Module 3: Labor Demand PDF

Module 3: Labor demand McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights 5-1reserved. Questions for discussion: What is the law of demand? How is this connected...

Module 3: Labor demand McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights 5-1reserved. Questions for discussion: What is the law of demand? How is this connected to the demand for labor? Do firms demand labor when production increases? Is this assumption true in all stages of production? What is the difference between a short- run and long- run demand for labor? What is the effect of a wage change in the demand for labor? https://www.youtube.com/watch?v=mWwXmH-n5Bo 5-2  The demand for labor is a derived demand. it is derived from the demand for the product or service that the labor is Derived helping produce. Demand The demand for hamburgers leads to the demand for hamburger workers. Demand for workers depends on: How productive the workers are. The price of the product the workers are helping produce 5-3 Short-run Production Function A production function shows the relationship between inputs and outputs. Assume that only two inputs are used to make a product-- labor (L) and capital (K). In the short run, at least one input is fixed. The total product for a firm in the short run is: TPSR=f(K,L), where K is fixed. 5-4  Definitions Total product (TP) is the total product produced by each combination of labor and the fixed amount of capital. Marginal product (MP) is the change in total product associated with the addition of one more unit of labor. Average product (AP) is the total product divided by the number of units of labor. 5-5  Law of Diminishing Returns Total Units of Total Marginal Average Product Total Variable Product Product Product 80 Product resource 0 0 70 1 8 2 20 60 3 34 50 4 46 5 56 40 6 64 30 7 70 8 74 20 9 75 10 73 10 1 2 3 4 5 6 7 8 9 10 Quantity of Labor 5-6  Law of Diminishing Returns The Marginal Product curve will initially increase (when TPC is increasing at an increasing rate), reach a maximum, and then decrease (as TPC Units of Total Variable Product Marginal Average increases at a decreasing Resource (Output) Product Product rate). 0 0 ----- ----- 1 8 8 8 The Average Product 2 20 12 10 curve will have the same 3 34 14 11.3 general form except that its 4 46 12 11.5 maximum point will be at a 5 56 10 11.2 higher output level. 6 64 8 10.7 7 70 6 10 8 74 4 9.3 9 75 1 8.3 10 73 -2 7.3 5-7  Law of Diminishing Returns Average and/or Marginal Product 16 Marginal Product 12 Average Product 8 Important Note : 4 MP always crosses AP at its maximum point. Quantity of Labor 1 2 3 4 5 6 7 8 9 10 5-8  Graphed together, one can see the Law of relationship between the TP, MP, and AP curves more clearly. Diminishing Returns TP Total AP & MP 80 Product 16 Marginal Product 70 60 12 Average Product 50 40 8 30 20 4 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Quantity Quantity of Labor of Labor 5-9  THE LAW OF DIMINISHING RETURNS PRODUCTION STAGE 30 STAGE 1 STAGE 2 STAGE 3 25 20 15 TP AP 10 MP 5 0 0 1 2 3 4 5 6 7 8 -5  THE LAW OF DIMINISHING RETURNS PRODUCTION STAGE Stage 1 – additions to labor increase efficiency of labor and efficiency of capital Stage 2 – Zone of production, an efficient combination on labor and capital Stage 3 – additions to labor reduces efficiency of labor and efficiency of capital Thus, MP curve in stage 2 is also the firm’s short-run demand for labor curve Short-Run Demand for Labor: The Perfectly Competitive Seller 5-12 Perfect competition Perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Since the conditions for perfect competition are strict, there are few if any perfectly competitive markets. Still, buyers and sellers in some auction-type markets, say for commodities or some financial assets, may approximate the concept. Perfect competition serves as a benchmark against which to measure real-life and imperfectly competitive markets. 5-13  Hiring Decision Profit-maximizing firms will hire additional workers as long as each worker adds more to revenue than s/he costs. Marginal revenue product (MRP) is the change in total revenue that results from hiring an additional worker. MRP= Marginal Revenue (MR) * MP Marginal wage cost (MWC) is the change in total wage cost of hiring an additional worker. The Hiring Rule: Hire additional workers until MRP = MWC. 5-14  Short-Run Demand for Perfectly Competitive Firm For each unit processed the firm receives $200 (4). Column (2) shows how total output changes as additional data-entry operators are hired (given a fixed capital level). The Marginal Revenue Product schedule (6) indicates how hiring an additional operator affects the total revenue of the firm. Total MP MRP Units of Product (TP) (units per week)  TP Sales Price Total  TR Labor (L) (2) L (Per Unit) Revenue L (1) (3) (4) (5) (6) 0 0.0 ----- $200 $ 0 ---- 1 5.0 5.0 $200 $1,000 1000 2 9.0 4.0 $200 $1,800 800 3 12.0 3.0 $200 $2,400 600 4 14.0 2.0 $200 $2,800 400 5 15.5 1.5 $200 $3,100 300 6 16.5 1.0 $200 $3,300 200 7 17.0 0.5 $200 $3,400 100 5-15  Short-Run Labor Demand Wage Rate Since a profit-maximizing firm will only hire an additional 1000 worker only if the worker adds more to revenues than she adds to wage costs, the MRP 800 curve is the firm’s short run demand curve for labor. 