Please recall how TP, MP and

AP are plotted
The Marginal Revenue Product
(MRP)
Units of
Labor
TP MP Product
Price
TR MRP
(TR/L)
VMP
(MP x P)
4
5
6
7
8
9
15
27
36
42
45
46

12
9
6
3
1
2
2
2
2
2
2
30
54
72
84
90
92

24
18
12
6
2

24
18
12
6
2
The increase in total revenue for every additional labor unit employed.
PERFECTLY COMPETITIVE MARKET
MRP declines because of DIMINISHING MARGINAL PRODUCT
The Marginal Wage Cost
(MWC)
Units of
Labor
TP MP Product
Price
TR MRP
(TR/L)
VMP
(MP x P)
4
5
6
7
8
9
15
27
36
42
45
46

12
9
6
3
1
2
2
2
2
2
2
30
54
72
84
90
92

24
18
12
6
2

24
18
12
6
2
The increase in total wage cost resulting from the employment
of one more labor unit.
RECALL: VMP = w ---------- the marginal gain from hiring an additional worker
equals the cost of that hire
VMP = MRP rule: MRP = MWC
MWC = w
Thus, the short run labor demand curve was derived from VMP and MRP curve

The Equality of VMP and MRP
in Perfectly Competitive
Markets
Since in PC markets, price is constant, thus
P = MR
MRP (MR x MP) the extra revenue to the firm from employing an
additional unit of labor = VMP (P x MP) the social value of the extra
unit of output

Units of
Labor
TP MP Product
Price
TR MRP
(TR/L)
VMP
(MP x P)
4
5
6
7
8
9
15
27
36
42
45
46

12
9
6
3
1
2
2
2
2
2
2
30
54
72
84
90
92

24
18
12
6
2

24
18
12
6
2
Short Run Labor Demand:
Imperfectly Competitive
Markets
Units of
Labor
TP MP Product
Price
TR MRP VMP
4
5
6
7
8
9
15
27
36
42
45
46

12
9
6
3
1
2.60
2.40
2.20
2.10
2.00
1.90
39.00
64.80
79.20
88.20
90.00
87.40

25.80
14.40
9.00
1.80
-2.60

28.80
19.80
12.60
6.00
1.90
Has some degree of monopolistic/market power
RECALL IN MICROECONOMICS: In IC markets, P is not equal to MR, thus,

MR < P, thus, MRP < VMP
MRP declines because of
DIMINISHING MARGINAL PRODUCT and
PRICE DECLINES AS OUTPUT INCREASES
Short Run Labor Demand:
Imperfectly Competitive
Markets
Units of
Labor
TP MP Product
Price
TR MRP VMP
4
5
6
7
8
9
15
27
36
42
45
46

12
9
6
3
1
2.60
2.40
2.20
2.10
2.00
1.90
39.00
64.80
79.20
88.20
90.00
87.40

25.80
14.40
9.00
1.80
-2.60

28.80
19.80
12.60
6.00
1.90
Notice the value of the added output from societys perspective. (VMP)
But the MRP of the 5
th
worker is only 25.80. Why is there a 3.00 difference?
= 28.80 (15 x 0.20)
To sell the 12,
There must be a 0.20 cut
Plot the short run labor demand
curve for the imperfectly competitive
seller using the MRP = W rule
IC firm restricts output in the market because
it will be more profitable to produce less
output, thus, will employ less workers.
Therefore, IC firm will be less responsive to
wage rate changes than a PC seller.
NOTE: VMP is not equal to MRP thus,
(MRP = MR x MP) < (VMP = P x MP)
Long Run Labor Demand
q = f ( E, K)

Schedule or curve indicating the amount
of labor that firms employ at each
possible wage rate when both labor and
capital are variable
Output Effect or Scale Effect
Change in employment resulting solely
from the effect of a wage change on the
employers cost of production.
Illustrate the effect of a decline in wage
rate using Marginal Cost curve and
Marginal Revenue curve of a PC firm.
Substitution Effect
Change in the employment resulting
solely from a change in the relative price
of labor, output being held constant.
A firm responds to a wage decline by
substituting the relatively less expensive
labor for some types of capital. Thus,
long run demand for labor is more
elastic than short run.
Combined Effects
A wage decline will result to:
An Output Effect Q to Q
(short run)
A Substitution Effect - Q to Q
(long run)
Isoquant-Isocost Analysis of
Long Run Labor Demand
Isoquant
Downward slope
Convexity to the origin (MRTS=K/L)
Higher output to the northeast
Isocost
Plabor/Pcapital
Least cost combination of K and L
MRTS = PL/PK

Deriving the Long Run Labor Demand
Recall:
I = 120
Plabor =4
Pcapital = 6
optimal level = 15
What if price of labor increased
to 12?
a-b ----SE
b-c ---- OE
Long Run Labor Demand
Elasticity of Labor Demand
The sensitivity of the quantity of labor
demanded to wage rate changes (wage
elasticity coefficient)
Ed = %Qd for labor /% in wage rate
Elastic - >1; employers are responsive to
wage changes
Inelastic - <1; employers are relatively
insensitive to wage changes
Total Wage Bill Rules
Total Wage Bill = W x Qlabor
RECALL effect of elasticity to TR
e.g. price and demand is elastic TR

Thus, if labor demand is elastic,

wage will total wage bill (increases the
wage bill but creates a decline in
employment)
Seatwork crosswise
Determinants of elasticity: Explain how the following affect
elasticity of labor demand:
1. Elasticity of product demand
2. Ratio of labor costs to total costs
3. Substitutability of other inputs (capital)
4. Supply elasticity of other inputs
Determinants of Labor: Illustrate the effect of the following to
labor demand, ceteris paribus:
1. Increase in product demand
2. Increase in marginal product of labor (productivity)
3. Decrease in the number of employers
4. The price of capital increased and it is a gross substitute for
labor
5. The price of capital decreased and it is a gross complement
of labor