DEMAND FOR LABOR Overview � Short-run Demand for Labor � Long-run Demand for Labor � LIR 809 OVERVIEW: � Question of interest: � How do firms decide how many people to hire and what to pay them? � Demand for labor is Derived � Primary role of firm is to produce LIR 809 DEMAND FOR LABOR DEPENDS ON 3 FACTORS � COMPOSITION OF OUTPUT � What do we Make? � TECHNOLOGY (or Production Process) � How do we Make it? � LEVEL OF OUTPUT � How Much do we Make? LIR 809 1
Firms Have to take 3 Markets into Account LIR 809 PRODUCTION FUNCTION (Formal version of how, what, how much) Q = F(x 1 ,x 2 ,...L,K) or Q = G(x 1 ,x 2 ,...L 1 ,.L 2 , K 1 ,.K 2 ) Where: Q is quantity of output • x 1 ,x 2 are intermediate inputs or raw materials • L is labor • K is capital LIR 809 EXAMPLE: PRODUCING A SUMMER DINNER PARTY � BASE CASE : SALAD FOR 4 � NEW LEVEL OF OUTPUT : SALAD FOR 24 � Intermediate inputs: � Intermediate inputs: � 1 head of lettuce, 2 tomatoes, 1 onion, � 6 heads of lettuce, stuff for 1/2 cu. 12 tomatoes, 2 mayonnaise onions, stuff for 1 1/2 cu. mayonnaise � Capital: � Capital: � Cutting Board, knife, bowl, wire whisk � Cutting Board, knife, bowl, wire whisk � Labor: � Labor: � 1 Person hour � 4 person hours LIR 809 2
EXAMPLE, CONT. � CHANGE IN � CHANGE IN TECHNOLOGY : SALAD COMPOSITION OF FOR 24 OUTPUT : PIG ROAST FOR 24 � Intermediate inputs: � Intermediate inputs: � 6 heads of lettuce, 12 tomatoes, 2 � 1 pig, firewood, 1 onions, stuff to make apple 1 1/2 cu. mayonnaise � Capital: Shovel, spit � Capital: 1 Cuisinart � Labor: 6 person hours � Labor: 1 person hour LIR 809 ASSUMPTIONS OF SIMPLE MODEL OF LABOR DEMAND 1. Employers want to maximize Profits 2. Two factors of production: Capital & Labor: Q = f(L,K) 3. Labor is homogeneous 4. Hourly wage only cost of labor 5. Both labor market and product market are competitive. LIR 809 II. SHORT-RUN DEMAND FOR LABOR � Major Distinction between long and short run. In short run: � Firm can only vary labor to change output � Technology is fixed � Product price does not change LIR 809 3
THE FIRM’S PROBLEM: HOW MANY WORKERS TO HIRE? � Firm’s Problem: Needs labor to produce output & needs decision rule to determine how much labor to use � Answer based on Marginal Productivity Theory of Labor: � Answer: Hire additional workers as long as each one adds to firm’s profits LIR 809 SOME DEFINITIONS � MARGINAL PRODUCT OF LABOR (MP L ) � Additional output produced with one additional unit of labor � MARGINAL REVENUE (MR) � Additional revenue generated by selling one additional unit (= product price in competitive economy) � MARGINAL REVENUE PRODUCT OF LABOR (MRP L ) � Extra revenue generated by selling one additional unit that can be attributed to labor � MRP L = (MP L ) * MR � MARGINAL COST OF LABOR � Cost of hiring 1 additional unit of labor (=wage in competitive economy) LIR 809 DEMAND FOR LABOR: FIRMS LOOKING FOR A ‘STOPPING RULE’ � MARGINAL PRODUCT CURVE � Visual representation of the effect on output of adding 1 more worker � MP L is positive as long as output increases with additional labor � WHY OUTPUT BEGINS TO DECLINE: LAW OF DIMINISHING RETURNS � Increases in output begin to decline with increases in 1 input with other inputs constant LIR 809 4
DECISION RULE FOR EMPLOYMENT LEVEL � Recall: Firms maximize profits � Firms hired up to point where MRP from hiring last worker = marginal cost of that worker If MRP L > MC L , increase employment If MRP L < MC L , decrease employment If MRP L = MC L , do not change employment LIR 809 Marginal Product Curve Product Marginal Labor LIR 809 Relationship between Marginal and Total Product Marginal Product Total Labor LIR 809 5
DETERMINING HOW MANY TO HIRE Labor Qty. MP MR MRP MC 0 0 0 0 0 0 1 6 6 2 12 6 2 14 8 2 16 6 3 20 6 2 12 6 4 24 4 2 8 6 5 27 3 2 6 6 6 29 2 2 4 6 LIR 809 Demand Curve Demand curve starts here Product Marginal Labor LIR 809 Demand Curve Demand curve starts here Market wage Product Marginal rate Stop hiring here Labor LIR 809 6
