The Demand for Labour (Cambridge (CIE) A Level Economics): Revision Note

Labour as a derived demand

• The demand for labour is a derived demand - it arises from the demand for the goods and services that labour helps to produce, rather than being demanded for its own sake

  • If demand for a firm's output rises, more workers are needed

    • labour demand increases

  • If demand for a firm's output falls, fewer workers are needed

    • labour demand decreases

  • Labour demand therefore fluctuates directly with the demand for final goods and services

Factors that affect the demand for labour

1. The demand for the final product

• As labour demand is derived, changes in demand for the final good or service are the most important determinant of labour demand

  • When an economy is booming and consumer demand is high, firms need more workers to meet output requirements - labour demand rises

  • During a recession, demand for goods and services falls and firms reduce their workforce - labour demand falls

  • This applies at both firm level (a firm losing a major contract needs fewer workers) and occupational level (a declining industry such as coal mining reduces demand for miners economy-wide)

• For example, the global shift towards renewable energy has simultaneously reduced derived demand for coal miners in South Africa, Poland and India while increasing derived demand for solar panel engineers and wind turbine technicians

2. The price of the product being produced

• A higher product price increases the revenue generated by each unit of output and therefore the value of each worker's contribution to the firm

  • This raises the marginal revenue product of labour (MRP_L) - covered in detail on the next page

    • this makes firms willing to employ more workers at any given wage rate

• A fall in product price has the opposite effect

  • each worker generates less revenue, so firms demand less labour

• For example, falling global coffee prices reduce the marginal revenue product of coffee pickers in Brazil and Ethiopia, reducing labour demand in those occupations even if wages are unchanged

3. The productivity of labour

• If worker productivity rises (through training, improved technology or better management) each worker produces more output per hour

  • This raises the value of employing an additional worker, increasing labour demand

  • Conversely, if productivity falls, each worker contributes less to output and labour demand falls

• For example, the introduction of automated machinery in Chinese and Vietnamese manufacturing has increased the productivity of remaining workers, raising demand for skilled machine operators while reducing demand for unskilled assembly workers

4. The ability to substitute capital for labour

• Firms continually assess whether it is more cost-effective to use capital (machinery and technology) or labour to produce their output

  • If capital becomes relatively cheaper (through technological improvement or falling equipment costs), firms substitute capital for labour, reducing labour demand

  • If labour becomes relatively cheaper (for example following a reduction in social security contributions), firms substitute labour for capital, increasing labour demand

• For example, the rapid adoption of automated checkout systems in retail across Singapore, Japan and many European economies has reduced derived demand for checkout operators, while increasing demand for technology maintenance workers

The demand curve for labour

• The demand curve for labour shows the relationship between the wage rate and the quantity of labour demanded

• It is downward sloping - as the wage rate falls, labour becomes cheaper relative to capital and relative to the marginal revenue it generates, so firms demand more labour

• The market demand curve for labour is the horizontal sum of all individual firms' demand curves for labour in that market or occupation

Diagram analysis

• The demand curve D_L is downward sloping

  • a higher wage rate reduces the quantity of labour demanded

• A change in the wage rate causes a movement along the demand curve

  • from one point to another on the same curve (W₁ to W₂)

• A change in any other factor (product demand, productivity, price of capital) causes a shift of the demand curve

  • the entire curve moves left or right

Factors that shift the demand curve for labour

• Caused by a change in any factor other than the wage rate

  • Rightward shift (D_L increases): higher product demand, higher product price, higher labour productivity, capital becoming more expensive relative to labour

  • Leftward shift (D_L decreases): lower product demand, lower product price, lower productivity, capital becoming cheaper relative to labour

Summary table