Factors Influencing the Demand for Labour (AQA A Level Economics)

The Demand for Labour is a Derived Demand

• The labour market is composed of sellers of labour (households) and buyers of labour (firms)

  • Workers supply their labour, and firms demand labour
     

• The demand for labour is a derived demand

  • This means that it depends on the demand for goods and services

    • If demand for goods and services increases, then demand for labour will increase, and vice versa

    • E.g As the demand for technology devices increases, technology firms require more skilled labour to design, manufacture and market the products

Marginal Productivity Theory & the Demand for Labour

• Wage rates are determined by the contribution of labour to the firm

  • Demand for labour depends on:  

    • The Marginal Physical Product of Labour (MPP_L)

    • The Marginal Revenue Product of Labour (MRP_L)

• The Marginal Physical Product of Labour (MPP_L) is the extra output produced when an additional unit of labour is employed 

  • This is also known as law of diminishing marginal returns for labour 

  • As more workers are employed, their marginal product will eventually begin to decline

  • MPP_L = Change in total output divided by change in quantity of labour

• The Marginal Revenue Product of Labour (MRP_L) is the extra revenue earned when an additional unit of labour is employed

  • If output is sold in a perfectly competitive market, then marginal revenue is equal to price charged

  • MRP_L = MPP_L X Price

Using the MRP of Labour to make a hiring decision

• If the extra output produced when one additional labour unit is employed, is 5 units and selling price of each unit is £15

  • MRP_L = 5 x £15 = £75

• Firms will only hire an additional unit of labour if the cost of hiring is equal to or less than the wage rate

• Therefore, an extra worker needs to cost equal to or less than £75 to hire, according to marginal productivity theory of wages

The Demand Curve for Labour

• According to the Marginal Productivity theory, there is an inverse relationship between wage rate and the quantity  of labour demanded

Diagram: Market Demand Curve for Labour 

As wages rise, the quantity demanded of labour falls

Diagram analysis

• The market demand curve for labour (D_L) is the sum of all individual firms MRP_L curves 

• It shows that firms demand more labour as the wage rate decreases, which results in a downward sloping demand curve

  • If the wage rate increases (W₁ to W₂), then demand for labour falls (Q₁ to Q₂)

Factors that Shift the Demand Curve for Labour

• If the wage rate is the only factor that changes, there will be a movement along the demand curve for labour

• However, a range of factors can shift the entire demand curve for labour to the left or right

  • When the demand curve for labour shifts to the left, it indicates that fewer workers are employed at each wage rate 

  • When the demand curve for labour shifts to the right, it indicates that more workers are employed at each wage rate 

Factors that Shift the Demand for Labour

Determinants of the Elasticity of Demand for Labour

• The elasticity of demand for labour refers to how responsive a firms demand for labour is to a change in the price of labour (wage rate)

  • If the demand for labour is elastic, then an increase in the wage rate will result in a more than proportional decrease in the quantity of labour demanded by firms

  • If the demand for labour is inelastic, then an increase in the wage rate will result in a less than proportional decrease in the quantity demanded of labour demanded by firms

• If demand is elastic, firms will be very responsive to changes in wage rates, rapidly hiring workers when wages fall and firing workers when wages rise

• If demand is inelastic, firms will have a much smaller response to rising or falling wages

Factors that Influence PED of Labour