L8.1 (Derived) Demand for Labor

Firms demand labor as input into their production process. Consumer's demand goods for consumption; this is called the FINAL demand. Firms produce goods to supply to consumers. In order to produce goods, they need to hire labor. So the demand for labor of the firms is DERIVED from the original demand of consumers for goods. If consumers stop demanding goods then firms would stop producing them and stop demanding labor.

The Demand for Labor for a SINGLE FIRM

Demand for Labor: Labor is an input into the production function of the firms. Each additional unit of labor hired produced an additional amount of output, which we can call the Marginal Physical Product of Labor (MPPL). Multiplying this by the price of the output gives the MRPL: Marginal Revenue Product of Labor. If hiring an additional unit of labor costs w (wage), firms will hire as long as MRPL > w. As firms hire more labor, the MPPL decreases – diminishing marginal productivity of labor. So firms will keep on hiring labor until the MRPL becomes exactly equal to the wage. At this point, if they hire more labor, the amount they have to pay for labor will be larger than the revenue they earn from hiring the additional unit of labor. So they will stop hiring. Based on these considerations, we can draw a curve for the demand for labor from a single firm as follows:

Here the blue curve is the MRPL. If the wage, or price per unit of labor is 150, the firm will hire 5 units of labor. The demand curve for labor is exactly the same as the declining portion of the blue curve. If the wage is higher than 225, the firm will have zero demand for labor. At w=225, the firm will demand 2.5 units of labor. As the wage declines, the firms demand will increase along the blue curve.

The declining portion of the MRPL curve is the demand of one firm for additional units of labor as the wage declines. This is under the assumption that the firm is small, so that the additional units it produces as it expands do not affect the price of the good in the market.