Labor Demand in the Long Run

The long run

 in the long run, all inputs are variable,
 model used in discussion has 2 inputs:
L (labor) and K (capital).
 Q = f(L,K)
 isoquant - a graph that contains all of
the combinations of inputs that result in
a given level of output.
Isoquant
Isoquant
Isoquants
 Marginal rate of technical substitution
The marginal rate of technical substitution of L for K
(MRTS) is defined as the additional amount of capital
needed to replace a unit of labor, holding output constant.
Mathematically, the MRTS can also be expressed as:
Law of diminishing MRTS
 Law of diminishing
MRTS – the MRTS
declines as the level
of labor use rises
along an isoquant
(i.e., isoquant
curves are convex)
 Alternative derivation of the MRTS

Along an isoquant:

With a little manipulation:

More precisely:

Or:
 Isocost curves
TC = wL + cK
where: TC = total cost
w = wage
c = price of capital
L = quantity of labor
K = quantity of capital

In slope-intercept form, this equation becomes:

K = (-w/c)L +(TC/c)
Isocost curve
Isocost curves
Cost minimization
Cost-minimization rule
 cost minimization occurs when an isocost
curve is tangent to the isoquant
 -MRTS = -w/c
 MRTS = w/c



Substitution and scale effects
 the substitution effect associated with a
change in the wage rate is the change in the
mix of inputs that results from the change in
relative prices, holding output constant.
 the scale effect is the change in the mix of
inputs that occurs because of the change in
the level of output resulting from a change in
factor prices, holding relative factor prices
constant.
Substitution effect
Scale effect