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2.3 Demand and Supply in a Labour Market,

2.3 Demand and Supply in a Labour Market,

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Published by: Foisal Mahmud Rownak on Aug 01, 2011
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D
EMAND
 
AND
S
UPPLY
 
IN
 
A
 
LABOUR 
 
MARKET
2.3
Demand for labor
As the diagram below illustrates, it is argued that there is an inverse relationshipbetween the wage rate and the quantity of labor demanded. This negativerelationship between the wage and the quantity of labor demanded is the result of two effects:
o
a substitution effect, and
o
a scale effect.Suppose that the wage rate increases. The substitution effect of the wage increaseinvolves the substitution of other resources (such as capital, energy, materials, andother categories of labor) for the category of labor that has become more expensive. As thewage rate rises, the substitution effect resultsin a reduction in the quantity of labordemanded.The scale effect resulting from a wage increaseis a bit more complex. As the wage rate rises,the scale effect involves the following chain of effects:higher wages result in higher averageand marginal costs of production,higher average and marginal andaverage costs result in an increase inthe equilibrium price of the product,as the price of the product rises, theequilibrium quantity of the product demanded declines (a reduction in the"scale" of production), andthe reduction in output results in a reduction in the quantity of all inputs usedto produce this product (including this category of labor).Thus, both the substitution and scale effects result in a reduction in the quantity of labor demanded when the wage rate rises.Be sure to not confuse a change in the quantity of labor demanded with a change inthe demand for labor. A change in the wage changes the quantity of labordemanded, but does not affect labor demand. Labor demand changes only if thelabor demand curve shifts in some manner (as discussed below).
Changes in labor demand
The labor demand is affected by:
o
the demand for the product, and
o
the prices of other resources.Let's examine how each of these factors affectslabor demand. The demand for labor (and anyother resource) is a derived demand. This meansthat the demand for a resource is derived fromthe demand for the output that the resourceproduces. For example, the demand for workers
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2.3
in automobile factories is derived from the demand for automobiles. When thedemand for the final product rises, the demand for labor increases. As the diagrambelow indicates, an increase in demand for labor is represented by a rightward shiftin the labor demand curve (since the quantity of labor demanded is greater at eachwage along the curve D').The effect of changes in the prices of other resources is not quite as straightforward.Consider, for example, the effect of an increase in the price of capital on the demandfor labor. The substitution effect resulting from a higher price of capital raises thedemand for labor. The scale effect, on the other hand, will lower the quantity of bothlabor and capital demanded. Thus, the effect of a higher price of capital on labordemand will depend on whether the substitution effect or the scale effect is larger inmagnitude.Another example might help to illustrate this point. Suppose that the wage rate risesfor adult workers in the fast-food industry. How will this affect the demand forteenage workers in this industry? On the one hand, each fast-food restaurant will tryto substitute teenagers for adults in each location. Since adults and teenagers arenot perfect substitutes, firms will still need some adult workers. This results in higherproduction costs and a higher equilibrium price of output. As the price of fast-foodproducts rises, firms cannot sell as much and will be forced to shut down somelocations and layoff workers (including both teenagers and adults). This scale effectresults in a reduction in the demand for teenage workers. When the price of adultworkers rises, the demand for teenager workers will rise if the substitution effect islarger than the scale effect; the demand for teenage workers will fall if the scaleeffect is larger than the substitution effect.To be sure that you understand this concept, think about the effect on the demandfor adult workers if a lower minimum wage was introduced for teenage workers.
Market, industry, and firm demand for labor
When discussing labor demand, it's important to distinguish whether we are talkingabout labor demand at the level of a market, an industry, or a firm. To understandthese distinctions, it is important to understand the following definitions: An industryconsists of all of the firms that produce a given type of output. An industry's demandfor labor consists of the total demand for a particular type of worker in a givenindustry. For example, we could investigate the demand for carpenters in theconstruction industry, or the demand for carpenters in the education industry (notethat carpenters are hired in many industries). The market for a given category of labor consists of all of the firms that might hire a given type of labor, regardless of the industry in which the firm operates. Thus, the market for carpenters includes thedemand for carpenters in all industries. An industry's labor demand curve isdetermined by adding together the labor demand curves for all of the firms in theindustry (this involves a horizontal summation of all of the individual firms' labordemand curves). The market demand for labor is determined by adding together allof the industry demand for labor curves.
Long-run vs. short-run labor demand
As you may recall from prior economics classes, economists define the short run asthe period of time in which capital is fixed. In the long run, all inputs, includingcapital, may be changed. The main difference between the short-run and long-run
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2.3
demand for a given category of labor is that there are more possibilities forsubstituting other factors of production in the long run. Thus, it is expected that thequantity of labor demanded will change by a larger amount in the long run when thewage rate rises. This is illustrated in the following diagram.
Demand for labour : a derived demand
Demand for labour is a derived demand, From macro economic view point thedemand for labour mainly depends on the level of the aggregate demand. But at thefirm level it depends on Marginal Revenue Product if others thing remain constant.Consequently, The Firms demand for labour or any other input is derived indirectlyfrom the consumer demand for its product.
Market labor supply
The market labor supply curve is expected to be upward sloping because an increasein the wage in a particular labor market will: (a) cause some workers in this marketto work additional hours, (b) induce some workers to shift from other labor marketsto this relatively more remunerative alternative employment, and (3) will causesome individuals who are not currently in thelabor force to enter this market.A possible labor supply curve is illustrated here.Changes in the wage in this market result inchanges in the quantity of labor supplied, but donot affect labor supply. Labor supply changesonly if some other factor changes and the laborsupply curve shifts. The diagram belowillustrates an increase in labor supply from S toS'.
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