Demand for Labour

Introduction
The market for labour in an economy will consist of all those people who are willing
and able to supply themselves for work and all those firms will and able to demand
their employment. There can be many different markets for labour within an
economy. They can be local, national or even international (if people are willing and
able to travel overseas to find work, e.g. the labour market for Indians and Philipinos
in the Middle East). Labour markets will also exist for every different occupation or
type of skill, e.g. the market for IT consultants, bricklayers, civil engineers etc.
Within each labour market the wage paid to workers will be determined by the forces
of labour demand and supply.

Derived demand
The demand for labour is unlike the demand for other goods and services. Consumers
demand food, clothing and other goods for the satisfaction that consuming these
goods brings. However, firms do not demand labour for the same reasons. Labour,
unlike a car or a gadget, is not wanted for itself, but is demanded to make the goods
and services that consumers want. If consumers demand more goods and services,
more labour is demanded to produces these and vice-versa. Hence the demand for
labour is known as a derived demand.

Downward sloping demand curve

Firms need workers to produce goods and services. The demand curve for labour
shows how many workers will be hired at any given wage rate over a particular time
period. A firm might want to hire 100 workers if the wage rate was £2/hr but only
say 60 workers if the rate was £4/hr. Economic theory suggests that the higher the
price of labour (the wage rate), the less labour (workers) firms will hire.

Quantity of labour demanded depends on the wage rate

Each extra worker employed in a firm will increase the value of total output
produced. (although there is a situation where diseconomies of scale kicks in. It can
get to a stage where the extra worker actually detracts from the production process
and the value of the total output decreases).

Let us look at the example of a firm producing table lamps. If we start off with one
worker, say producing an output of 50 units, with each lamp selling for £5. Another
worker added produces a total of 120 units (through specialisation). If a third worker
is added, the total output rises to 220. This can be shown in the table below.

1
No. of workers Firm’s Total Extra output Selling price of Value of extra
weekly output per worker per lamp (£) output (price x
week (Marginal quantity) - £
Physical Product) (Marginal Revenue
Product)
1 8 0 5 0
2 20 12 5 60
3 44 24 5 120
4 78 34 5 170
5 108 30 5 150
6 128 20 5 100
7 138 10 5 50
8 138 0 5 0
9 128 - 10 5 - 50

This can be plotted on a graph with MRP up the y axis and number of workers on the
x axis.

2
At present the firm employs 4 workers and wants to increase output but doesn’t know
how many extra workers to employ. The above table shows that employing a fifth
worker would add 30 lamps to the total output. When these extra lamps are sold, the
firm’s revenue would rise by £150 per week. If the wage rate was fixed at £100 per
week, it is worth employing that worker as well as a sixth worker. If the firm
attempted to employ a seventh worker, they would gain £50 in extra output but lose
£100 in wage costs and profits would fall by £50.

What we have then constructed is the individual firm’s marginal revenue product
curve for labour. This is the same as the firm’s demand curve for labour. Clearly,
the only way to increase the quantity of labour demanded by the firm is to either
raise productivity (i.e. each worker produces more per week) or to cut the wages paid
to their workers. E.g. if wages were cut to £50 per week, then the 8th worker would
be worth employing.

Common sense suggests that if the firm cuts the wages they will be able to increase
their demand for labour and if wages rise, then they will contract their demand for
workers (this was the fear that firms had prior to the introduction of the minimum
wage, which was artificially forcing up the wages for the lowest paid workers –
meaning that the firms would not be able to keep as many workers).

Also, as technology improves, the demand for certain types of labour falls while the
demand for other types of labour rises. E.g., the introduction of word processors has
reduced the demand for typists, and at the same time, has increased the demand for
IT engineers.

As wages rise and workers become more expensive, employers will replace labour with
machines. This substitution of capital for labour can be seen in many industries where
much of the work is done by machinery.

The shaded area above the wage line and below the MRP curve would be the money
the business would get back over and above the cost of employing the workers.

Shifts in the demand curve

If demand for the product increased and the price the firm received for the product
increased to say £7, then this would have the following effect:

3
No. of workers Firm’s Total Extra output Selling price of Value of extra
weekly output per worker per lamp (£) output (price x
week (Marginal quantity) - £
Physical Product) (Marginal Revenue
Product)
1 8 0 7 0
2 20 12 7 84
3 44 24 7 168
4 78 34 7 238
5 108 30 7 210
6 128 20 7 140
7 138 10 7 70
8 138 0 7 0
9 128 - 10 7 - 70

Therefore the demand curve would shift outwards to MRP1. The same thing would
happen if the production process improved and became more efficient, through
either re-designing the job and/or the introduction of new technology.

If demand for the product dropped resulting in a reduction in the price the firm
received for the lamp, this would result in the MRP shifting inwards.