The Firm’s Short-Run Demand for Labor

The firm’s demand for labor depends on what the market for the firm’s output looks like, as well as on the level of competition in the labor market.

Perfect Competition in both the Input and Output Market

In the simplest case, we have perfect competition in both the input and in the output market. The firm cannot influence the price, p, on the good, which, in turn, makes the marginal revenue equal to the price : MR = p. The value of the marginal product of labor is consequently MRP_L = p*MP_L. Furthermore, the marginal cost of labor equals the wage, MCL = w. The firm will then hire workers as long as MRP_L > w, i.e. as long as the revenue is higher than the cost of hiring, and the criterion for equilibrium is

Note now that this means that the MRP_L curve will become the firm’s demand curve for labor. Furthermore, remember that we have the law of diminishing marginal returns. MRPL = p*MP_L will therefore, eventually, start to diminish the more workers we hire (since MP_L will diminish while p is constant). We will then get a downward sloping demand curve for labor, as in the left part of Figure 16.2.

Since we have perfect competition in the labor market, both the firm and the workers take the wage, w, as given, and as we have perfect competition in the output market as well, the firm takes p as given. The market’s demand for labor is the sum of all firms’ demand curves, and the market’s supply is the sum of all individuals’ supply curves (to the right in Figure 16.2). The individual firm will then hire workers until MRP_L = w.

Monopoly in the Output Market

We continue to assume that there are many buyers and sellers of labor, but now we assume that the good is sold in a monopoly market. The firm maximizes profit in the same way as before, i.e. it hires workers until the cost, w, is as large as the marginal revenue product, MRP_L. However, since the good is now sold in a monopoly market, MR will not be equal to the price anymore. Instead, MR (< p) will fall with increased production. This, in turn, means that MRP_L (= MR*MP_L) will be steeper than in the case of perfect competition in the output market (since now both MRP_L and MR are ownwardsloping curves). The monopolist produces a smaller quantity than a firm in a competitive market does, and therefore she will hire fewer workers.

In Figure 16.3, we have drawn the demand curves for labor, both for a monopolist and for a firm in a competitive market. The monopolist’s demand curve is MRP_L (= MR*MP_L) and it will lie below the MRP_L (= p*MP_L) for a firm in a competitive market. The wage, w, is set in a competitive labor market and cannot be affected by either workers or firms. However, the firm hires fewer workers, L_M, than it would in a competitive market, L_C. A monopoly in the output market will consequently create inefficiencies in both the market for goods and in the labor market.

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