employment

Benefits for U.S. workers:
 To
the extent that firms can outsource their
labor needs, they will operate more efficiently.
 This means that the products they sell have
lower prices.
 In turn, each dollar in a worker’s paycheck
has a greater purchasing power.
23
Monopoly in the Product Market

Constructing the monopolist’s input
demand curve
 In
reconstructing the demand schedule for an
input, we must recognize that:
The marginal physical products falls because of
the law of diminishing returns as more workers
are added.
 The price (and marginal revenue) received for the
product sold also falls as more is produced and
sold.

24
A Monopolist’s
Marginal Revenue Product
Figure 29-7, Panel (a)
25
A Monopolist’s
Marginal Revenue Product
Figure 29-7, Panel (b)
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Monopoly in the Product Market

Why does the monopolist hire fewer
workers?
 The
marginal benefit to the monopolist of
hiring an additional worker is affected by the
fact that the selling price of the product will
decline as output is expanded.
27
Other Factors of Production

Profit maximization revisited
 MRP
of labor = price of labor (wage)
 MRP of land = price of land (rent)
 MRP of capital = price of capital (cost per unit
of service)
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Other Factors of Production

Cost minimization
 To
minimize total costs for a particular rate of
production, the firm will hire factors of
production up to the point at which the
marginal physical product per last dollar spent
on each factor is equalized.
29
Other Factors of Production

Cost minimization
MPP of labor
MPP of capital
MPP of land
=
=
price of labor
price of capital
price of land
30
ECON 152 – PRINCIPLES OF MICROECONOMICS
Chapter 29: Labor
Demand and Supply
Materials include content from Pearson Addison-Wesley which has been modified
by the instructor and displayed with permission of the publisher. All rights reserved.