- Derived demand
- Derived demand is the demand for an input such as labour, which depends on the demand for the product the firm is producing.
- Marginal revenue product
- The marginal revenue product of labour is the marginal product of one more worker multiplied by the marginal revenue from selling that output.
Factors that shift the demand for labour
Can you name three factors, besides demand for the product, that shift the demand for labour?
A change in the wage moves along the demand curve; each of these shifts the whole curve.
The productivity of labour is the output each worker produces, and a better-trained, more productive workforce raises the demand for that labour.
Can you think of an example?
Employers hire more from a well-trained pool of workers at the same wage, and less from a pool they would first have to spend time and money training.
Technology can substitute for labour, cutting the demand for it, or complement labour, raising the demand for the workers who use it.
Can you think of an example?
Word processing cut the demand for typists and raised it for IT staff who keep a firm's computers and network running.
Government regulation can raise or lower the demand for labour at any wage, by requiring certain workers for certain tasks or barring others.
Can you think of an example?
A rule that only nurses may carry out certain treatments raises the demand for nurses and cuts it for less-trained healthcare assistants.
A firm hires until the last worker is worth the wage
A profit-maximising firm will never pay a worker more than that worker's marginal product is worth to it. With a fixed stock of capital, the marginal product of labour falls as the employer hires more workers, so each extra worker is worth less than the ones before. The firm hires until the marginal revenue product of the last worker equals the going wage, which makes the marginal revenue product curve its demand curve for labour.
Wage W1At wage W1 the firm hires L1 workers: the last one hired brings in just W1.
Check yourself
A firm's tenth worker has a marginal revenue product of £14 an hour, and an eleventh would add £11. The wage is £12 an hour. How many workers does the firm hire?
10
The tenth worker brings in £14 against a £12 wage, so hiring them adds to profit. The eleventh would bring in £11 and cost £12, so the firm stops at ten.
The demand for labour comes from the demand for the product
Because the demand for labour is marginal product times the revenue each unit of output earns, it depends on the demand for what the firm sells. An increase in demand for the product drives up its price, which increases the firm's demand for labour. The demand for chefs depends on the demand for restaurant meals.
Check yourself
A long cold winter raises the demand for boiler repairs. What happens to the demand for heating engineers?
Can you think of an example before you look?
A bakery sells loaves at a market price of £2. Its fourth baker adds 8 loaves an hour, a marginal revenue product of £16, and a fifth would add 5 loaves, worth £10. At a wage of £12 an hour it hires four bakers. If demand for bread lifts the price to £2.50, the fifth baker's output is worth £12.50 and a sixth's 4 loaves only £10, so the bakery hires five at the same wage.
If only the last worker is paid what they bring in, aren't the others underpaid?
The earlier workers bring in more because of the capital and technology they work with. The gap between their worth and their pay goes to pay for that capital and to the employer's profit, and without either the firm would close and there would be no job. Whether the profit is excessive is a separate question.
Where a question changes something in the product market, write the chain in full: demand for the product rises, its price rises, each worker's marginal revenue product rises, and labour demand shifts right. Then give the effect on the wage and employment. Naming derived demand without the chain earns the knowledge mark only.
Check yourself
Three of these shift the demand curve for hospital nurses. Which one does not?
Exam question
A supermarket chain's sales fall sharply. Using the idea of derived demand, explain what happens to its demand for shop-floor staff. [3]
The demand for labour is derived from the demand for the product. With lower sales, the extra output of each worker brings in less revenue, so the marginal revenue product of shop-floor staff falls. The demand curve for staff shifts left, so fewer are wanted at every wage.
One mark for linking labour demand to demand for the product, one for the fall in marginal revenue product, one for the leftward shift. Saying staff are cheaper or dearer misses it: the wage has not changed.
The demand for labour is a derived demand: firms hire workers for the revenue their output brings in, so it depends on the demand for the product. A firm pays a worker no more than the marginal revenue product. That falls as more workers are added, so the demand curve slopes down. It shifts when product demand, productivity, technology or regulation changes.