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Chapter 29
Labor Demand
and Supply
Introduction
When the trucking industry experienced an
expansion at the end of the 2001 recession,
there were expectations of more employment
and higher wages for truck drivers.
The labor market outcome was also affected
by federal regulations governing the number
of hours drivers could spend on the road.
Slide 29-2
Learning Objectives
 Understand why a firm’s marginal
revenue product curve is its demand
for labor curve
 Explain in what sense the demand for
labor is a “derived” demand
 Identify the key factors influencing the
elasticity of demand for inputs
Slide 29-3
Learning Objectives
 Describe how equilibrium wage rates are
determined for perfectly competitive firms
 Explain what labor outsourcing is and how it
will affect U.S. workers’ earnings and
employment prospects
 Contrast the demand for labor and wage
determination by a product market
monopolist with outcomes that would arise
under perfect competition
Slide 29-4
Chapter Outline
 Marginal Physical Product
 Derived Demand
 The Market Demand for Labor
 Determinants of Demand Elasticity
for Inputs
Slide 29-5
Chapter Outline
 Wage Determination
 Labor Outsourcing, Wages, and
Employment
Slide 29-6
Chapter Outline
 Monopoly in the Product Market
 Other Factors of Production
Slide 29-7
Did You Know That...
 The principles we have used to explain
the market in which goods are sold will
also describe the labor market?
 Profit-maximizing firms will hire labor
up to the point where the marginal
benefit equals the marginal cost?
Slide 29-8
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
Slide 29-9
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
Slide 29-10
Marginal Physical Product
 Marginal Revenue Product (MRP)
– The marginal physical product (MPP)
times the marginal revenue
– The additional revenue obtained from a
one-unit change in labor input
Slide 29-11
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
Slide 29-12
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
Slide 29-13
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
Slide 29-14
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.
Slide 29-15
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.
Slide 29-16
International Example:
Confusing MPP and MRP
 Violinists in the Beethoven Orchestra
in Germany filed a lawsuit in 2004
asking for higher wages.
 Their rationale was that they play more
notes than do woodwind and brass
players.
Slide 29-17
International Example:
Confusing MPP and MRP
 Responding to the lawsuit, orchestra
managers pointed out that violinists do
indeed have a higher marginal physical
product (more notes) than do oboe and
French horn soloists.
 But the marginal revenue product of
the soloists is probably higher.
Slide 29-18
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.
Slide 29-19
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
Figure 29-2
Slide 29-20
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.
Slide 29-21
Derivation of the Market Demand
for Labor
Wage Rate per Hour ($)
Firm
20
10
Wage rate of $20
• firms will hire
2000 workers
Market (200 firms)
a
A
b
c
MRP0 = d0
MRP1 = d1
0
10
15
22
Quantity of Labor
per Time Period
0
2000
Quantity of Labor
per Time Period
Slide 29-22
Derivation of the Market Demand
for Labor
Wage Rate per Hour ($)
Firm
20
10
Market (200 firms)
a
A
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
Slide 29-23
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
Slide 29-24
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.
Slide 29-25
The Equilibrium Wage
Rate and the CD Industry
Figure 29-4
Slide 29-26
International Example: How Long Does
it Take to Earn a Big Mac?
 One way to make an international
wage comparison is to see how long it
takes the average worker in various
countries to earn enough to purchase a
standardized item.
 In the U.S., the typical worker can earn
a Big Mac sandwich in 9 minutes.
Slide 29-27
International Example: How Long Does
it Take to Earn a Big Mac?
 In Nigeria, the earnings necessary to
purchase a Big Mac require an hour for
the typical worker.
 This time cost for the same sandwich
is 2 hours in Pakistan and 3 hours in
Kenya.
Slide 29-28
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
Slide 29-29
Wage Determination
 Shifts in labor supply will alter the
equilibrium wage rate:
– Change in wages in other industries
– Changes in working conditions
– Job flexibility
Slide 29-30
International Example: Manufacturing
Jobs Disappear Worldwide
 Though many U.S. manufacturing jobs
have disappeared since 1995, it is not
consistent with the data to conclude
that those jobs have been relocated
overseas.
 Manufacturing employment has
declined in nearly all countries.
Slide 29-31
International Example: Manufacturing
Jobs Disappear Worldwide
 The correct interpretation is that
technological improvements have
lessened the amount of labor input
needed in industrial production.
 The labor resources liberated from the
manufacturing process are now used
in telecommunications, software
design, and other endeavors.
Slide 29-32
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.
Slide 29-33
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.
Slide 29-34
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.
Slide 29-35
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.
Slide 29-36
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.
Slide 29-37
A Monopolist’s
Marginal Revenue Product
Figure 29-7, Panel (a)
Slide 29-38
A Monopolist’s
Marginal Revenue Product
Figure 29-7, Panel (b)
Slide 29-39
Monopoly in the Product Market
 What do you think?
– 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 her
product will decline as she expands
output.
Slide 29-40
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)
Slide 29-41
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.
Slide 29-42
Other Factors of Production
 Cost minimization
MPP of labor
MPP of capital
MPP of land
=
=
price of labor
price of capital
price of land
Slide 29-43
Issues and Applications: How
A Federal Labor Rule Affected Wages
 A new 2003 U.S. regulation limited the
number of daily hours truckers could be on
the road.
 This had the effect of shifting the labor
supply curve to the left.
 At the same time, the demand for trucking
services was increasing due to a nationwide
economic recovery.
Slide 29-44
Issues and Applications: How
A Federal Labor Rule Affected Wages
 As is shown on the graph on the next
slide, both the increased demand and
the decreased supply for truck drivers
had the effect of raising the equilibrium
wage.
Slide 29-45
Issues and Applications: How
A Federal Labor Rule Affected Wages
Figure 29-8
Slide 29-46
Summary Discussion
of Learning Objectives
 Why a firm’s marginal revenue product curve
is its labor demand curve
– In competitive markets, firms hire labor to the
point at which the wage equals MRP.
 The demand for labor as a “derived demand”
– The demand for labor by perfectly competitive
firms is derived from the demand for the final
products they produce.
Slide 29-47
Summary Discussion
of Learning Objectives
 Key factors affecting the elasticity of
demand for inputs
– Price elasticity of demand for the final
product
– Ease of substitution of other inputs
– Proportion of total costs
– Time period
Slide 29-48
Summary Discussion
of Learning Objectives
 How equilibrium wage rates at perfectly
competitive firms are determined
– The wage at which the quantity of labor supplied
by all workers equals the quantity of labor
demanded by all firms
 U. S. wage and employment effects of labor
outsourcing
– Decreased demand for U. S. workers when
cheaper labor is available overseas
– Increased demand for some U. S. labor
Slide 29-49
Summary Discussion
of Learning Objectives
 Contrasting the demand for labor and wage
determination under monopoly with outcomes
under perfect competition
– A monopolist’s labor demand curve is to the left of
that of a perfectly competitive industry
– Marginal revenue for a monopolist is less than
price
– Fewer workers are employed by the monopolist
Slide 29-50
End of
Chapter 29
Labor Demand
and Supply