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

• 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

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

• 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)

• 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 Influence the 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