600 In the short-run, it will slope 400 downward because the marginal product of labor falls as more of it is used with a 200 fixed amount of capital. MRP=DL 1 2 3 4 5 6 7 Quantity of Labor 5-16  Value of Marginal Product The value of marginal product (VMP) is the extra output in monetary (dollar) terms that society gains when an extra worker is employed. VMP=Price * MP For a perfectly competitive seller, MR=Price. As a result, VMP = MRP for such firms. 5-17 Short-Run Demand for Labor: The Imperfectly Competitive Seller 5-18 Imperfect competition Imperfect competition is the competitive situation in any market where the conditions necessary for perfect competition are not satisfied. It is a market structure that does not meet the conditions of perfect competition. Forms of imperfect competition include: Monopoly, in which there is only one seller of a good. Oligopoly, in which there are few sellers of a good. Monopolistic competition, in which there are many sellers producing highly differentiated goods. Monopsony, in which there is only one buyer of a good. Oligopsony, in which there are few buyers of a good. Information asymmetry when one competitor has the advantage of more or better information. There may also be imperfect competition due to a time lag in a market. An example is the “jobless recovery”. There are many growth opportunities available after a recession, but it takes time for employers to react, leading to high unemployment. High unemployment decreases wages, which makes hiring more attractive, but it takes time for new jobs to be created. 5-19  Short-Run Demand for Imperfectly Competitive Firm In the numerical example below, the company uses both technology and data- entry operators to provide services in an imperfectly competitive market. Since it is in an imperfectly competitive market, the firm faces a downward sloping product demand curve (4). That is, the product price falls as the firm sells more units. Total MP MRP Units of Product (TP)  TP Sales Price Total  TR Labor (L) (units per (2) week) L (Per Unit) Revenue L (1) (3) (4) (5) (6) 0 0.0 ----- $210 $ 0 ---- 1 5.0 5.0 $200 $1,000 1000 2 9.0 4.0 $190 $1,710 710 3 12.0 3.0 $180 $2,160 450 4 14.0 2.0 $170 $2,380 220 5 15.5 1.5 $160 $2,480 100 6 16.5 1.0 $150 $2,475 -5 7 17.0 0.5 $140 $2,380 -95 5-20  Short-Run Labor Demand Wage Rate For imperfectly competitive firms, the labor demand curve will slope because of a falling marginal product of labor and 1000 because the firm must decrease the price on all units of output as more output is produced. 800 Since it is in an imperfectly competitive market, the firm 600 faces a downward sloping product demand curve (4). That is, the product price falls as the 400 firm sells more units. The labor demand curve for an imperfectly competitive firm 200 VMP (MRP) is less elastic than that for a perfectly competitive firm (VMP). As a result, they will hire 0 fewer workers other things 1 2 3 4 5 6 7 Quantity of Labor equal. MRP=DL 5-21 Long-Run Demand for Labor 5-22  Long-Run Labor Demand In the long run, both labor and capital are variable. The total product for a firm in the long run is: TPLR=f(K,L) The long-run labor demand curve is downward sloping because a wage decline has both an output and substitution effect. 5-23  Output Effect Price MC1 A decline in the wage rate will 10 MC2 reduce the marginal cost (MC1 to MC2) and increase the profit maximizing level of output (40 to 8 70). 6 M To produce the higher output R level, the firm will have to hire more workers. 4 2 This output effect is present in the short run. 10 20 30 40 50 60 70 Quantity of Output 5-24  Substitution Effect The substitution effect is the change in employment resulting from a change in the relative price of labor, output being held constant. If a decline in the wage rate occurs, firms will substitute labor for the now relatively more expensive capital. Since capital is fixed in the short run, this effect can’t occur in the short run. 5-25  Long-Run Labor Demand Wage Rate A wage decrease from $800 per week to $600 increases the 1000 short-run quantity of labor from 3 to 4 (A to B). This is the output A effect. 800 B C In the long-run, the firm also 600 substitutes labor for capital, resulting in a substitution effect DLR of 2 units (B to C). 