LABOUR MARKET

Demand for Labour:

[Link] for labour is derived demand.
Producers demand labour for the production
of those goods and services being demanded
by the people. Therefore, demand for labour
is derived from product being produced by
labour.
[Link] for labour is derived from marginal
revenue product of labour.

Marginal Revenue Product of Labour:

Revenue generated by one extra labour or change
in total revenue when one extra labour is
employed or revenue generated by last labour is
known as marginal revenue product of labour.
MRPL= Change in total revenue/Change in total
labour employed.
OR
MRPL=MP * Price
In perfect competition when there is an increase
in number of labours, MRPL will fall only because
of fall in MP due to diminishing return. In this case
whether there is an increase in number of labour
or decrease in number of labours to change the
production and supply, price for single firm will
remain unchanged because single firm in perfect
competition is price taker.

In the above diagram when there is an increase in

number of labours, supply curve for the product
will shift rightward due to increase in production
but price will remain unchanged.
On the other hand, in case of imperfect
competition when there is an increase in number
of labours, MRPL will fall not only due to fall in MP
( diminishing return ) but also due to fall in price
or marginal revenue from product.
In the case of imperfect competition when there
is an increase in number of labours, production
will rise and supply curve for product will shift
rightward. This will lead to fall in price( AR) and
MR from product.

Marginal Revenue Product Theory of

Labour:
The MRP theory assumes perfect competition in
the labour market. A perfect competition labour
market means that there are many employers and
many sellers ( workers ) who offer their services.
Both workers and employers are wage takers. All
workers are equally efficient. There is perfect
knowledge and freedom of entry into the labour
market. There is also perfect mobility of labour
from one occupation to another.
Moreover, it is also assumed that firm’s objective
is to maximize their profit. Therefore, firm will
employ the workers till the point where
MRP(Labour)= MC(Labour)
The marginal revenue product theory seeks to
explain how wages are determined and how many
workers will be employed by firm if its objective is
to maximize the profit.
Firstly, the marginal revenue product, MRP, is the
increase in revenue due to employing one more
unit of labour.
MRPL = Change in total Revenue / Change in
Number of Workers
OR
MRPL = MP * Price
The marginal product ,MP, is the increase in
output when one more worker is employed. The
AR or average revenue is the price of the finished
product. Due to the law of diminishing marginal
returns, LDMR, the MP eventually falls as more
workers are employed to work on the given
amount of fixed factor. In a perfect competition
market, the AR ( Price ) remains constant.
Therefore, a firm in the short-run may experience
production and revenue as follows.
No of Total Marginal Price/AR TR MRP $
worker Product Product $ $ (MP*P
s
1 5 5 5 25 25
2 11 6 5 55 30
3 18 7 5 90 35
4 23 5 5 115 25

5 27 4 5 135 20

6 30 3 5 150 15

7 32 2 5 160 10
When more workers are employed, MRP
eventually falls. The MRP is determined by the MP
multiplied by the AR
It will look like:

The downward sloping portion of the MRP is the

demand for labour by firms. The supply curve of
the firm is the average cost of labour. If it is a
perfectly competitive market, the AC will equal
the MC on labour. Firms can employ unlimited
number of similar workers at the same wage rate.
This is shown as follows
No of Wage Rate Total Cost MC
Workers ( AC ) ($) $
1 500 500 500
2 500 1000 500
3 500 1500 500
4 500 2000 500
5 500 2500 500

The supply curve of labour will look like

The equilibrium level or profit maximizing level of

output is where MRP cuts MC from above.
In the diagram below, the profit maximizing firms
will employ workers up to q1.
If MRPL is greater than MCL, firm will increase the
number of workers.
On the other hand, if MCL is greater than MRPL,
firm will reduce the number of workers.
Therefore, firm will employ the number of
workers till the point where MRPL=MCL to
maximize the profit.
In perfect competition, as for single firm there is
no difference between MCL and ACL, therefore if
firm’s objective is to maximize the profit, wage
rate will be determined at point where
MRPL=MCL=Wage Rate/ACL
Therefore, in perfect competition if firm wants to
maximize the profit, firm will employ the labours
till the point where
MRPL= Wage Rate
If there is change in wage rate, firm will change
the number of labours to attain a point where
MRPL=MCL. This is shown below
In the above diagram, initially wage rate is ow1
and firm is employing “q” number of workers to
maximize the profit. When there is change in
wage rate ( i.e. w2 and w3 ), firm change the
number of workers to attain the point where
MRPL= Wage Rate
In the same way if firm objective is to maximize
the profit, firm will change the number of workers
when there is change in labours productivity or
when there is change in demand for finished
product produced by labour.

In the above diagram, initially wage rate is ow1 –

determined by the interaction of MRPL and MCL.
At this wage rate firm is employing oq1 number of
labours. When there is change in MRPL due to
change in labour’s productivity or change in
demand for finished product produced by labour,
firm will change the number of labours to attain
the point where MRPL = MCL

Limitation of MRPL Theory/ Reason due

to which theory cannot explain real
world situation of wage determination:
The MRP Theory assumes perfect competition.
Therefore, the marginal revenue productivity
theory may not be useful in explaining wages in
the real world. It is theory based on a number of
assumptions which may not be realistic; thus,
making the theory itself unrealistic.
Firstly, the MRP theory assumes that all workers
are equally efficient. In real world, this is not so.
Secondly, the theory assumes that MP of a labour
can be measured. In many cases it is not possible
to separate the contribution of labour in terms of
actual physical units.
Thirdly, theory assumes that labours are
occupationally and geographically mobile. In real
world labours could be occupationally and
geographically immobile.
Fourthly, theory assumes that in labour market
there is perfect information about wage rate and
jobs available but in real world it is not so.
The above points are some factors which show
the weakness of the MRP theory which assumes a
perfect competition situation.
In real world, labour markets are far from a
perfect competition situation. If trade unions are
powerful, they will be able to set the wage rate
above the equilibrium wage rate in the same way
government also intervenes in the labour market
to set the national minimum wage rate which is
set above the equilibrium wage rate.
Other factors which explain why wages differ are
as follows:
 In some firms, workers are compensated not
just in money form but in rewards; they get
medical benefits, more leaves, and
recreational facilities.
  Wages differ because of discrimination. It can
be based on sex, race, and nationality.
Sometimes discrimination is even endorsed by
the government.
 Employers may pay differently because of
difference in cost of living and the exchange
rate. Due to lack of information, workers may
be paid different wages for the same job.
 If there is monopoly in the labour market,
monopsonist can exploit the workers by
keeping the wage rate as low as possible.
In conclusion, we can say that in real world, we do
not have a perfect competition labour market.

Demand for Labour:

Demand for labour is derived demand. It is
derived from marginal revenue product of labour.
Demand curve for labour shows the number of
workers being demanded at various wage rates
over certain time period. It slopes downward from
left to right showing the inverse relationship
between wage rate and quantity of labours
demanded.
Demand curve slopes downward because of the
law of diminishing marginal return. The marginal
revenue product of labour falls as more labours
are employed. Therefore, firm will employ more
labours when there is fall in wage rate.

Shift in Demand Curve:

Whenever, there is change in wage rate there is
movement along the demand curve and when
there is change in factors other than wage rate,
there will shift in demand curve for labour.

Other factors include:

[Link] in labours productivity.
[Link] in demand for finished product
produced by labour.
[Link] in price of labours substitutes.
[Link] in price of labours complements.