The Demand of Labor

Presented by:
Hina Shahzadi
Ph.D Economics
Session 2020-2023
Government College University
Faisalabad
 The Demand of Labor
• The demand for labor is a derived demand, in that workers are hired for the
contribution they can make toward producing some good or service for sale
• The demand for labor is influenced by wages, the employee benefits (they
qualify) for and environment (by the government)

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 Demand /Supply of Labor under Short run

DL= f(W) ----- Other factors remain constant SL= f(W) -------Other factors remain constant
Expansion and Contraction in DL Expansion and Contraction in DL

Shifting factors in DL and SL

skill levels, education, training, technology, demand of goods, price of substitute, Immigration of labor
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• Nominal wage or money wage is the money paid by an employer to labor against services. A
nominal wage is not adjusted for inflation
• Real wages are nominal wages adjusted for the effects of inflation.
• Minimum wages are the minimum amount of remuneration that an employer is required to pay
employee for the work performed during a given period which cannot be reduced by collective
agreement or an individual contract
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 Profit Maximization
• Firms or employer wants to Profit maximization constantly ( basic assumption of labor
demand theory)
• Profit = Total Revenue (TR) – Total Costs (TC).
Ist order condition:

• 2 order condition: MC cuts MR from below

nd

• Firms can make changes in output only by change in the variables inputs(L, K) that are within
its control

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Continued

• For optimal level of output, that is, MR = MC. the marginal revenue from
an added unit of output must exceed its marginal cost
• If MR > MC at those levels of output, and the firm can make higher
profits by expanding output and expand the demand for labor-
Employment of the input
• If MR < MC firm has to reduced output and reduced the demand for
labor-Employment of the input

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 Relationship between Marginal Income (Revenue) and Additional Unit of Inputs

• Adding one more unit of either labor or capital generates additional income for
the firm
• If the firm employed the two factors of production/inputs then:
• Q=f (L,K)
MPL= dQ/dL (holding K constant) MPK= dQ/dK (holding L constant)
• Firm can expand or reducing out put by increasing or decreasing the use of labor
or capital and resultantly increase or reduces a its marginal income/revenue
• Firm Marginal revenue depends upon the type of market in which it operates:
• Under P.C
• MR=AR (D)=P (Fix)
• Under Monopoly or imperfect market 7

• MR< AR (D) ( price changes)

• By combining the Marginal product of input (L) ✕ Marginal revenue we get MRPL
(Marginal Revenue Product of Labor)
• MRPL= MPL*MR
OR
• MRPL=MPL*P
Table:1
Labor Output MPL=dQ/dL Price of TR=P.Q MR=dTR/dQ MRPL=MPL* APL= Q/L
Output P
0 0 ---- 5 0 -- --- 0
1 12 12 5 60 5 60 12
2 22 10 5 110 5 50 11
3 30 8 5 150 5 40 10
4 36 6 5 180 5 30 9
5 40 4 5 200 5 20 8
6 42 2 5 210 5 10 7
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 Marginal Expense/Cost of an Addition unit of input
• The Total cost faced by firm to produce output by employed factor of production (L, K) then:
•TC =f (Q)
•TC=TFC+TVC
•TFC= cost of fixed inputs (K – interest (r))
•TVC= cost of variable inputs (L- wages (w))
•MC =dTC/dQ

• Changing the levels of labor or capital employed will add to or subtract from the firm’s total costs
• The marginal expense of labor (MEL) that is cost incurred by hiring more labor from a
competitive labor market and has no control over the wages, then MEL:
• MEL= wage rate
• Wage rate= DL=SL-----market wage
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 Short-run Demand For Labor When Both Product And Labor Market Are
Competitive

• A period when one input can vary like L in production process only and other inputs
cannot vary like capital is called Short-Run. This time period vary from firm to firm (3
months- to time)
• Firm only needs to decide whether to alter its output level by adjusting employment level-
Demand for labor
• Refer to Table 1: MPL follows diminishing Marginal Productivity Laws
• MPL> APL ( output rises by employing Labor and MPL is positive)
• MPL=APL (output max by employing labor and MPL=0)
• MPL< APL (output falls by employing labor and MPL =-ve)

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 Continued

• If output increases as labor is added, labor’s marginal product is positive

• With the increase in labor the marginal product of labor decreases according to
the law of diminishing marginal returns

• Diminishing marginal returns say that as employment expands, each additional

worker has a progressively smaller share of the capital stock to work with;
therefore, labor’s marginal product decreases

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 From Profit Maximization to labor demand
• The firm should keep increasing its demand for labor or employment level
when labor’s marginal revenue product exceeds its marginal expense
MRPL (MPL*P)>MEL (wages)
• Firms Profits are maximized only when employment is such that any further
one-unit change in labor would have a marginal revenue product equal to
marginal expense
MRPL = MEL ….. eq (1)

By putting the value of MRPL and MEL in eq (1)

