Demand for labour

Demand for labour is derived demand, meaning that is depends on the demand for the product/service the worker is producing.

The demand curve for labour is the Marginal Revenue Product (MRP) of a worker. The MRP is the revenue a firm gains when it hires an additional worker. It is calculated by multiplying the productivity the worker adds to the firm (Marginal Physical Product (MPP)) and the revenue of the last good sold (Marginal Revenue (MR)).

MRP = MPP x MR

The above graph plots the MRP of labour against the marginal cost (MC) of labour. Where MRP meets MC is where the maximum profit is made. So in the graph, 6.5 workers will be hired (either 6 or 7), as anymore would not add enough productivity to compensate the cost of them being hired. The MC of a worker is the wage that has been determined for all workers in the market. It is based on the supply and demand in the labour market. Here is the MC is about £375.

As the firm initially increases the number of workers it employs, the demand curve slopes upwards as each worker produces a lot more than the one before (e.g two people will produce more than double what one person does, and three people even more than two people). However, soon each additional person adds less and less product, and the curve begins to slope downwards. This is the law of diminishing returns. As more labour is added, the firm gets less out of each additional unit of labour.

The demand curve depends on the two factors in the equation, MR and MPP.

MR - the price of the good/service (product of labour)
Changes in demand for the product itself will shift the price of the product and so will shift demand for workers.

MPP - the productivity of labour

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