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Chapter Five Demand for Labour in Competitive Labour Markets Created by: Erica Morrill, M.Ed Fanshawe College © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-1 Chapter Focus Labour demand curve Short and long run Elasticity Competitiveness of Canadian labour Globalization © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-2 Demand for Labour Factors inputs of production into the production of final goods Linked to the firms demand for goods/services Derived demand © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-3 Employment Decisions – one or more factors of production cannot be varied Long-run – firm can adjust all of its inputs State of technical knowledge is assumed to be fixed Short-run © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-4 Demand for Labour The quantity of labour services the firm would employ at each wage Depends on the firms objectives and constraints Objective is to maximize profits © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-5 Firm’s Constraints Demand for product (output) Supply of labour (and other factors of production) Production function ( the maximum output given the various combinations of inputs) Fixed quantity of one or more factors of production (short run only) © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-6 Theory of Labour Demand Examines the quantity of labour the firm desires given the market-determined wage rate given the labour supply function the firm faces Assume: The firm is a perfect competitor in the labour market. © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-7 Market Behaviour A firm’s behaviour in the product market impacts demand for labour wage rate employment decisions The structure of the labour market affects supply curve - amount of labour available to the firm at various wage rates © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-8 Categorizing the Structure of Product Markets Industry Structures perfect competition monopolistic oligopoly monopoly decreasing degree of competition © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-9 Categorizing the Structure of Labour Markets Industry Structures perfect competition monopsonistic competition oligopsony monopsony decreasing degree of competition © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-10 Characteristics of Industry Structures Categories are independent of each other 16 possible combinations that affect wage and employment outcomes © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-11 Demand for Labour in the Short Run Perfect Competition Case © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-12 Production Function Firms use factors of production (labourN, capital -K) to produce Q (quantity of a single output) Q=F(K,N) In the short-run K is fixed so the production function is simply a function of N © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-13 Profit-Maximization Situation Costs fall into two categories: fixed variable Decision Rule #1 Operate as long as variable costs are covered Total revenue exceeds total variable costs © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-14 Profit-Maximization Decision Rule #2 Increase output until the additional cost associated with the last unit produced equals the additional revenue associated with that unit Marginal Costs equal Marginal Revenue MC=MR © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-15 Profit-Maximizing in Terms of Labour Demand Terminology is modified: Total Revenue Product (TRP) - the total revenue associated with the amount of an input employed Marginal Revenue Product (MRP) - the change in total revenue associated with a change in the amount of input employed © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-16 Profit-Maximizing Decisions in terms of Labour Firm should: produce as long as the total revenue product generated by the variable input exceeds the total costs associated with employing that input expand employment of labour to the point at which its marginal revenue product equals marginal cost © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-17 A Firm’s Short-Run Demand for Labour In competitive markets: price taker can hire labour without affecting market wage marginal (and average) cost is market wage hire labour until the MRP equals the W short-run labour demand curve is it’s marginal revenue product curve (for labour) © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-18 Figure 5.1 Short-Run Demand for Labour Wages higher than W1 the firm would shut down Wage Rate W1 W0 MRPN N*1 N*0 ARPN Labour Services © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-19 Short-Run Demand for Labour Firm will shut down if average cost of labour (wage rate) exceeds the average revenue product of labour Short-run labour demand curve MRPN curve below the point at which the average and marginal product curves intersect © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-20 Short-Run Labour Demand Curve Downward sloping because of diminishing marginal returns to labour in wage rate entice in demand for labour in wage rate