WHAT THIS SAYS ABOUT WAGES � EFFICIENT POINT: � MC L = MRP L or � MC L = MR * MP L � In competitive economy, MC L = W and MR = P, so: � W = MP L * P or � W/P = MP L � Real wage must = marginal productivity Digression: Nominal versus Real Wages LIR 809 DEMAND FOR LABOR CURVE: MOVEMENT ALONG VS. SHIFTING � Movement along demand curve : � If wage rate changes, employment changes � Negative slope: if wages increase, demand drops & vice versa. � Shifting the demand curve � If MRP L changes, demand curve will shift � If demand for firm’s product increases, product price will increase, increasing MRP L LIR 809 LONG-RUN DEMAND FOR LABOR BY FIRMS I. Overview II. Theory: Demand response to wage changes III.Elasticity: Measuring demand response LIR 809 7
I. Overview: LONG-RUN DEMAND � Firms still looking for decision rule � How much labor AND how much capital? � Firms: profit maximizers � In long-run, firms can vary capital and labor � Production function: � Combination of capital and labor firm can use to produce some level of output � 2 inputs: Capital and Labor LIR 809 Production Function � Shows possible combinations of labor & capital used to produce output � Marginal Rate of Technical Substitution � Slope of the Production function � Shows relative productivities of 2 inputs: Technological relationship � MRTS = MP L /MP K � Family of isoquants: � Each level of output, different curve � Greater output level, further curve is from origin � Firm wants to be on highest curve LIR 809 Production Function Capital Q 1 Q 0 Labor LIR 809 8
Constraints on Production � Marginal costs = W for labor, C for capital � Isoexpenditure line (or cost constraint) shows trade-off between these two costs given firm’s resources � Shows how many units of capital firm can buy if gives up one unit of labor, and � Shows how many units of labor firm can buy if gives up one unit of capital � Slope shows relative prices of K & L LIR 809 Cost Constraint Capital Labor LIR 809 FIRM’S PROBLEM � To find the best, most efficient combination of capital and labor � Use modified version of old decision rule (MR=MC): � Now want relative costs = relative productivities � Want MC L /MC K = MP L /MP K (= W/C) LIR 809 9
Most Efficient (Profit Maximizing) Point Most Efficient Combination of Capital & Labor Capital Q 0 Labor LIR 809 II. Theory: EFFECT OF PRICE CHANGE ON DEMAND FOR LABOR � Two Simultaneous Effects: � Substitution Effect � Reaction to fact that relative prices have changed � Scale (output) Effect � Reaction to change in total cost of production � We only observe the net effect LIR 809 SUBSTITUTION EFFECT � Response to change in Relative Price of Capital and Labor � When price of 1 input goes up, firm will substitute away from the relatively more expensive input. � Example: Price of equipment decreases, firm will try to use more inexpensive equipment and less labor LIR 809 10
SCALE (OUTPUT) EFFECT � Response to change in Total Cost of production � Price in one input increases --> --> Increase in total production cost --> Increase in product price --> Decreases demand for product --> Decreases output --> Decreases demand for labor & capital LIR 809 NET EFFECT OF RELATIONSHIP BETWEEN TWO INPUTS � Increase Wages and: 1) Demand for Capital will increase (substitution effect) 2) Output will be reduced decreasing demand for both capital & labor � In Practical terms: � Substitution effect result of change in technology � Scale effect result of change in output � Net effect – what we observe LIR 809 ELASTICITY � Definition: � % Change Quantity/% Change in Price � Measure of Responsiveness � Quantifiable (i.e., tells us magnitude) � Empirically determined � Two types: � Own-Price � Cross-Price LIR 809 11
Own-Price Elasticity � Definition: % Change Quantity/% Change in Own Price � Is negative though expressed as absolute value � The larger the absolute value, the more employment will decline with a wage increase � Measure of Economic Power: The more inelastic the demand for labor, the more powerful the workforce. LIR 809 CROSS-PRICE ELASTICITIES � Definition: � % Change in Quantity i/% Change Price j � Two Directions: � Gross Substitutes: If cross-elasticity is + � Gross Complements; If cross-elasticity is - � Determinants: � Production Technology (Substitution effect) � Demand Conditions (Output effect) LIR 809 HICKS-MARSHALL LAWS OF DERIVED DEMAND Own-price elasticity of demand is high when: 1) Price Elasticity of product demand is high � Logic: If consumer demand for a product responds to price changes (i.e., product demand is elastic), firms will not be able to pass higher labor costs to consumers without a fall in product demand. LIR 809 12
Recommend
More recommend
