Topic 4: Labour Demand Flashcards
Labour Demand Decisions I Labour as the only factor of production I Capital and labour in the short run I Capital and labour in the long run I Elasticity of labour demand
Who demands labour?
Firms
Why does a Firm want to hire workers?
- To produce an output that the firm can sell.
- “Derived demand” (Derived demand is an economic term describing the demand for a good/service resulting from the demand for an intermediate or related good/service. It is a demand for some physical or intangible thing where a market exists for both related goods and services in question.)
What determines how much labour a firm wants to hire?
- How much a unit of labour costs
- How much a unit of labour produces
- Price at which firm can sell output
- Market structure
Simple Production Function: Labour as the Only Input
What is a firms production function?
What are its characteristics?
Q = A · F(N) (N) denotes labour
- A is productivity ⇒ higher A means higher Q, given N
- A can be related to the technology used in production
- More labour input produces more output: F(N) is increasing in N
- MPN = ∂Q/∂N: marginal product of labour, i.e. increase in output when labour increases by a small amount
- MPN is decreasing (e.g. because of crowding): As N increases, the rate at which F(N) increases falls
Simple Production Function: Labour as the Only Input
Why does a curve for Q (output) as a function N (labour) slope drop has it reaches it peak?
Add graph of a typical production function
MPN is decreasing (e.g. because of crowding): As N increases, the rate at which F(N) increases falls.
Keep in mind: MPN = ∂Q/∂N: marginal product of labour, i.e. increase in output when labour increases by a small amount
Add graph of marginal product of labour
Simple Production Function: Labour as the Only Input
What is a firm’s objective and what equation symbolizes this?
- The firm’s objective is to maximize profits
- Profits are given by: π = PQ − WN
- P*Q represents profits, W*N represents costs
- P is the price of the good that the firm sells; W is the wage
- The firm takes P and W as given.
- In a competitive market, the firm has no control over the price of its output or the wage
Add graph of revnue and cost
Simple Production Function: Labour as the Only Input
When is profit maximized?
P ∂Q/ ∂N − W = 0 ⇒ P MPN = W
Maximization achieved when the value of the marginal product of labour is equal to the wage
- Intuition: Firm will hire labour up to the point where the extra revenues achieved by hiring one more unit of labour are equal to the extra cost of hiring one more unit of labour
- For each level of W, everything else equal, we can back out how many workers the firm wants to hire ⇒ this gives us the labour demand function
As wages increase, what happens to profits assuming constant employment?
Profits decline with increasing wages.
Define Production function, MPK, MPN and their interrelationships?
Production function: Q = F(K, N)
MPK : increase in output when input of capital increased by small amount, holding input of labour constant
MPN : increase in output when input of labour increased by small amount, holding input of capital constant
Both positive and decreasing
MPK depends on the level of N; MPN depends on the level of K
What are the 2 types of production function types? And what does the cobb-douglas form entail?
- Cobb-Douglas:
Q = F(K, N) = A · K αN β 0 < α < 1, 0 < β < 1
MPN = A · βK αN β−1
MPK = A · αK α−1N β
MPN decreasing in N; MPK decreasing in K
Everything else equal, increase in K increases MPN
Increase in A (productivity) increases output and marginal product, for given levels of K and N
2. Constant Elasticity of Substitution (CES)
What does the Constant Elasticity of Substitution (CES) production type entail?
Look at notes and memorize nuances from cobb-douglas.
What’s the difference between the firms objective (profits formula) when output is a function of labour and capital vs just labour?
For output due to labour and capital:
π = PQ − WN − rK
r is the rental rate of capital
The firm takes r as given
For output due soley to labour:
π = PQ − WN
What is the difference for demand for labour in short run vs long run?
In the short run, firms’ capital input is fixed ⇒ The firm chooses the amount of labour that maximizes profits, taking capital as given
P MPN = W
Value of the marginal product of labour is equal to the wage
But now MPN depends on the firm’s level of capital
In the long run, firms choose both labour and capital ⇒ The firm chooses the optimal combination of labour and capital that maximizes profits
Long run: Profits are maximized when:
P MPN = W
P MPK = r
Maximization achieved when the value of the marginal product of each input is equal to their marginal cost
What is the Marginal Rate of Technical Substitiution (MRTS)?
The marginal rate of technical substitution shows the rate at which you can substitute one input, such as labor, for another input, such as capital, without changing the level of resulting output.
Producer equilibrium is a concept where all producers strive to generate the maximum amount of profit for the minimum amount of cost. The producer obtains equilibrium by putting together factors of production in a combination that requires the least amount of money. Thus, the producer is responsible for determining the combination of production factors that best achieve this result.
The decision the producer makes involves the MRTS and the principle of substitution. Consider that a producer has only two production factors, factor A and factor B. If factor A can produce a greater amount of output than factor B, with an equal amount of capital being spent on both, this would lead to the producer choosing to substitute factor A for factor B.
