Labor Demand. Labor Economics VSE Praha March 2009

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1 Labor Demand Labor Economics VSE Praha March 2009

2 Labor Economics: Outline Labor Supply Labor Demand Equilibrium in Labor Market et cetera

3 Labor Demand Model: Firms Firm s role in: Labor Market consumes labor Capital Market consumes capital Product (output) Market supplies its output

4 Labor Demand Model: Firms Markets are competitive: firms are price takers. Competitive Markets Assumptions: Firms can hire at a constant wage rate w unlimited labor hours (L) Firms can rent at a constant rental rate r unlimited amounts of capital () Firms can sell at a constant price p unlimited amounts of a single good (q).

5 Production Function Function: q=f(l, ) More output with more inputs: MP L f ( L, ) L 0 Marginal Product of Labor (MP L ) is the change in output resulting from hiring an additional worker, holding constant the quantities of all other inputs.

6 Marginal Product and Average Product Average Product of Labor (AP L ) is the amount of output produced by the typical worker. AP L = q/l Marginal Product of Capital (MP ) is the change in output resulting from one-unit increase in the capital stock, holding constant the quantities of all other inputs. MP f ( L, ) 0

7 Marginal Product and Average Product

8 Graphical Interpretation

9 SR: How many workers should the firm hire?

10 The Employment Decision Firm s problem: max L pf ( L, ) wl r Solution: 1. Partial derivative with respect to L p f ( L, ) L w

11 Problem Suppose the production function is given by F( L) 6L 2/3 How many units of labor will the firm hire, if the cost per unit of labor is 12 and the price of output is 6?

12 Firm s problem Hire labor so that the value of marginal product is equal to the wage. and how much capital to rent?

13 The Employment Decision in the LR Isoquants: Similar to ICs (MRS): the slope of the isoquant at any given point is the marginal rate of technical substitution MRTS= L MP MP L

14 Isocosts Isocost line: equally costly combinations of L and. C = wl + r C 1 >C 0 Slope of isocost: C r w r L

15 Cost Minimization: graph (Wage = \$10 per Hour; Price of a Unit of Capital = \$20)

16 Cost Minimization min L, wl r s.t. f ( L, ) q Solution: the slope of isoquant = the slope of isocost w r MP MP L

17 Profit Maximization = pq wl r Firms CHOOSE L and to max, but NOT CHOOSE prices (w and r) and output (q). max L, pq wl r s.t. q f ( L, ) max L, pf ( L, ) wl r

18 The Employment Decision max L, pf ( L, ) wl Deriving first order conditions: 1. Partial derivative with respect to L r p f ( L, ) L w 2. Partial derivative with respect to f ( L, ) p r 3. Solve two equations for two unknowns: L*(w,r,p), *(w,r,p) q* = f(l*(w,r,p), *(w,r,p))

19 Changes in cost of inputs: w

20 Changes in cost of inputs: w Two simultaneous changes in capital labor ratio production size

21 Substitution and Scale Effects

22 Elasticity of Substitution The elasticity of substitution indicates how easily firms can change their input mix as relative input prices change. Note: for profit maximization w/r=mrts 0: higher values of indicate that the firm can more easily substitute inputs as the relative input prices change. L r w r w L r w L / / ) / ( ) / ( or ) / ( % ) / ( % L MRTS MRTS L MRTS L / ) ( ) / ( or ) ( % ) / ( %

23 Elasticity of Substitution is determined by the production function! q 0 =al + b q 0 =min{cl, d}

24 Elasticity of Labor Demand The elasticity of demand is defined as the percentage change in quantity resulting from a percentage change in price. % L*( w, r, % w p) or L*( w, r, w p) w L* It is a measure of how responsive employment is to a change in the wage.

25 Elasticity of Labor Demand = 0 perfectly inelastic demand; -1< < 0 inelastic demand; = -1 unit elastic labor demand; < -1 elastic labor demand; = - perfectly elastic demand.

26 Elasticity of Labor Demand Perfectly inelastic demand: L/ w w/l=0 Same employment is demanded at any wage. Perfectly elastic demand: L/ w w/l = - No labor is demanded above market wage.

27 Elasticity of Labor Demand Inelastic demand -1 < L/ w w/l < 0 % in L < % in w. Elastic demand L/ w w/l < -1 % in L > % in w. Unit Elastic demand L/ w w/l=-1 % in L = % in w.

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