Chapter 3 Labor Demand. The labor is worthy of his hire. —The Gospel of St.Luke. 3.1 The Short-run Labor Demand. What does the term “short-run” mean? Firm can only change the employment of labor to maximize profit. That is, the stock of capital is assumed to be fixed.
The labor is worthy of his hire.
—The Gospel of St.Luke
Firm can only change the employment of labor to maximize profit. That is, the stock of capital is assumed to be fixed.
–The objective of hiring workers is to produce product that firm can sell.
–That is, demand for labor is a derived demand, which is derived from consumer’s demand for final product.
–The guide rule is simple: maximizing profit.
–Profits are maximized at the point where added revenue of one extra unit of input equals added cost of one extra unit of input.
–Both product and labor market are competitive.
Production technology:Q=f(K,L), Kdenotes capital input and Ldenotes labor input
Examples: Q=L+K; Q=LK; Q=L1/2K1/2
–Marginal Product (MP) of labor
–Similarly, marginal product of capital
Additional revenue generated by an extra unit of output.
MR depends on the characteristics of the product market.
e.g., MR=Pin the competitive product market.
Simply combines marginal product and marginal revenue, i.e., MRP=MP*MR
–Defined as average output produced by one unit of labor input.
–Defined as average output produced by one unit of capital input.
Graphical MP and AP
–Added cost resulting from employing an additional unit of input.
–Marginal product of labor will eventually decline as employment increases given a fixed capital.
–Why? Specialization, cooperation, externality, …
–Example of 4S.
MPL*P=W <=> MPL=W/P
–According to the law of diminishing marginal returns, we expect a negative relationship between employment and MP.
–Or a negative slope for the MPL curve.
–Again with the law of diminishing marginal returns, we have a labor demand curve sloping downward.
–Example of detective hiring. (also, e.g., police size)
–*The MRPLcurve and the labor demand curve coincide here.
–The term “marginal” is not a function of individual’s characteristics.
–The size of “margin” depends on the number of employees that are already hired.
–The size of “margin” also depends on the size of other input.
–Employers do not know the accurate output of individual workers, no mention of MRP.
–Additional labor produces nothing in some cases.
C denotes the cost of capital (e.g., interest)
–The left-hand side W/MPLdenotes the added cost of producing one additional unit of output using labor.
–The right-hand side C/MPKdenotes the added cost of producing one additional unit of output using capital.
–Equation W/MPL=C/MPKis disturbed.
–In the short-run, the marginal cost of production using labor exceedsthe marginal cost using capital.
•First the firm will cut the size of employment as before, which leads to raise MPL.
•Less labor also results in falling MPK, which will lead to reduction of its capital input.
–Increase of MPLdue to higher capital per worker
–Decrease of MPK due to the Law of Diminishing Marginal Return
–Falling output level (scale effect)
–More capital input (substitution effect)
–However, whether the sizes of capital increase is ambiguous.
–See Figure in next slide
–Labor demand is now a function of wage rate and the prices of all other inputs.
–Inputs are substitutes,
–Inputs are complements
•Only scale effect
–Monopolistic product market
–Monopolistic labor market
–Change the market supply curve
–Change the firm’s MEcurve
–Change both the average cost and marginalcost of labor
–If Wmlie between Wm’ and W0, both wage and employment rise.
–If Wmis higher than Wm’, then ?
–Substitution effect more labor, less capital
–Scale effect:less output lower employment level
–Uncertain gross effect