400 200 DSR The long-run demand curve results from both effects and is found by connecting points A and C. 1 2 3 4 5 6 7 Quantity of Labor 5-26  Other Factors Product demand Product demand is more elastic in the long run than in the short run, making labor demand more elastic the longer the period. Labor-Capital interaction If the wage rate falls, the short-run quantity demanded of labor rises. This will increase the MP of capital and thus the MRP of capital. The higher MRP of capital, the quantity of capital will increase and thus the MP and MRP of labor. As a result, the long-run response will be greater than the short-run response. 5-27  Other Factors Technology If the wage rate falls, technological innovators will try to reduce the use of relatively more expensive capital and increase the use of labor. The long run response will be greater than the short-run response. 5-28 Market Demand for Labor 5-29  Market Labor Demand Wage Rate The market demand curve for labor is less elastic than a horizontal summation of the 1000 demand curves of individual firms (D). A 800 A lower wage induces all firms to hire more labor and produce B C 600 more output, causing the supply of the product to increase. 400 D The resulting decline in the product price shifts the firms’ DMARKET labor demand to left. 200 As a result, total employment rises to A to B rather than from 10 20 30 40 50 60 70 Quantity of A to C. Labor 5-30 Elasticity of Labor Demand 5-31 Wage Elasticity Coefficient The wage elasticity coefficient measures the responsiveness of the quantity demanded of labor to the wage rate. % Change in Wage Elasticity quantity demanded % Q Coefficient = % Change in Wage = % W (Q0 − Q1 ) (Q0 +Q1 ) - or put simply - (W0 − W1 ) (W0 + W1 ) 5-32  Determinants of Elasticity Elasticity of product demand The greater the price elasticity of product demand, the greater the elasticity of labor demand. Firms with market power tend to have more inelastic product demand, and thus a more inelastic labor demand. Product demand tends to be more elastic in the long run and thus labor demand is more elastic in the long run. 5-33  Determinants of Elasticity Ratio of labor costs to total costs The larger the share of labor costs in total costs, the greater will be the elasticity of labor demand. A 10% rise in wages if labor accounts for 50% of total costs, will raise total costs by 5%. If costs rise more, the price rise must be greater and thus decrease quantity more. 5-34  Determinants of Elasticity Substitutability of other inputs The greater the substitutability of other inputs for labor, the greater will be the elasticity of labor demand. Supply elasticity of other inputs The greater the elasticity of supply of other inputs for labor, the greater will be the elasticity of labor demand. 5-35  Estimates of Elasticity Most estimates of elasticity indicates the overall long-run elasticity of demand is about -1.0. A 1% rise in the wage rate will lower the quantity demanded of labor by 1%. 5-36  Significance of Elasticity Labor unions Unions can achieve greater wage gains when the labor demand curve is more inelastic. Minimum wage The employment decline of a hike in the minimum wage will be larger when the labor demand curve for affected workers is more elastic. 5-37 Determinants of Demand for Labor 5-38  Determinants of Labor Demand Product demand A change in product demand will shift labor demand in the same direction. Productivity Assuming that it does not cause an offsetting decrease in the product price, a change in marginal product will shift labor demand in the same direction. 5-39  Determinants of Labor Demand Number of employers Other things equal, a change in the number of firms employing a particular type of labor will change labor demand in the same direction. Prices of other resources Normally labor and capital are substitutes in production. One can substitute labor for capital and vice versa in the production process. 5-40 Determinants of Labor Demand Gross complements Gross complements are inputs such that when the price of one changes, the demand for the other changes in the opposite direction. Implies output effect outweighs the substitution effect. Example: the decline in the price of telephone switching equipment has increased the demand for communications workers. Pure complements Pure complements in production are inputs that are used in direct proportion to each other. Since no substitution effect occurs, the inputs must be gross complements. 5-41 Policy Applications Minimum Wage Legislation Job Creation ( Build, Build, Build, TUPAD, Government Internship Program) Labor Contracting and Outsourcing Skills Development and Training Programs (TESDA, K-12) Public-Private Partnership CREATE Act (Corporate Recovery and Tax Incentives for Enterprises Act) Special Economic Zones 5-42