Labour Demand and MRP

UK Recession

• During the recent recession the UK housing market experienced a severe downturn. House prices fell significantly and house-building companies started to slow down their rate of construction (particularly in the Midlands and North of England).

Discuss the impact on:• Bricklayers• Estate Agents • Plasterers

Labour is a derived demand• Labour is a derived demand.

• Derived Demand – demand for one item depending on demand for another.

• Typically – the number of workers a firm wishes to employ depends on the revenue that can be earned from what is produced.

• Firms hire workers to help them achieve their objectives, which we assume to be to maximise profits.

• So if hiring an extra worker helps to maximise profits, they will do so

Influences on Demand for Labour

1. Demand and expected future demand2. Productivity3. Wage rate4. Complementary labour costs e.g. National

Insurance5. The price of other factors of production

Marginal Revenue Product (MRPL)• Demand for labour and the wage rate will have a negative

(inverse) relationship

• Marginal revenue productivity (MRP) is a theory of wages where workers are paid the value of their marginal revenue product to the firm.

• MRP theory suggests that wage differentials result from differences in labour productivity and the value of the output that the labour input produces

• A profit maximising firm will employ an extra worker if the worker’s marginal revenue product exceeds the cost to the firm of employing him/her

Key terms:

Marginal Cost of Labour – The cost of hiring one extra worker

Marginal Product of Labour – The change in total output from hiring one more worker

Marginal Revenue – The extra revenue from producing one more unit

Marginal Revenue Product of Labour – The value of the extra physical output arising from hiring one extra unit of labour

Marginal Revenue Product (MRPL)• People are employed because of the value of their

output. This depends on:– The extra output that each extra worker produces (Marginal

Product /marginal physical product) MP– The extra revenue this extra worker generates when it is sold

(Marginal Revenue) MR

• The value of the output produced by an extra worker is called the Marginal Revenue Product (MRP)

MRP=MPxMR

Assumptions behind MRPL theory

• Labour is the only variable factor of production• Labour is homogeneous- labour cannot dictate

price• The labour market is perfectly competitive so no

one employer can influence the wage rate• The firm operates in a perfectly competitive

product market• It is possible to measure productivity in all

labour markets

Why is the Labour demand curve downward sloping

• The demand for labour is downward sloping due to the law of diminishing returns, which states:

• As successive units of a homogeneous variable factor of production are added to a fixed factor, the increments to total output will rise first and then eventually diminish, ceteris paribus.

• But - In the short term division of labour can be used to delay the onset of diminishing returns.

• In the long run, it is assumed that the fixed factor can be increased, such as by moving to a larger premises.

• This will mean diminishing returns will not set in as quickly, but they are ultimately unavoidable as will still set in, at a higher level.

The Labour Demand curve (MRP)

Problems with MRP theory• Will all items which are made, be sold?• Would it be fair to assume that all the workers are

equally as good and that the eleventh worker should or shouldn’t be hired without considering if he/she is worse or better than the other workers currently employed?

• Does this theory work for people who own their own business and employ themselves?

• Ignores the possibility that a rise in pay itself may lead to a rise in the productivity (MPP) of the worker.

• Ignores the possibility that a rise in pay may increase demand for the product (MR) from which demand for labour is derived

MRP is difficult to measure as difficult to isolate:

• Individuals contribution when working in a team

• Contribution made by labour & capital• Difficult to measure the Marginal Product of

some workers in the tertiary sector e.g. surgeons and teachers

• Only works in perfect competition – it is a model!