factors-influencing-the-demand-for-labour

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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

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

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

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

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

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

The price of the product being produced	The demand for the final product
If the selling price of the product increases, then the firm will be incentivised to supply more, and the firm’s demand for labour will increase The demand for labour will shift right	As demand for labour is a derived demand, when an economy is booming, demand for most goods and services will be high – and the demand for labour will be high The demand for labour curve will shift right Conversely, when an economy is in a recession, demand for most goods and services will be lower – and the demand for labour will be lower The demand for labour curve will shift left
The ability to substitute capital (machinery) for labour	The productivity of labour
Firms will constantly evaluate if it will be possible and more cost effective to switch production from using labour to capital (machinery) If it is more cost effective, then demand for labour will fall The demand for labour curve will shift left	If the productivity of labour increases (possibly through training) this will lower average costs and firms will likely demand more labour The demand for labour curve will shift right

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

Determinant	Explanation
Proportion of labour costs to total costs	The higher the proportion, the more elastic the demand for labour will be The lower the proportion, the more inelastic the demand for labour will be
Ease and cost of factor substitution	If substituting capital for labour is easy and the cost is comparable to the increase in wages, the demand for labour will be more elastic, and vice versa
PED of the final product	If the product being produced is price inelastic in demand, then the demand for labour is likely to be more inelastic If wages rise, firms will pass on the increased costs of production to the final consumers
Time period	In the short-run, demand for labour is likely to be more price inelastic An increase in wages will have a less than proportional decrease in the quantity demanded In the medium to long-term firms can research alternative methods of production & the demand for labour becomes more price elastic