LABOR DEMAND

Devi Hildayanti
-1206206631-

McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc. 2008

 Firm’s Production Function

q = f (E,K)
Capital
 Marginal product of
capital
Output  Marginal product of
labor
Employment
 Average product

2
 Firm’s Production Function
140 25

120 Average Product

20
100

Output
Output

80 15

60 Total Product
10
Curve
40
5
20 Marginal Product

0 0
0 2 4 6 8 10 12 0 2 4 6 8 10 12

Number of Workers Number of Workers

- Slope of Total Product curve = marginal product of labor

- Marginal Product of Labor and Capital are positive
- Law of Diminishing Returns
3
 Profit maximization

Profits = pq – (wE + rK)

Asumsi:
- Firm is a small player in industry

4
 The Employment Decision (Short Run)

Assumption: capital is fixed

Value of marginal product VMP =
p x MP

Value of average product VAP =

p x AP

Perusahaan akan hire workers

pada titik dimana VMP = w

1 4 8
5
 Wages Changes in Short-Run Labor Demand Curve

wage
wage

20 20

10
10

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employment 30 56 employment
15 30 60

a) Individual firms b) Industry

-When wages fall, labor demand increases…

-Impact in industry: total output ↑ ; prices ↓
6 -VMP falls, labor demand curve of each individual firm shifts to the left
 Elasticity of Labor Demand

δSR =
Example: industry hires 30 workers when the wage is 20, and hires 56
workers when the wage is 10

δSR = = 1,7333

1,7333% change in short-run employment (E SR) resulting from 1%

change in the wage

7
 Firm’s Output Decision

Dollars A profit-maximizing firm

MC produces up to the
point where the output
p Output Price
price equals the
marginal cost of
productions.
Output MC = w x 1/MPE
q*
w = p x MPE
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 Employment Decisions in the Long Run

- Describes the possible

combinations of labor and
capital that produce the same
level of output.
- Absolute value of an isoquant is
called marginal rate of
technical substitution
∆K/ ∆E = -MPE/MPK

Isoquant Curves

9
 Employment Decisions in the Long Run

C = wE + rK

Isocost line: the line

connecting all the various
combinations of labor and
capital that the firm could hire
with a cost outlay of C0 dollars.

Isocost lines

10
 The Firm’s Optimal Combination of Inputs

A firm minimizes the costs of

producing q0 units of output
by using the capital-labor
combination at point
P, where the isoquant is
tangent to the isocost.

11
 Wage Reduction

A wage reduction flattens the

isocost curve.
If the firm were to hold the initial
cost outlay constant at point C0
dollars, the isocost would rotate
around C0 and the firm would
q0 move from point P to point R.
A profit-maximizing
firm, however, will not generally
want to hold the cost outlay
constant when the wage
changes.
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 Dampak Penurunan Upah pada Output dan Employment

Firm’s output decision Firm’s hiring decision

- A wage cut reduces the marginal cost of production and encourages the firm to
expand
- The firm moves from point P to point R, increasing the number of workers hired
13 from 25 to 50
 The Long-Run Demand Curve for Labor

The long-run demand curve for

labor gives the firm’s
employment at a given wage
and is downward sloping.

14
 Substitution and Scale Effect

The scale effect (the move from

point P to Q) encourages the
firm to expand, increasing the
firm’s employment.
The substitution effect (from Q to
R) encourages the firm to use a
more labor-intensive method of
production, further increasing
employment.

15
 The Short & Long-Run Demand Curve for Labor

In the long run, the firm can

take full advantage of the
economic opportunities
introduced by a change in
the wage. As a result, the
long-run demand curve is
more elastic than the short-
run demand curve.

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 Isoquants
Capital Capital

100

q 0 Isoquant q 0 Isoquant
5

200 Employment 20 Employment

Capital and labor are perfect substitutes if the isoquant is linear. The two inputs are
perfect complements if the the isoquant are right-angled. The firm then gets the same
output when it hires 5 machines and 20 workers as when it hires 5 machines and 20
17 workers.
 Elasticity of Substitution

The elasticity of substitution gives the percentage change in the

capital/labor ratio resulting from a 1 percent change in the
relative price of labor.

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 Policy Application: Affirmative Action
Black Labor
(a) (b)

P
q*
White Labor

The discriminatory firm chooses the input mix at point P, ignoring the cost-minimizing rule that the
isoquant be tangent to the isocost. An affirmative action program can force the firm to move to point
Q, resulting in more efficient production and lower costs.
A color-blind firm is at point P, hiring relatively more whites because of the shape of the isoquants. An
affirmative action program increases this firm’s costs.
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 Marshall’s Rules of Derived Demand

Labor demand is more elastic when:

 Elasticity of substitution is greater
 Elasticity of demand for the output is greater
 The greater labor’s share in total costs is
 The greater the supply elasticity of the other factor of
production, such as capital

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 Factor demand with many inputs

 There are many different inputs

– Skilled and unskilled labor
– Old and young
– Old and new machines
 Cross-elasticity of factor demand
– %∆xi%∆wj
– If cross-elasticity is positive, the two inputs are said to be
substitutes in production

21
 The Demand Curve for a Factor of Production
is Affected by the Prices of Other Inputs

The labor demand curve for input i shifts when the price of another input changes.
- If the price of a substitutable input rises, the demand curve for input i shifts up.
- if the price of a complement rises, the demand cure for input i shifts down.
22
 Labor Market Equilibrium

In a competitive
market, equilibrium is
attained at the point where
supply equals demand. The
“going wage” is w* and E*
workers are employed.

23
 Minimum Wages in Indonesia

UMR Indonesia (dalam ribuan rupiah)

2000
1500
1000
500 Rata-rata Indonesia

24
 The Employment Effects of Minimum Wages

A minimum wage set at w̅

forces employees to cut
employment (from E* to E̅). The
higher wage also encourages
(Es - E*) additional workers to
enter the market. The minimum
wage, therefore, creates
unemployment.

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 Adjustment costs
“The expenditures that firms incur as they adjust the size of their
workforce”

Variable Adjustment Fixed Adjustment

• Depend on the number of • Do not depend on the
workers that the firm is going number of workers the firm
to hire or fire is going to hire or fire

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 Asymmetric Variable Adjustment Costs
Variable
Adjustment Costs

C0

Change in
Employment
-25 0 +50

If government policies prevent from firing workers, the cost of trimming the
workforce will rise even faster than the cost of expanding the firm
27
 Slow Transition to New Equilibrium

Variable adjustment costs

encourage firm to adjust the
employment level slowly.
The expansion from 100 to
150 workers might occur
more rapidly than the
contraction from 100 to 50
workers if government
policies “tax” firms that cut
employment

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 Rosie the Riveter as an Instrumental Variable: Estimating
Labor Demand Curve

o Market equilibrium: point P

o If only supply curve shifts, we
can observe w1 and E1 ;
available data trace out labor
demand curve
o If both supply and demand
curve shifts, we then observe
w2 and E2 ; available data trace
out curve ZZ

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