3. The demand for labor

3.1 The determinants:– Changes on the curve wages (-)– Shifts of the curve (ceteris paribus):• DC (+)• Workers productivity (+)• No. of firms (+)• PK, Pi (+ or -)• Other…

The demand for labor (and for all other inputs) is a derived demand–it derives from the demand for the product that helps produce

3.2 Profit maximization

• Main assumption behind the DL profit max.

• Classical assumption firms are “price-takers”– Perfect competition

• Decisions on production (what, how, how much)

• DL stems from marginal changes– Decision flow output level and optimal mix of inputs– Incremental decisions how long?

• Maximizing firm expand output…insofar asMR > MC YC up

• When will output be diminished?MR < MC YC down

• Equilibrium MR = MC YC constant

• For ΔYC Δ inputs (L, K) In terms of inputs:MRPL > MWC L upMRPL < MWC L downMRPL = MWC L constant profit maximization

3.2 Profit maximization

• This flow of decisions will determine how to increase or diminish production marginally

• Therefore, whenever we employ 1 additional unit of L (or K), we will generate additional income for the output produced and sold

• So, the MRPL is the multiplication of two terms:– Δ output (MPL)– Δ revenue for the additional unit of output, produced and sold (unit MRPL)

3.2 Profit maximization

Some definitions:

• MPL = ΔY/ΔL; with K fixed• MPK = ΔY/ΔK; with L fixed

• unit MRPL depends on market conditions– Equal to price of perfect competition (“price-takers”)

• MRPL = MPL x unit MRPL also = MPL x P (in PC)• MRPK = MPK x unit MRPK also = MPK x P (in PC)

3.2 Profit maximization

3.3 Demand in the short run: perfect competition (product market)

The “short run” assumption allows us to treat K as fixed

PFSR = YSR = f ( L, K )

In the short run, decisions by the firm regarding output and labor input are two sides of the same coin

The only thing that matters in the short run is whether the output level should be altered (we know how to do it: with L)

3.3 Demand in the short run: perfect competition (product market)

What can be deduced from the production function?MPL = ΔY/ΔLAPL = Y/L

The relationships between Y, MPL, & APL are importantWhen MPL > APL APL is growing

Production function (zones):1) Y grows, growing rate (MPL & APL grow)2) Y grows, falling rate (MPL falls and APL grows then falls)3) Y falls (MPL < 0 and APL falls)

Why Y, MPL, & APL behave like that?– Law of diminishing returns (LDR)

Why MPL grows, falls, and then < 0?

It is NOT that labor is now of less quality– Labor is homogeneous

The fact is that, with t, a heavier burden will fall upon K– L is becoming abundant in relation to K– Loss of efficiency of L (APL falls)

3.3 Demand in the short run: perfect competition (product market)

Production zone (zone 2):From LDR to max. of Y (max. of APK also)

Summing up: • Firms will operate in “zone 2”– Successive ΔL will help increment efficiency– Exception: monopoly

• Firms will not operate in either “zone 1” or “zone 3”:– In 1 the efficiency of L & K goes up (as do APL & APK)– Incentives for incrementing Y up until we reach zone 2– In 3 the efficiency of L & K falls (as do APL, APK, while MPL < 0)

3.3 Demand in the short run: perfect competition (product market)