MPL ✕ P = W
By dividing “P” B.S
MPL = W/P ….. Eq (2)
MPL= Marginal product of labor
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W/P= Real Wage
 Labor Demand In terms of real wages
Given any real wage, the firm should thus employ/demand for labor to the point at which MPL just equals
the real wage
MPL = W/P (MEL)
MRPL=MPPL*P
MRPL=W
• The firm’s demand for labor in the short run is equivalent to the downward-sloping segment of its MPL
• To maximize profits, given any real wage rate, a firm should stop employing labor at the point at which
any additional labor would cost more than it would produce

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Fig 3.1
Relationship between Real
wage and
employment/demand for
labor
Fig 3.2
Nominal wage and
employment or demand for
labor 14
 Market Demand Curves

• The demand curve for an individual firm

indicates how much labor that firm will want to
employ at each wage level
• When the real wage falls, the number of workers
that existing firms want to employ increases
• The lower real wage may make it profitable for
new firms to enter the market
• When the real wage increases, the number of
workers that existing firms want to employ
decreases, and some firms may be forced to
cease operations completely
• Marginal Product played a vital role in to explore
the demand for input-Labor
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 Labor Demand in Competitive Market when other inputs can be varied
(long-run)

• To maximize profits in the long run, the firm must adjust both labor and
capital so that the marginal revenue product of each equals its
marginal expense
MPL ✕ P = MEL=W
MPK ✕ P = MEK=C (the profit-maximizing condition
for capital)
• To maximize profits, the firm must adjust its labor and capital inputs so
that the marginal cost of producing an added unit of output using labor
is equal to the marginal cost of producing an added unit of output using
capital:
W/MPL =C/MPK 16
Continued
• To maximize profits, a firm must be producing its chosen level of output in
the least-cost manner
• If the firm can expand output more cheaply using one input than the other, it
cannot be producing in the least-cost way
• If a firm to be maximizing profits, it must be operating at the point such that
further marginal changes in both labor and capital would neither lower costs
nor add to profits
• If the wage rate rise , the demand for labor in the long run will decrease and
employment will reduced and output will reduced (Scale Effect)
• To rise MPL the cuts in L and reduced employment (Fig 3.1)
• Further, the W> MPL and MPK>C , use of K in place of L (Substitution Effect) 17
Continued

The increase in Wages will cause the firm to reduce its desired employment level for
two reasons
1. The firm’s profit-maximizing level of output will change (reduce) and the
reduction in required inputs (both capital and labor) is an example of the scale
effect
2. The rise in Wages also causes the firm to substitute capital for labor so that it can
again produce in the least-cost manner, which is substitution effect
3. If S.C > S.E (Both L and K are gross complementary inputs)
4. If S.E> SC (both L and K are gross substitute inputs)
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 Labor demand when the product market is not competitive

• The profit-maximizing of is:

MR=MC (Ist order condition or Necessary Condition)
Slope of MR < Slope of MC (2nd order condition or Sufficient Condition)

• MRPL=MEL
• MRPL=MR.MPL (under monopoly MR not equal to Price rather MR<P)
• MR.MPL=W
• output is lower under monopoly than under competition, so the level of employment
ambiguous ( rise and fall both can happen)
• The wage rates that monopolies pay, however, are not necessarily different from
competitive levels even though employment levels are.
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 Payroll taxes and its effects on Labor Demand

• Governments widely finance certain social programs through taxes that require
employers to remit payments based on their total pay-roll costs
• Increased payroll taxes levied on the employer raise the cost of hiring labor
• Increased payroll taxes can be expected to reduce the demand for labor

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Fig 3.4 depicts that At point G D0=S0 and wage is OW0. At point F
wages received by labor is Wo-X ( payroll Tax)
At point C wages firm paid is Wo+X (payroll Tax)
DL shifted to Do to D1 due to taxes and employment reduces E0 to
E2
CAG Tax burden shared by employer
AF GTax burden shared by employees

Fig 3.5 depicts that SL is vertical

At point C D0=So DL wage is OW0 and employment level is
Eo
After pay roll tax , tax burden shift to employees wages
received by labor is Wo-X . At point F where D1 =S0 and
employment Level not reduced it remains at E0

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 Who bears the burden of a payroll tax
• Payroll taxes require employers to pay the government a certain percentage of
their employees’ earnings, often up to some maximum amount
• Employees bear a burden in the form of lower wage rates and lower
employment levels
• Employees are not exempted from bearing costs, when the government
chooses to generate revenues through a payroll tax on employers
• Most of a payroll tax is shifted to wages, with little long-run effect on
employment

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 Wage subsidies effects on Labor Demand

• Governments widely finance certain social programs through subsidize the

wages paid by employers, the demand for labor would increase

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 Employment subsidies
• Payroll subsidies to employers can take many forms Like Targeted Job
Tax Credit Program (TJTC)
• They can be in the form of cash payments or tax credits to employers by
reducing the cost of hiring labor
• Subsidies can be either general or selective
• A general subsidy is not conditional on the characteristics of the people
hired
• Selective plan makes the subsidy conditional on hiring people from
certain target groups-skilled labor/age

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 Suggest to read Appendix

• Production function with two inputs L and K---IQ

• Demand for inputs (L, K)
• Cost Minimization
• Scale Effect and Substitution Effect

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Thanks

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