will cause in demand for labour © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-21 Industry Structure Perfectly Competitive Company price taker can sell output without affecting market price MRQ=product price employs labour services until the value of MP of labour just equals the wage Monopoly firm is so large it influences price when the monopolist hires more labour to produce more output, both the marginal physical product of labour and the marginal revenue falls © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-22 Perfectly Competitive Firm Perfectly Competitive Company price taker sells output without affecting market price MRQ=product price Employs labour services until the value of MP of labour just equals the wage © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-23 Labour Demand in Long-Run © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-24 Isoquants “Equal quantity” Combinations of labour and capital used to produce a given amount of a product (output) Slope exhibits a diminishing marginal rate of technical substitution MRTS © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-25 Figure 5.2 Isoquants K Q1 Q0 0 N © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-26 Isocost Line All combinations of capital and labour that can be bought for a given total cost CM=rK+wN Total Cost =(price of capital x amount)+(wage rate x employees) © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-27 Figure 5.2 b Isocost K KH=CH r0 KM=CM r0 0 NM=CM W0 NH=CH N W0 © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-28 Figure 5.2 c Cost-Minimizing K K1 KM E0 K0 0 Q0 N1 N0 NM © 2002 McGraw-Hill Ryerson Ltd. N Chapter 5-29 A Firm’s Labour Demand Obtained by varying the wage rate and tracing out the new equilibrium, profit maximizing amounts of labour employed © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-30 Figure 5.3 a K Isocost Rotation from a Wage Increase Slope=-w1/r0 KP=C1 r0 Slope=-w0/r0 KM=C0 r0 E0 K0 0 N0 Q0 NP=C1 w1 NM=C0 N w0 © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-31 Profit Maximizing Output and Derived Labour Demand Figure 5.3 b K KN KM E1 E0 Q0 Q1 0 N1 NN N0 NM © 2002 McGraw-Hill Ryerson Ltd. N Chapter 5-32 Figure 5.3 c Derived Labour Demand Schedule K w1 w0 D 0 N1 N0 N © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-33 Perfect Competition wage rotates isocost line downwards with a greater slope The firm will maximize profit by moving to a lower level of output wage also shifts up the firms’s marginal and average cost curves In a perfect competitive industry each firm reduces output raising the price of the product © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-34 Figure 5.4 a Perfect Competition Price MC1 MC1 FIRM P1 P0 Q1 Q0 © 2002 McGraw-Hill Ryerson Ltd. Output Chapter 5-35 Figure 5.4 a Industry Price S1 S0 P1 P0 D q1 q0 © 2002 McGraw-Hill Ryerson Ltd. Output Chapter 5-36 Figure 5.4 a Monopoly Price MC1 MC0 P1 P0 MR q1 q0 © 2002 McGraw-Hill Ryerson Ltd. D Output Chapter 5-37 Substitution and Scale Effects of a Wage Change Figure 5.5 K KN KM ES E0 E1 Q0 Q1 0 N1 NS N0 NM © 2002 McGraw-Hill Ryerson Ltd. N Chapter 5-38 In Theory Demand schedule is downward sloping firm would substitute cheaper inputs for the more expensive labour SUBSITUTION EFFECT Firm would reduce its scale of operations because of the cost increase associated with the increase in wage SCALE EFFECT © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-39 Relationship Between the Short and Long Run Short-Run amount of capital is fixed no substitution effect Long-Run firm has flexibility by varying its capital stock response to a wage change will be larger in the long run © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-40 Elasticity of Demand for Labour Demand for labour decreases as wages increase (negative function) Wage increases have an adverse effect on employment The magnitude of the effect can be seen by the elasticity of the derived demand for labour © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-41 Elasticity of Demand Measures the responsiveness of the quantity of labour demanded to the wage rate Equals the % change in the quantity of labour demanded divided by the % change in the wage rate © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-42 Figure 5.7 a Inelastic W D 0 N © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-43 Figure 5.7 b Elastic W D 0 N © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-44 Elasticity of Demand for Labour Basic determinants of the elasticity of demand for labour: availability of substitute inputs supply of substitute inputs demand for output ratio of labour cost to total cost © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-45 Elasticity of Demand inputs can not be easily substituted elasticity of labour demand If demand for output is not effected by a price increase (due to cost of wage increase) demand for labour will be inelastic Demand for labour will be inelastic if labour cost is small portion of total cost If © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-46 End of Chapter Five © 2002 McGraw-Hill Ryerson Ltd. Chapter 5-47
