Some important questions

Why does a top professional footballer earn

so much more than a professor?
Why does an unskilled worker in the EU earn
more than an unskilled worker in India?
Why do market economies not manage to
provide jobs for all their citizens who want to
work?
Why are different methods of production
used in different countries?
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The demand for labour

Derived demand
the demand for a factor of production is
derived from the demand for the output
produced by that factor.

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Demand for factors in the long run

The optimum mix of capital and labour depends on
the relative prices of these factors.
This helps to explain why more labour-intensive means of
production are used in some countries where labour is
relatively abundant.

A change in the price of one factor will have both

output and substitution affects.
A rise in the wage rate leads to
substitution towards more capital-intensive techniques

but also leads to lower total output.

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The demand for labour in the short run

The marginal value product of labour is the
revenue obtained by selling the output produced
by an extra worker

W0

MVPL

Under perfect
competition, with
diminishing marginal
productivity:
the firm maximises profit
when the marginal cost
of employing an extra
worker equals the MVPL.

Employment
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The demand for labour in the short run

E
W0

MVPL

this occurs at E
where wage = MVPL.
Employment is L*.
Below L*, extra employment
adds more to revenue than
to labour costs.
Above L*, the reverse is so.
This decision is consistent
with the MR = SMC rule for
maximising profit under
perfect competition.

L* Employment
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Monopoly and monopsony power in the

labour market
A firm may have MONOPOLY power in its
output market
facing a downward-sloping demand curve
so the marginal revenue (MRPL) received from
expanding output is less than the MVPL
as the firm must reduce price to sell more.

A firm may face MONOPSONY power in its

input market
facing an upward-sloping supply curve for inputs
so the marginal cost of labour rises with
employment.
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Monopoly and monopsony power (2)

Under perfect competition,

a firm sets MVPL = W0
and employs L1 workers.
W0

MRPL
L3

MVPL

Facing a downwardsloping demand curve

for its product, the firm
sets MRPL = W0
and employs L3 workers.

L1 Employment
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Monopoly and monopsony power (3)

MCL

A monopsonist recognises
that additional employment
bids up wages for existing
workers, so MCL shows the
marginal cost of an extra
worker.

W0

MRPL

L3 L2

MVPL
L1 Employment

Facing a given goods

price, the monopsonist
sets MCL = MVPL and
employs L2 workers.

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Monopoly and monopsony power (4)

MCL

W0

MRPL

L4 L 3 L 2

MVPL

For a monopsonist who

also faces a downwardsloping demand curve
for the product, MCL
is set equal to MRPL to
employ L4 workers.
So monopoly and
monopsony power
both tend to reduce
the firms demand
for labour.

L1 Employment
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The supply of labour

The LABOUR FORCE
all individuals in work or seeking employment.

Labour supply
for an individual, the decision on how many hours
to offer to work depends on the real wage
an individuals attitude towards leisure and income
determines if more or less hours of work are
supplied at a higher real wage rate.
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The individuals supply curve of labour

SS2

SS1

For the labour supply

curve SS1, an increase
in the real wage induces
higher labour supply.
Whereas for SS2,
there comes a point
where a higher wage
induces less hours of
work to be supplied:
labour supply is
backward-bending.

Hours of work supplied

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Labour supply in aggregate

If we consider the economy as a whole, or an
industry
a higher real wage rate also encourages a
higher participation rate
so labour supply is likely to be upwardsloping.

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Labour market equilibrium for an industry

SL

DL

The industry supply curve

SLSL slopes up
higher wages are needed
to attract workers into the
industry

W0

DL

SL

For a given output demand

curve, industry demand for
labour slopes down
Equilibrium is W0, L0.

L0

Quantity
of labour
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A shift in product demand

SL

DL
D'L

Beginning in equilibrium,

a fall in demand for the

product also shifts the
derived demand for labour
to D'L

W0
W1

DL

SL

D'L
L1 L 0

The new equilibrium is

at W1, L1.

Quantity
of labour
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A change in wages in another industry

S'L
SL

DL

Again starting in equilibrium,

an increase in wages in
another industry attracts
labour,

W2
W0

so industry supply shifts

to the left

S'L

DL

SL
L 2 L0

The new equilibrium is

at W2, L2.

Quantity
of labour
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Transfer earnings and economic rent

Transfer earnings
the minimum payments required to induce a
factor of production to work in a particular job.

Economic rent
the extra payment a factor receives over and
above the transfer earnings needed to induce the
factor to supply its services in that use.

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Transfer earnings and economic rent (2)

In labour market
equilibrium at W0, L0,

Wage

W0

SS

if workers were paid only

the transfer earnings, the
industry would need only
pay AEL0 in wages.

D
A
0 A

L0

Quantity

But if all workers must be

paid the highest wage
needed to attract the
marginal worker into the
industry (W0), then workers
as a whole derive economic
rent of 0AEW0.
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